Revised Edition July 2012

To be read with the Banks Lending Policy and extant guidelines / instruction issued or to be issued by the RBI / Bank, and the same to be updated time to time.

INTRODUCTION TOPIC 1.1 1.2 1.3 1.4 1.5 Basic principles of lending Collection of Credit Information Credit Information Report Advance Proposal Received Register Decision making process PAGE NO

1.1

Basic principles of lending

1.1.1. Two prime functions of any bank are acceptance of deposit and lending of fund. Lending is always the prime source of earning for a bank. As such, for growth and progress, extension of credit on sound basis is essential. The quality of advance will chart out the path of success and failure. 1.1.2. Although receipt from non-interest income contributes a fair amount of profits, the earnings of banks are mainly derived from interest charged on loans and discounts. It is, therefore, necessary to consider carefully the loans and advances of a bank. For this purpose a general principle of lending is to be followed within the lending policy of the bank for building up good quality loans and advances portfolio. 1.1.3. During the year 1992-93, Report of the Committee on the Financial Systems (November, 1991), popularly known as Narasimham Committee-I Report, was implemented. In the context of the norms laid down for income recognition, asset classification and provisioning for impaired loans, quality lending has become more important. Since than, RBI has been giving regulatory IRAC norms in its annually published master circular which must be followed. 1.1.4. In the context of the changed circumstances, the prime principle of lending should be safety of the loan and the perception of risk. It is not enough that the loan is safe now it should continue to remain safe during the entire period of the loan account. We have to consider certain aspects before we decide to sanction or decline a proposal in the line of our Credit Policy to be declared from time to time. 1. Applicant : Applicant is the key person for success or failure of an enterprise. Honesty and integrity of the borrower is of prime importance. The information about the applicant is required to be collected from the market, from the banker and from other sources. One information we must collect is his reputation to meet his commitment in time. Visit to the place of business will tell us about the managerial efficiency. Upkeep of the premises/factory is an index of efficiency. By visiting the place of business and the residence of the applicant we will know whether he/she has the tendency to live beyond his/her own means. In case of a new entrepreneur his/her age, academic qualification, experience and social status is to be enquired of. Purpose of advance : The loan should be sanctioned for a purpose that is permitted by the Bank. The purpose of the advance should be in tune with the corporate goal.

2.

The branch should ascertain that the proposal that the borrower wants to take up is reasonable and is not too ambitious or of a speculative nature. If the unit is an existing one and the proposal is for expansion of the unit, it has to be ensured that the expansion is not too rapid a rate that may prove to be fatal for the unit. The branch should ensure that the loan should be utilised for the purpose for which it was sanctioned. The branch should closely supervise all accounts after disbursement to ensure utilisation of the limit for the sanctioned purpose. 3. Source of Repayment: Fund based limits granted by the bank will normally be of the following types : (a) Term Loan to acquire fixed assets where the repayment is done over a period of time. (b) Working Capital finance (c) Bridge loan to sound companies against public issue of equity/expected proceed of NCDs, ECB, Global Depository Receipts on satisfaction that firm arrangement has been made to raise such resources. (d) Unsecured personal loan Whatever may be the nature of the loan, the borrower will have to repay it. The bank desires the loan to be repaid from the income generated, if it is a productive loan. It has to be ascertained that for all types of loans the borrower after drawing enough fund to maintain himself and his family, will be left with sufficient surplus from operations to meet banks commitment. However, if the borrower has other source of income that can be apportioned towards repayment of loan, it will be a collateral advantage for the bank. While projecting the repayment, it should be ascertained that the projection is realistic and it has been worked out taking all factors including margin for contingency into consideration. It should also be ensured that the applicant would not depend heavily on depreciation for repayment. The long-range projection prepared by the borrower or a consultant should be interpreted based on independent study and analysis. 4. Risk rating of the account: To decide whether to sanction a proposal or not and to price the loan risk rating of the account has to be done. The Bank will issue circulars on this exercise from time to time and the branches will follow the guidelines in this respect. Not a single account shall be sanctioned without assigning the risk rating of the account.However the following categories of advances are exempted from computing risk rating (a) schematic and

structured loan (b) staff loan (c) all standard advances having credit limit upto 10 lacs as stated in the Lending Policy (Page 43- Vol II) 5. Security: The bank sanctions loan after proper appraisal of the proposal. The assets created out of bank loan remain charged to the bank as primary security. Nevertheless, there is always an element of uncertainity. To take cover of the uncertainty, additional securities are obtained. In case of priority sector advances and Government Sponsored Schemes, the quantity of collateral security is prescribed. For all other loans, the amount of collateral security will depend upon the borrower and the risk perception, as assessed by the recommending and the sanctioning authority.

1.1.5. Role of Manager/ Officer of Advance Department : Manager is the sanctioning authority at the branch. All the proposals received at the branch are either to be sanctioned or to be declined. The decision to sanction or to decline a proposal is to be taken by the Manager. Before sanctioning of the proposal it is to be processed by an officer of the Branch as entrusted by the Manager and should be placed to a committee in case of extra large and very large branches and for other Branch procedure is described below: For proposals under financial power of DGM/AGM/Chief Manager of Extra Large and Very Large Branches committee will consist of the following members: Chief Manager (in case of DGM/AGM headed branches) Sr. Manager (Advance) Sr. Manager (Operations) Manager / Officer (Advance) In case of non-availability of any of the above mentioned members, officer in the Branch immediately below the above hierarchy may also represent the committee. In Scale III/II/I branches the Committee approach may be dispensed with. However, processing and sanctioning of loans (except non-mortgage based loans upto Rs.5 lacs) must involve two officers including Branch Manager. If there is no separate processing /appraising officer available, any other officer of the branch shall verify the facts and the securities offered and shall submit the comments under his/her signature to the Branch Manager to facilitate the processing and disposal of the proposal. If the permissible amount of loan is more than the discretionary power of the Manager, the proposal with recommendation shall be forwarded to the Regional Office/Head Office for necessary consideration at Regional Level Credit Committee / Head Office Level Credit Committee/ Credit Aproval Committee etc. as the case may be according to the DP of the committee. All loan proposals are to be disposed of as early as possible and within the time frame prescribed from time to time.

1.2

Collection of Credit Information 1.2.1. There are different sources of credit information. The designated officer should collect information with regard to various points discussed above from as many sources as possible. All aspects of information must be investigated. 1.2.2 Personal Interview: Appraisal of the proposal starts with the assessment of the applicant. Personality of the borrower should be objectively assessed before a credit decision is taken. Personal interview of the applicant should result in assessment of the traits of his / her personality. The borrower himself is a very good source of information. The designated officer should prepare the questionnaire before the borrower is invited for interview. The officer, during the interview, should probe into the past history, present activities and future plan of the borrower. As the interview of the prospective borrower is a very important element of loan proposal appraisal, the interviewing officer should create a climate so that the applicant speaks freely as much as he desires, and pass on maximum information. 1.2.3 Market Report: Information regarding character and integrity and particularly about the servicing of market borrowing should be carefully collected from the market. Such information should always be cross verified as the informer may be biased in passing on the information. After collecting information from more than one source, a balanced opinion is to be formed about the applicant.

1.2.4. From other Banks: If the applicant has dealings with other banks, confidential report from the banker must be obtained. The designated officer may also visit the bank to elicit opinion of the Manager of that Bank through discussion. 1.2.5. a. Reserve Bank of India publishes list of defaulter borrowers of Rupees one crore and above every half year. . Bank-wise account-wise information contain the name(s) of the proprietor/partners/directors. The branches should go through the list to verify whether the applicants name or the name of any of the partner/director of the firm figures in that list. If the branch does not have the list published by RBI with them, they may search at the website [http://www.rbi.org.in] or they may write to the Regional Office. b. CIBIL and other Credit Information Agencies (accredited by RBI) publishes list of suit filed defaulter borrowers of Rupees one crore and above with Bank-wise accountwise information on loan availed along with the name(s) of the proprietor/partners/directors. The branches should go through the list to verify whether the applicants name or the name of any of the partner/director of the firm figures in that list. The Branch / offices has to verify the status of loan if availed by the

applicant from CIBIL website (ID & Password provided to the Branches / offices) and website of other Credit Information Agencies before taking decision on loan proposals.

1.2.6. For almost all types of activities there are trade associations. Such associations are of good use to the bankers. From the office bearers of such associations the branches may collect information, particularly the present trend and prospect, on the proposed activity as well as of the applicant. Study of Financial Statements will provide information not only about the financial health of the unit, these statements will also throw light on the managerial efficiency and the Auditors Report will tell us the quality of the accounts maintained. In case of all credit proposals (both existing & new), submission of audited Balance Sheet & Profit & Loss account is mandatory for (i) all corporate entities, (ii) entities like trust, society, (iii) entities formed under statutes, (iv) individual/firms having turnover of Rs.60 lacs and above [Rs.40 lacs and above upto 31.03.2010], (v) professional firms having turnover of Rs.15 lacs and above [Rs.10 lacs and above upto 31.03.2010], where audit is must as per IT Act. However, notwithstanding to the mandatory audit requirement as stated above, to enforce discipline and ascertain true financial position of the borrowers no credit proposal (except schematic lending) of Rs.10 lacs & above from individuals/firms shall be entertained without audited financials. 1.2.8. A visit to the place of stay and the place of business will tell us about the lifestyle of the applicant. The lifestyle led by the applicant is an index of the propensity of the applicant to live beyond his own means. The branch official during the visit should try to find out among others: (1) Is the area where the unit is located or proposed to be located suitable for the activity? Whether the real estate is owned by the borrower and whether there is enough spare land for future expansion? What is the companys policy regarding replacement of machinery and equipment? What is the general get up of the factory workers? What is the condition of inventory? Whether storage arrangements are proper and adequate?

(2)

(3)

(4) (5)

1.3

Credit Information Report 1.3.1. The decision of Branch Manager to grant advance is based upon a lot of information which is collected from various sources about the borrower and his business. All these

information are to be processed to arrive at a logical conclusion. The Branch will prepare the opinion sheet on the borrower. Preparation of opinion sheet has been discussed in Chapter X.

1.4

Advance Proposal Received Register 1.4.1. In our Bank there is a Register known as Register of Advance Proposals (in the format of Book No. 226). All the loan applications received by the Branches/offices are to be entered in this Register. 1.4.2. Maintenance of this Register is very useful for the branch. Many queries can be replied from this Register. If this Register is maintained, the Branch/Office can cross check with the Discretionary Power Register whether all the accounts sanctioned have been reported through the DP Statement or how long a proposal has been pending for disposal. 1.4.3. Particulars to be written under columns are self explanatory. Under column number 2, 5, 7 & 8 Branches will fill in the code numbers required to be put in Book Debt Statement. All these information are to be filled in for all the proposals received, whether sanctioned or declined.

1.5

Decision Making Process 1.5.1. After obtaining all the information as discussed above, the Manager will have to take a decision on whether to sanction the proposal or to decline it. The procedure is described under para 1.1.5 above. 1.5.2. Sanctioning proposal will depend upon the amount of the loan and discretionary power of the Manager. If the loan amount falls within the DP of the Manager, it shall be disposed of without any avoidable delay. We should never give an impression that the applicant is not welcome even if we have already decided to decline the proposal. If the proposal can be sanctioned, it should be sanctioned without getting the applicant annoyed due to our response or attitude. 1.5.3. If the proposal is to be forwarded to the Regional Office or to Head Office through the Regional Office, the Branch will forward the proposal along with their recommendations. All necessary papers required for making the decision should be sent along with the application. Similarly, if the decision is to be taken at Head Office level or Regional Office level, Branch will forward the proposal to Regional Office with its recommendations. 1.5.4. Rejection of proposal:

In case any proposal for advance has to be declined, the guidelines are to be followed. The sanctioning authority should put forth cogent reasons for turning down the proposal and should not be apologetic or tentative or evasive in his approach. If the proposal has to be declined due to poor credit record, the matter should be handled carefully and nothing should be said or given in writing casting aspersion on the integrity of the party.

CHAPTER-II

TYPES OF BORROWERS TOPIC 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 Proprietorship Firm Minor Pardanashin Lady Joint Account Joint Hindu Family Club, Society, School Co-operative Society Partnership Firm Limited Company PAGE NO.

2.10 Govt. Company 2.11 Foreign Company 2.12 Self Help Group 2.13 Lunatics and Insolvent Annexure 1

10

CHAPTER II

TYPES OF BORROWERS 2.1 Proprietorship Firm 2.1.1. When an individual as proprietor carries on a business, either in his own name or a trade name, the business is a proprietary one. For advance in such a case it is usual to obtain a declaration of sole-proprietorship (Form S-Documentation Manual) to the effect that as the proprietor the person concerned is solely responsible for the liabilities of the firm. 2.2 Minor 2.2.1 A minor is a person who has not completed 18 years of age. However, in the case of a minor for whose person or property, or both, a guardian has been appointed or declared by any court of justice before the age of 18 years, and in case of every minor the superintendence of whose property has been assumed by the Court of Wards, age of majority will be 21 years and not 18. 2.2.2 In terms of the Indian Contract Act, 1872, a minor cannot enter into a contract and a contract by a minor is void abinitio. A contract made by a minor cannot be ratified even on attaining majority, as the contract is void. In term of section 26 of the Negotiable Instrument Act, 1881 a minor can bind all parties except himself. In terms of subsection (3) of Section 26 of the Indian Partnership Act, 1932 only the minors share in the partnership firm and its profit is liable for the acts of the firm. Neither the minor personally nor his other personal property are liable for the acts of the firm.

2.2.3

2.2.4

2.2.5. From the position of different relevant sections of different acts it is evident that the loan given to a minor cannot be recovered from him as the contract for the loan is void abinitio and if any security has been provided for the loan, by the minor, the same cannot be enforced. If the loan to a minor is backed by personal guarantee, the same cannot be invoked as the minor as the principal debtor is not liable to repay the loan. 2.3 Pardanashin Lady: 2.3.1 A contract by a Pardanashin lady is voidable at the option of the lady on account of undue influence. The onus of proving the absence of undue influence is on the Bank.

11

Further, there may be chance of impersonation. Following formalities are to be observed in case of advance to Pardanashin ladies: a) Pardanashin lady borrower is to be identified by a person to whom she is known and before whom she normally appears (Annexure-I), Such a borrower should be introduced and identified by a person known to the bank and a declaration in the banks standard form to be obtained from the said introducer, A photograph of the identifier should also to be submitted if the introducer is illiterate, The photograph is to be attested by the Manager of the Branch or any other officer so authorised, Particulars of the identifier, his/her whereabouts and standing should be kept on record duly certified by the officer making the enquiry, The bank need not insist upon the production of photograph of the concerned borrower where other safeguards such as proper identification of the parties concerned, obtaining sureties and their photographs etc. have been duly observed.

b)

c)

d)

e)

f)

2.4

Joint Accounts 2.4.1 When two or more individuals join together to avail of loan from the branch of a bank, the account is known as a Joint Account. Although number of such loan account is likely to be small, there may be some such cases. All the joint account holders will sign the application form and all the documents to be executed by them jointly.

2.4.2

2.4.3. Instructions, under the signature of all the joint account-holders, should be obtained, before disbursement. In the absence of any such instructions, securities are to be delivered against discharge of all the joint account-holders. 2.4.4 In the event of death of any of the Joint Account-holder: (a) In the event of death of any of the joint account holders, in case of an operative account like cash credit and overdraft, operation of the account should be stopped immediately so that the estate of the deceased could be made liable for the debt due to the Bank. Operation in the account should be stopped in the event of one of the joint borrowers becoming insolvent or insane. Future operations should be routed through a new account opened specially for this purpose.

(b)

12

(c)

The branch should review the account within a fortnight and shall decide whether the existing credit facility should be continued based on various factors such as Credit worthiness of the remaining borrowers, future prospects of the business, effect of death of the person on the unit etc. In case it is decided that the credit facility would not be renewed, necessary steps should be taken to realise the outstanding debit balance in the account.

(d)

(e)

In case it is decided that the credit facility would be renewed and continued, a fresh sanction should be accorded in favour of the surviving account-holders and all formalities including documentation should be completed.

(f)

When a limit is sanctioned, the outstanding balance in the old account, if any, should be repaid by a cheque drawn on the new account

2.5

JOINT HINDU FAMILY 2.5.1. Great care shall be taken in dealing with a Joint Hindu Family advances due to certain legal complexities involved. No advance to a Joint Hindu Family shall be granted unless it is for the purpose of carrying out with the family business for the interest of the family as a whole. 2.5.2 In case of an advance to a Joint Hindu Family the application in Banks standard form shall be signed by the Karta and other major coparceners. On behalf of the minor coparceners, their guardians will sign. In the application form, it should be clearly mentioned that the advance required is for the ordinary purpose of family business. All the documents are to be signed by the Karta on behalf of the firm or family and also in his personal capacity undertaking joint liability not only to the extent of his share in the family property but also personal liability for the entire debt contracted by him on behalf of the family.

2.5.3

2.5.4. The liability of all coparceners is limited to the extent of their respective share in the family assets. The major coparceners and guardians of the minors, whether born or unborn, shall sign the documents in their personal capacity. 2.5.5. The names and dates of birth of the minor co-parceners, if there be any, shall be mentioned in the Joint Hindu Family letter (Form No. 306) and the application for advance shall be signed on their behalf by their respective guardians and the same shall be ratified by such minors on their attainment of majority. 2.5.6 As a measure of further pre-caution an undertaking shall be obtained from all the major coparceners to the effect that the liability of coparceners is limited to the extent of their shares in the family assets. It shall also be mentioned in the undertaking that in the event of separation on closure of the family business, a written notice will be given to

13

the bank and until such notice is given all of them shall be liable for the advance granted to the family. 2.6 Club, Society, School etc. 2.6.1 Club, Society, School etc. if not, incorporated within the laws governing them, have no power to enter into agreement as they have no legal entity. They cannot be sued. Members of such bodies are not liable for any credit/facility even if they sign the cheques in their representative capacity. In case a proposal is entertained, it has to be ascertained from the bye laws of the body that the Managing Committee has the power to charge the assets of the club etc. and raise loan. Appropriate resolutions have to be adopted by the Managing Committee.

2.6.2

2.6.3. Advances to such bodies are to be made as a very special case. Proposals sanctioned under the discretionary power of the Branch Manager will be disbursed with the approval of the Regional Manager. 2.7 Co-operative Societies 2.7.1. Certificate of Registration In order to be eligible for Bank advances Co-operative Societies must be registered under the Co-operative Societies Act in force in various States. A certificate of registration signed by the Registrar is the conclusive evidence that the Society is registered, and must be produced for inspection before an advance proposal can be entertained. 2.7.2 Rules and Bye-Laws As co-operative societies are governed by their respective rules and bye-laws, it is necessary to examine the Rules or Bye-laws for(a) (b) (c) Borrowing powers Power to charge assets Authority of office bearers.

It is also necessary to examine whether any restriction is imposed on opening and operation of Bank accounts. 2.7.3. Restriction on borrowing A registered co-operative society shall receive loans from persons who are not members only to such extent and under such conditions as may be prescribed by the rules or bye-laws. In certain states the Co-operative Societies Act does not permit opening of Bank accounts by Co-operative Credit Societies except with Co-operative

14

Banks without the permission of the Registrar of Co-operative Societies. It is, therefore, necessary that the restrictions imposed on borrowing shall be carefully studied before entertaining any advance proposal. 2.7.4. Inspection of Affairs In case of an existing advance where inspection of books of indebted society becomes essential, the Registrar shall, on payment of a prescribed fee, inspect or direct some person authorised by him by order in writing on his behalf to inspect the books of the society. 2.7.5. Registered Address of Societies Every registered office shall have an address registered in accordance with the rules, to which all notices and communications may be sent.However, a lending banker has the authority to inspect the books of accounts of a Socity. 2.8 PARTNERSHIP FIRMS 2.8.1. The number of partners in a partnership firm should not exceed 20 except in case of banking business where the number of partners should not exceed 10. 2.8.2 If the partnership firm includes one or more firms as partners, the number of partners of those firms should be individually added up to determine the number of partners of the new firm [example : ABC & Co. is a partnership firm with 10 individuals and 2 partnership firms as partners. Number of partners in these 2 firms is 9. So, total number of partners of ABC & Co. will be taken as 10 + 9=19]. If a limited company is partner in a firm, it should be treated as one partner. In case if Hindu Undivided Family, all the major coparceners are to be individually treated as partners.However if HUF is a partner, the proposal must not be entertained. 2.8.3. Liabilities of the partners are joint and several. The partners are liable both as a partner and as individual. Their liability is limited to their share as partner and unlimited as an individual. For a limited Company, their liability is unlimited in meeting the liability of the firm. However, no director or shareholder of the company is personally liable for the liability of the company. 2.8.4. PARTNERSHIP AGREEMENT A Partnership is the relation between persons who have agreed to share profits of a business carried on by all or any of them acting for all (Section 4 Indian Partnership Act, 1932). A partnership agreement which deals mainly with the constitution and relationship between the partners may be created verbally or in writing. A partnership deed in writing is not always available neither it is required to be produced for the purpose of the Bank. In case, however, a copy of the partnership deed is in record of

15

the Bank, it will be useful to note whether there are any special clauses restricting the authority of any of the partners to borrow on behalf of the firm. 2.8.5. PARTNERSHIP LETTER The declaration of partnership as on the reverse of the account opening form No. 303 shall be obtained under signatures of all the partners in their individual capacity. It is essential to note from the partnership letter that there is no restriction imposed on the authority of a partner to raise a loan on behalf of the firm. N.B. : The Bank shall not be affected by any restriction imposed on the authority of a partner undisclosed in the Partnership letter. 2.8.6 REGISTRATION OF A FIRM Registration of a partnership firm under Section 69 of the Indian Partnership Act 1932 must have to be made if loan or advances is allowed in the firms account. Registration of a firm can be effected any time during the continuance of the business by submitting a statement to the Registrar of Firms in a prescribed form which contains amongst other particulars of the names and addresses of all the partners. When considering an advance proposal the Bank is required to verify who the partners are. This can be best done by reference to the Registrar of Firms, where the names of partners recorded in the register are regarded as conclusive. In certain states, it is mandatory to register a partnership firm within a certain period of time from the date of the constitution of the firm. Branches should ascertain the position in this respect in respective states and shall act accordingly. REMEMBER: REGISTRATION OF DEED IS NOT REGISTRATION OF FIRM. 2.8.7 ON DEATH, INVOLVENCY AND RETIREMENT OF A PARTNER In case of death, insolvency or retirement of a partner, the account, if it shows a debit balance, shall be stopped at once to retain the Banks recourse against the deceased, insolvent or retiring partners estate. This is done to avoid operation of Claytons Rule. Further operations should be recorded in a fresh account on a separate page of the ledger getting the confirmation of the continuing partners. In case of death or retirement of a partner the surviving partners shall not be allowed to draw the unavailed portion of the limit on the date of death or retirement until fresh sanction is granted to the reconstituted firm on the basis of credit rating of the partners. In case of insolvency of a partner, the securities held against the debit balance, shall be frozen in order to retain the Banks rights against the insolvents estates. Operation in any personal account in the name of the insolvent partner shall be stopped.

16

The Banks claims in the event of insolvency of a partner shall be filed within the stipulated period notified by the official Receiver/Assignee for recovery of its dues. 2.8.8 EXECUTION OF DOCUMENTS All documents for an advance shall be executed by all the partners in their capacity as partners and individually. This has the effect of making the partners as principal debtors jointly and severally liable for the firms indebtedness to the Bank. Joint and several liability of the partners will give the Bank the right of set-off on any private account of a partner in respect of firms debt. In case of mortgage by deposit of title deeds of the partnership property the concurrence of all the partners must be obtained and the letter of admission shall be signed by all the partners. 2.8.9 INDEMNITY OR GUARANTEE Any indemnity or guarantee on behalf of a partnership firm must be executed by all the partners jointly to indicate their joint and several liability. No partner can bind his copartners by giving a guarantee or indemnity unless such guarantee or indemnity is a routine job normally undertaken by the firm in the usual course of business. 2.8.10. APPLICATION FOR ADVANCE Application for advance may be made by the partners jointly or any other partner/s singly on behalf of the firm. It may also be made by an agent on behalf of the principal on the strength of a power of attorney executed in his favour by all the partners. The powers delegated in such cases shall be properly checked up and confirmation from the principal that the power of attorney is in force shall be obtained. 2.8.11. LIMITED LIABILITY PARTNERSHIP FIRM LLP is a limited liability partnership firm incorporated under LLP Act 2008. LLP is a body corporate registered with Registrar of Companies, which is the administrating authority for LLPs. In LLP there is no limit of maximum number of partners and resignation/death of partner does not lead to dissolution of LLP. LLP can be wound up under law.

2.9.

LIMITED COMPANY 2.9.1 Of the different types of Companies registered under the Companies Act, companies limited by shares are more common. They are again classified as Public and Private Companies and are required by law to add the word(s) Limited or Private Limited as the case may be at the end of their names. Generally advance proposals received from companies engaged in manufacturing and trading business fall under either of the two

17

classes of companies referred to above. The following paragraphs deal mainly with advances to companies limited by shares both public and private. 2.9.2 A private company means a company which, by its articles (a) restricts the right to transfer its share, (b) limits the number of its members to fifty (minimum being two) and (c) prohibits any invitations to the public to subscribe for any shares in or debentures of the company. A Public Company means a company which is not a private company. In a public company, minimum number of shareholders should be seven. Every company is required to have two documents, one called Memorandum of Association and the other Articles of Association. The Articles of Association contains the regulations framed for the internal management of the company and by it the objects and powers of the company are carried into effect. The Arcticles usually deal with the following points: (1) Share Capital, (2) Rights attached to the different classes of share and various other matters related to share, (3) Directors, their number, power, duties, qualification, remuneration etc. (4) Proceedings at meetings, (5) Voting rights, (6) Accounts and Audit etc. Private companies limited by shares, an unlimited company or a company limited by guarantee must register its Articles of Association along with the Memorandum. For other companies, it is not mandatory to register the Articles. A Memorandum of Association is the document of utmost importance required to be registered on the formation of the company. It is a document for the guidance of the outside public, defining the companys powers and limiting the scope of its operations. Any act done outside the purposes stated in the Memorandum is null and void. Objects clause of a companys memorandum of Association should be specific; main objects have to be listed separately from the subsidiary objects. Memorandum also describes, except in case of trading companies, the state or states to whose territories the objects extend. 2.9.5 In terms of Section 34 of the Companies Act, on the registration of the memorandum of the Company, the Registrar shall certify under his hand that the company is incorporated and in the case of limited company that the company is limited. A companys borrowing power is regulated u/s 293(1) (d) and the provision for borrowing is incorporated in the Article of a company. This is to be ensured before granting loan. 2.9.7 Under Section 293 (1) (d) of the Companies Act, 1956, the Board of Directors of a public company or of a private company which is subsidiary to a public company,

2.9.3

2.9.4

2.9.6

18

cannot borrow in excess of the aggregate of paid up capital and free reserves i.e. reserves not set apart for any particular purpose. In arriving at the aggregate borrowings, the limits of temporary loans received from the companys bankers in the ordinary course of business in the shape of demand loan/overdraft/cash credit/bills purchased and discounted limits or advances on short term basis repayable on demand or within six months shall be excluded provided the proceeds of such borrowing are not used to acquire capital assets. In case of advance to a public limited company a certificate that the companys total borrowings are within the powers of the Director (as per Form F, Appendix II, and Documentation Manual) shall be obtained signed by the Chairman every year during the continuation of the Advance. The restrictions as to the limit of borrowings under the Section aforesaid do not apply to a private limited company. 2.9.8 Any borrowing in excess of the paid up capital and free reserves requires the prior consent of the shareholders in a general meeting. In such cases, a copy of the shareholders resolution in a general meeting specifying the total amount upto which the directors are authorised to borrow shall be obtained certified by the Chairman of the General Meeting. Any borrowing arrangement must be authorised by a resolution of the Board of Directors passed at a duly convened meeting of the Board. To be effective such resolutions should be in conformity with the provisions of the Memorandum and Articles of Association of the Company. It is desirable to have the resolution approved by the Bank before being passed in the meeting in order to ensure that they conform to the arrangements. The resolutions which may be drawn in the manner as shown in Form A, Appendix II of the Documentation Manual suitably modified whenever necessary shall specify amongst other things the date when the resolution was passed, the limit of borrowings, specific securities to be charged thereagainst and the names of persons delegated with authority to borrow and execute necessary documents. The power to borrow can be delegated to (a) Managing Director, (b) Committee of Directors, (c) Manager or to any person as may be authorised by the Board.

2.9.9

2.9.10 For entertaining an advance proposal from a limited company, the copies of the following documents need be produced : i) Certificate of Incorporation The original certificate should be inspected and returned. ii) Certificate of Commencement of Business The original certificate should be inspected and returned. No proposal for advance from a public limited company shall be considered until it has obtained

19

the Certificate of Commencement of Business. A private limited company requires no commencement certificate. 2.9.11 BALANCE SHEETS : Copies of the companys balance sheets including profit and loss account for the last three years shall be studied in the manner detailed in Chapter III relating to analysis of financial statements. One copy of each of the balance sheets shall be retained at the branch and the other to be sent to the Regional Office/H.O. as the case may be along with the proposal. In case of existing advances and in case of all new proposals sanctioned, two copies of balance sheets for each subsequent year shall be obtained, one copy of which is retained at the branch and the other sent to the Regional Office or Head Office as the case may be. Any adverse trend in business as revealed from the study of balance sheets should be forthwith brought to the notice of the Regional Office/H.O. as the case may be. 2.9.12 DEBENTURE : If the company, where proposal is under consideration, has issued debentures, the relative trust deed shall be inspected to ascertain that no charge has been created on the assets offered as security against the proposed advance. When a company having an existing advance issues debentures, the matter must be reported to the Regional Office and care taken sufficiently in advance to safeguard the interest of the Bank. 2.9.13 SEARCH AT THE REGISTRARS OFFICE: The Registrar of Companies maintains a Register of charges and also an Index to this Register, both of which are open to public inspection. Before an advance is made a search shall be caused to be made in the Office of the Registrar of Companies through a branch office located in the vicinity or through a lawyer, to ensure that there is no existing charge on the assets offered as a security for the advance. Similar search shall be conducted at the time of filing the charge for registration and 37 days after such filing to ascertain whether any other prior charge on the assets of the company has been registered. Subsequent searches shall be made every time the advance is reviewed or renewed. Now a day on line facility is available for searching and registration of charges. 2.9.14 REGISTRATION OF CHARGES The particulars of the undernoted charges created by a limited company together with the instruements, if any, by which the charges are created must be filed with the Registrar of Companies for registration within thirty days of their creation. (a) a charge for the purpose of securing any issue of debentures;

20

(b) (c) (d) (e) (f)

a charge on uncalled share capital of the company; a charge on immovable property wherever situate; a charge on book debts of the company; a charge, not being a pledge , on any movable property of the company; a floating charge on the undertaking or the property of the company including stock-in-trade; a charge on the calls made but not paid; A charge on goodwill, on a patent or license under a patent, on a trademark or on a copyright or a license under a copyright.

(g) (h)

Provided that the Registrar may allow the particulars and instrument or copy as aforesaid to be filed within thirty days next following the expiry of the said period of thirty days on payment of such additional fee not exceeding ten times the amount of fee specified in schedule- X as the Registrar may determine, if the company satisfied the Registrar that it had sufficient cause for not filing the particulars and instrument or copy within that period. Notwithstanding, arrangement for registration of all charges within the specified period of 30 days shall be ensured by the branches. If for any reason, beyond the control of the branch, it appears that the charge cannot be registered within 30 days, the branch shall bring this to the notice of the Controller within 21 days after the date of creation of the charge by execution of documents. The Controller will then assist the branch in filing the application for registration of charge within the specified period of 30 days since timely registration of charges establishes the right of the bank. 2.9.15. CHARGES EXEMPTED FROM REGISTRATION A charge by way of pledge of moveable properties such as i) ii) iii) goods pledged to the Bank G.P.Notes, Debentures and Shares Documentary D.P. and D.A. Bills accompanied by Negotiable Instruments i.e. a bill of exchange need not be registered with the Registrar of Companies. In case advance to any company is secured both by any of the aforesaid securities and hypothecation of or charge upon other assets of the company such as Book Debts, Moveable assets, Plant & Machinery etc. such charges (other than pledge) must be properly registered.

N.B. The original instruments creating the charge need not be filed for registration.

21

True copies of such instruments certified, as such by an officer of the borrowing company, will serve the purpose equally well. 2.9.16. PRESCRIBED FORMS TO BE FILED FOR REGISTRATION Creation of charge and any subsequent modification in charge shall be filed for registration within 30 days after the date of creation/modification in Forms Nos. 8 and 14 respectively as prescribed under the Companies Act, 1956. When registration has been effected the Registrar shall issue a certificate of registration which is sent to the Bank along with the instrument of charge. The certificate is the conclusive evidence that the requirements of the Act as to registration have been complied with. On repayment of the advance satisfaction of charge requires registration within 30 days from the date thereof in Form No.17 prescribed under the Companies Act, 1956. 2.9.17. REGISTRATION OF CREATION OF CHARGE: The prescribed form i.e. Form No. 8 (vide Form B, Appendix- II, in the Documentation Manual) has to be completed and the signature of the borrower obtained thereon. Under item 1 date and description of the instrument creating charge, such as hypothecation of goods, hypothecation of debts and moveable assets etc. should be given serially. If there is no instrument, as in the case of a mortgage by deposit in the following manner: No instrument, Deposit of title deeds made on to create an equitable mortgage in favour of the Bank. Under item 2, the amount secured by the charge shall be written. Under item 3 short particulars of the property charged should be written from the instrument/s. In the case of Hypothecation of Goods (vide Form No.1, Appendix I, Documentation Manual) the narration should be as follows: The whole of the Borrowers stock consisting of (Description of Goods to be given) whether raw or in process of manufacture and all products, goods and moveable property of any kind wherever situate including any goods in course of transit. In the case of Hypothecation of Debts & Moveable Assets (Form J, Appendix- I, and Documentation Manual) the narration should be: All the Borrowers present and future book debts outstanding moneys receivable claims bills contracts engagements securities rights and moveable assets. In the case of Hypothecation of Plant and Machinery (Form K, Appendix- I, Documentation Manual) the narration may be as follows:

22

All plant, machinery, engines, boilers, appliances, tools and implements described in general terms The Plant & Machinery wherever situate and in course of transit. In the case of charge created by deposit of title deeds without any instrument the particulars may be given as under or in a similar manner considered appropriate. Mortgage by way of deposit of title deeds in respect of the Companys property being premises No comprising all lands and buildings, structures, erections, fixtures and fittings thereon and therein. Under item 4 of the Form, gist of the terms and conditions and extent and operation against the instrument of charge shall be stated. For instance in the case of Hypothecation of Goods the description may be given as under: Stocks as described under item 3 which now or hereafter from time to time shall be in possession of the borrower shall remain hypothecated to the Bank by way of first charge to secure a demand cash credit limit of Rs.. with interest @ percent per annum(quarterly or monthly rests) or at such other rate as may be communicated to the borrower from time to time. Where a number of instruments creating charge are to be registered under cover of Single Form 8, the total amount of charge to be registered shall not exceed the overall sanctioned limit irrespective of the aggregate of sub-limits under different instruments. In such cases terms and conditions of sanction including limit thereof shall be given in brief at the top of the column followed by gist of the terms and conditions and extent and operation against each instrument of charge, in order to prevent any confusion on the part of the Registrar as to the amount of charge to be created. Under item 5 the name and address of the Bank as also Head Office address shall be given. Item 6 is applicable only in case of issue of debentures. 2.9.18. REGISTRATION OF MODIFICATION OF CHARGE Whenever there is a modification in the terms or conditions or the extent of operation, particulars of such modification shall be sent for registration in the prescribed Form No.14 (vide Form C, Appendix II, Documentation Manual) within 30 days from the date of execution of the documents. The form shall be completed for the signature of the borrower. Under Item 1 of the Form the date and brief description of instrument creating the original charge as also the date on Form 8 i.e. the date of registration shall be written. Under item 2 i.e. date and brief description of instrument modifying the charge such as

23

Supplemental Deed of Hypothecation Agreement (Form X, Appendix II, Documentation Manual) dated in favour of the Bank modifying the charge from Rs to Rs Should be written or in a similar manner suitably worded. Under item 3, the details of the modification shall be given. As an illustration, an enhancement of Rs.1,00,000/- having been sanctioned in an existing cash credit limit of say Rs.10,00,000/- the particulars under item no.3 may be given as follows: An additional limit of Rs.1,00,000/- has been granted to the company thereby raising the total limit to Rs.11,00,000/- in the cash credit account on with other conditions remaining the same. The details of all modifications shall be given in brief for registration purpose. Modification of interest rate is not however required to be registered in the case of instruments where variations in the rate of interest are covered by the insertion of clause. At such other rate as may be communicated to the borrower from time to time. or similar such clause, and registered as such in the form no.8 for the registration of the original charge. 2.9.19. REGISTRATION OF SATISFACTION OF CHARGE On repayment of the debts for which the charge was created Satisfaction of Charge in the prescribed form no. 17 (Form D, Appendix II, and Documentation Manual) has to be filed within 30 days. The procedure to get the form completed requires no elucidation. 2.9.20. NEGATIVE LIEN: A negative lien on the companys fixed assets which are not charged to the Bank or elsewhere, shall be obtained in Banks standard form (Form L, Appendix- II, Documentation Manual) to the effect that they are free from encumbrances and shall not be encumbered in any way during the period the advance shall continue without the written consent of the Bank. This declaration is usually incorporated in a resolution of the Board of Directors and a certified copy of such resolution shall be duly obtained. 2.9.21. COMPANYS REGISTERED OFFICE: All notices and documents meant for a limited company shall be served at its Registered Office (Section 51 of the Companies Act, 1956). But statements of accounts paid cheques and routine correspondence may be addressed and delivered to any office of the company under mutual agreement. 2.10 GOVERNMENT COMPANY

24

2.10.1 A company in which not less than 51% of the paid up capital is held by the Central Government or by any State Government or partly by Central Government or and partly by one or more State Government is called a Government Company. All the provisions of Indian Companies Act shall apply to such Government Companies subject to such exemptions or modifications that have been notified by the Central Government from time to time. 2.11 FOREIGN COMPANY 2.11.1 A Foreign Company is a company incorporated outside India and having business in India. A foreign company should file with the Registrar of Companies, New Delhi and the state in which the principal office of the foreign company is located, certified copies of principal documents in English and particulars in forms 44. They will furnish the foreign address of the company, particulars of directors and secretary of the company, particulars of the officers resident in India who would accept service of notice and documents on behalf of the company and the address of principal office in India. Any change in the above particulars shall be intimated to the Registrars of Companies in form 49 or 52. The foreign company has to file a report in form 54 about the places where it carries on business in India. 2.11.2 If any charge is created on the assets of a foreign company (i.e., a company incorporated outside India having a branch office in India), the charge has to be filed for registration within 30 days after the date of its creation with the Registrar of Companies, New Delhi (Sec. 600(4) of the Companies Act, 1956). As a measure of abundant caution it is desirable also to file the particulars with the Registrar of Companies of the State where the charge is being created even though the law does not require this step. 2.12 SELF HELP GROUP 2.12.1 A self help group is a small economically homogeneous and affinity group of rural poor, having a common perception of need and impulse towards collective actions and voluntarily formed to save and mutually agreed to contribute a common fund to be lent to its members as per group decision, to meet the emergent needs of the members both for productive & consumption purposes. The group should work democratically such groups may be registered or unregistered. 2.12.2 Size of such groups is normally between 5 to 20. The group should maintain proper records & accounts. They should maintain Membership Register, 2.12.3 Attendance Register, Proceedings Books, Savings Ledger, Borrowing/Deposit Ledger, and Loan Ledger.

25

2.12.4 The group is sanctioned loan in proportion to their savings and the proportion should initially be 1:1 ratio and will be increased to 1:4 depending upon rating of the group. Such loans can be sanctioned directly to the SHG or through NGO/VA. 2.12.4 Documents are to be executed by the authorised persons on behalf of the group. All the members of the SHG in all cases will execute an interse agreement. 2.13 LUNATICS AND INSOLVENT 2.13.1 Lunatic and insolvent are not competent to enter into a contract, so they are also not eligible for any loan. For all the above types of borrowers KYC norms are to be complied.

26

ANNEXURE 1 The Manager United Bank of India __________________ Branch Dear Sir, Re : Introduction of the account of Km/Smt. _____________________ _____________________ for the purpose of opening account with you and obtaining borrowing facilities This is to keep on record that at my request and introduction you have opened an account in the name of ________________________________ who is a Pardanashin lady and who had applied to you for opening account as also for borrowing facilities. Then Pardanashin lady above named is personally known to me and I am acquainted with her and her requirements. You have at her request agreed to grant her credit facility of Rs.__________ lac for which she has submitted to you necessary application and has also executed loan documents as noted below. She has affixed her signature on the loan documents, in my presence and her signature on the loan documents, which is in conformity with her usual signature and also the signature as recorded on this letter, has been attested by me on this letter evidencing for her execution of the loan documents in your favour. Yours faithfully, (Signature) A) Particulars of the loan documents Executed by ________________________ ________________________ in my presence. Name : Address : _________________________ Occupation _______________

1. 2. 3. 4. B) Signature of _____________________________

Attested : ________________________________ (Signature of Introducer)

27

28

CHAPTER III

ANALYSIS OF FINANCIAL STATEMENTS, RATIO ANALYSIS AND INTERPRETATION TOPIC 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 Introduction Balance Sheet Assets Classification Profit & Loss Account Ratio Analysis Ratios to Judge efficiency of operational management Ratios to judge efficiency of financial management Ratios to judge efficiency of debt service management PAGE NO.

3.10 Example 3.11 Limitations of Ratio Analysis 3.12 Cost volume Profit Analysis 3.13 Fund flow analysis Annexure I Annexure II Annexure III Annexure IV Annexure V Format of Balance Sheet Abstract of balance Sheet Format for analyzing PL account Exercise on abstract of balance sheet Exercise on analyzing PL account

29

CHAPTER III

ANALYSIS OF FINANCIAL STATEMENTS, RATIO ANALYSIS AND INTERPRETATIOIN 3.1 INTRODUCTION : 3.1.1 Credit decisions are to a large extent based on financial position of the borrowers. This chapter is restricted to the assessment of a business concern based on financial statements. These are powerful analytical tools for reaching sound credit decisions. Financial statements, as required by a banker, comprise of Balance Sheet, Profit and Loss Account and Fund Flow Statement. The key questions answered by these three statements are : Balance Sheet: What is the financial position of the firm at the end of an accounting year? Profit and Loss Account: How did the firm perform during the accounting year? Fund Flow Statement: What have been the sources and uses of funds during the accounting year? 3.1.3 The Companies Act requires that the Annual Report of the Company, a public document that is sent to share holders, contain the balance sheet, the profit & loss account, the Directors report and the Auditors report. Though not presently required by law, many companies present sources & uses of funds statement as well in the Annual Report.

3.1.2

3.2

BALANCE SHEET 3.2.1. Balance Sheet is a statement of position of Assets and Liabilities of a business firm on a given date i.e. at the end of an accounting year. 3.2.2. The liability side of the Balance Sheet indicates sources of funds. Depending on the types of sources, liability can be divided into three parts : (a) Net worth: This is a permanent source of fund to the firm and consists of Equity (owners capital) and Reserve & Surplus. Reserve is created out of profit earned from the business and capital surplus resulting from profit on sale of fixed assets, revaluation of fixed assets, capital subsidy, premium on share issue etc. However, revaluation reserve should not be considered for arriving at the Net Worth position. Similarly, such reserve should also be deducted from Net Block to arrive at the position of net block (net of revaluation reserve).

30

(b)

Term Liability: This is a source which is not permanent and is repayable over a period of time beyond one year. Examples of such items are : Term Loans from Banks, Financial Institutions. Loans from associates, friends & relatives Deferred Payment Credit Debentures, Fixed Deposits. Preference Shares etc.

(c)

Current Liability: Current liabilities originate from current or short-term promises made to non-owners of the business. Such liabilities are to be repaid/fulfilled within 12 months from the date of the balance sheet. Different items under this category are trade creditors, accrued liabilities i.e., the expenses which have been contracted but not paid till the finalisation of the balance sheet viz., dividend payable, taxation liabilities (accrued liabilities are the items that have been debited to Profit & Loss account but not actually paid and transferred to liabilities account), deposits from customers, bridge loan, cash credit/overdraft from banks, commercial paper, short term borrowing (including bills purchased & discounted) and that part of the long term liability that is repayable in a years time. Besides, there may be Contingent Liabilities which are not actual liabilities and may crystallize at a future date on happening of a certain event. As these are not actual liabilities and extent of the same cannot be specified, they do not figure in the balance sheet, but these are reported by way of note in the Balance Sheet. These are known as off balance sheet items. Branches will study these liabilities and try to assess the possibility of their being crystallized and its consequent impact on the balance sheet. Some examples of contingent Liabilities are: (a) Demands by different agencies like Income Tax, Sales Tax, Customs & Excise contested by the party & pending before the court or appellate authority. Bonds/Guarantees issued in favour of different beneficiaries. Probable claims against suit pending, if any, unclaimed liabilities for partly paid shares, arrears of unclaimed dividends etc.

(b) (c)

3.3

ASSETS The asset side of the balance sheet depicts the use of fund in different types of assets. Assets can be classified into four different types as under :

31

3.3.1. Fixed Assets: Fixed assets are those assets which are not normally disposed of within a short period, but are carried over to the following years for productive use, while a fraction of their value is charged to expenses every year as depreciation. Examples of such assets are Land and Building, Factory Shed, Plant & Machinery, Motor Vehicles, Furniture and Fixtures etc. Fixed assets provide the lifeline of the business. A lender, whether he is financing fixed assets or not, must therefore, make a thorough analysis of the fixed assets of an enterprise, because it is only on the proper functioning of fixed assets that the ultimate repayment capacity of the borrower lies. 3.3.2. Current Assets: They represent short-term use of fund. This category consists of cash and other resources, which get converted into cash during the operating cycle of the firm. Current Assets are held for a short period of time as against fixed assets, which are held for relatively longer periods. The major components of Current Assets are: Cash, debtors, inventories, loans and advances. (i) Cash: Cash denotes funds readily disbursable by the firm. The bulk of it is usually in the form of bank balance; the rest comprises of currency held by the firm. Debtors: This is also called accounts receivable. This represents the amounts owed to the firm by its customers who have bought goods and services on credit. Debtors are shown in the balance sheet as the amount owed less any allowance for the bad/doubtful debts. Total debtors are segregated into two components (a) Debts outstanding for more than six months (b) other debts (a debt within 6 months). If the amount owed to the company is evidenced by written bills of exchange or Hundi, these would appear under the caption Bills Receivable rather than accounts receivable. Normally such bills are for a specified period in case of usance bills and the payment is to be received on demand in case of demand bills. Inventory: Inventory is the most important element of Current Assets and bulk of working capital finance is given for inventory. Different components of Inventory are Raw Materials and spares, work-in-process (also known as Stock-in-Process) and Finished Goods. While manufacturing firms generally hold all three types of inventories, distribution or trading firms hold mostly finished goods. Need for inventory requires no emphasis. But what should be the optimum quantity of holding level will depend on the type of activity and location of the unit. Other aspects influencing the inventory of a firm are: (1) Whether they follow Economic Order Quantity (EOQ) Policy to order raw materials, (2) Order point and lead time in days for procurement, (3) Pricing of raw materials and (4) Monitoring and control of inventory. Amount of inventory to be maintained will also depend upon

(ii)

(iii)

32

anticipated scarcity, expected price change, obsolescence risk, government restriction and marketing consideration. iv) Loan & Advances : Under this head are included prepaid expenses, loans and advances and various deposits, both statutory & trade, which are not directly related to production, but incidental to business. Except advances made to suppliers of fixed assets, all other advances are in the nature of prepaid expenses. But in the former case, the amount should be treated as non-current assets and not current assets.

3.3.3. Non-current Assets : (NCA) : Non-current Assets are those types of assets which are neither classified as Fixed Asset nor Current Asset. For example, Loans made to employees for house building or purchase of conveyance repayable over a long period. Deposits made with various statutory authorities or earnest money deposit or security deposit which are more or less permanent in nature, investments in subsidiary companies/affiliates/others, sundry debtors over six months, advance to suppliers of capital goods etc. 3.3.4. Intangible Assets : From the accounting point of view, a loss represents a decrease in owners capital. Hence, when a loss occurs, the owners capital is required to be reduced by that amount. However, as per Company Law, the share capital cannot be reduced when a loss occurs. So, the share capital is kept intact on the liability side of the balance sheet and the loss is shown on the asset side of the balance sheet as intangible assets to be adjusted from future profit, if any or some time it is adjusted from Reserves if available without the requirement of showing the loss as intangible asset. Besides, Patents, Goodwill, preliminary expenses/bad/doubtful assets (not written off) also should appear as Intangible assets. 3.4 CLASSIFICATION: Classification of the various items as above relating to Balance Sheet and Profit & Loss statement into components of groups and sub-groups for the analysis of the balance sheet and income statement may sometimes lead to doubt as to the correct grouping of some items under proper heads and therefore according to Section 210 of the Companies Act, Companies are required to prepare their Balance Sheets at the end of each accounting year. Section 211 requires the balance sheet to be prepared in the prescribed form. The form of the Balance Sheet as given in Schedule VI of the Companies Act is furnished under Annexure- I. Assessment of the financial position of an entity based on its Balance Sheet may be made on analysis of the same on the basis of various important parameters/ratios computed from the abstracts as per Annexure- II.

33

3.5.

PROFIT & LOSS ACCOUNT (P&L A/c) : An entrepreneur is in business to earn profit. Sales generate revenues which net of expenses for the business will give either profit or loss. Apart from the revenues, in some cases there may be nonoperating surplus which is represented by gains arising from sources other than normal operations of the business. Its major components are income from investments and gains from disposal of assets etc. Similarly, non-operating deficit represents losses from activities unrelated to normal operation of the enterprise and the same also feature the P/L Account. Sales are the sum of the invoice price of goods sold during the period. Excise duty refers to the amount paid to the Government. Net sale means sale minus excise duty (if any). Cost of production consists of direct material cost, direct labour cost and factory overheads and depreciation plus opening stock-in-process minus closing stock in process. Cost of sales is represented by cost of production so arrived plus opening stock of finished goods minus closing stock of finished goods. Gross Profit is the difference between net sales and cost of sales and operating profit is the difference between gross profit and Selling, General & Administrative Expenses and interest. As a measure of profit it reflects operating performance and is not affected by non-operating income or loss, tax factor and financial leverage. Profit before taxes is the sum of operating profit and non-operating surplus/deficit. Tax represents the income tax payable on the taxable profit for the year. Profit after tax represents profit after payment of income tax. Retained profit denotes Post-tax Profit after making provision for dividend, if any. A format for analysis of P&L Account to represent the above is enclosed in Annexure-III.

3.6.

RATIO ANALYSIS 3.6.1 Ratios on the basis of various parameters obtained from analysis of Balance Sheet and P&L Account are used according to the need. However, while appraising any proposal care should be taken that all the pertinent ratios prescribed in the lending policy of the Bank are analysed and interpreted. The relationship between items or groups of items as classified in the analysis of balance sheet and P/L statements are examined by ratios. A ratio expresses the results of comparison between two figures in the same units. Ratios are calculated by dividing one number by another and results obtained are expressed as a pure ratio or a pure number or a percentage say (2:1) or (2) or (200%) respectively.

3.6.3

34

3.6.3. A banker is normally interested to know the following three efficiency aspects of the borrowers business:

1) 2) 3) 3.7.

Efficiency of operational management Efficiency of financial management Efficiency of debt-service management.

RATIOS TO JUDGE EFFICIENCY OF OPERATIONAL MANAGEMENT (a) Fixed Assets Turnover Ratio = Net Sales/Net Fixed Assets This ratio determines fixed asset utilization. (b) Return on Investment=PBIT/Total Operating Assets This ratio determines profitability on total assets employed. (c) Gross Profit Ratio = Gross Profit/Net Sales This ratio determines the operating efficiency of the business in keeping the rate of gross profit stable or increasing. (d) Inventory Turnover Ratio = Cost of Production/(Inventory of raw materials + work in process + Finished Goods). This ratio determines the efficiency of utilisation of inventory. (e) Operating Leverage = (Net Sales Variable Cost)/PBIT This ratio determines the sensitivity of relationship of sales and operating profit

3.8.

RATIOS TO JUDGE EFFICIENCY OF FINANCIAL MANAGEMENT (a) Debt Equity Ratio = Long Term outside liability/Shareholders Fund This ratio determines the level of permanent stake of the borrower. (b) Total Outside Liabilities/Tangible Net Worth(TOL/TNW) = Total Debt/Shareholders Fund This ratio determines the level of borrowers overall stake in the business. (c) Current Ratio = Current Assets/Current Liabilities. This ratio determines the general liquidity of the business. (d) Debtors- turnover ratio =Debtors x 365 /Gross sale This ratio determines the saleability of the product and efficiency of the collection. (e) Creditors-turnover ratio = Trade Creditors x 365/ Purchases This ratio determines the ability of the firm/company to obtain market credit.

35

(f)

Loan to Value ratio = Bank Borrowing/Working Capital Gap This ratio determines the contribution of bank borrowing in meeting working capital gap.

(g)

Net Working Capital Diversion ratio = Working Capital Gap This ratio indicates contribution of margin towards working capital gap.

3.9.

RATIOS TO JUDGE EFFICIENCY OF DEBT-SERVICE MANAGEMENT (a) Debt Service Coverage Ratio = (Profit after tax + Interest + Depreciation)/(Interest + Annual installment for term loan). This ratio determines the ability of the firm to service its total debt-service obligation. (b) Interest Coverage Ratio = Profit before interest and tax/Annual interest obligation. This ratio determines interest paying capacity of the firm. (c) Priority Obligation Ratio = Net Operating Cash Flow/Priority Outflow This ratio determines the cash position of the business to meet priority obligation.

3.10. EXAMPLE : All these ratios will now be computed and discussed on the basis of an example. XYZ CORPORATION LTD. Balance Sheet as on 31 March, ________ Liabilities Paid Up Capital Share Premium Revaluation Reserve General Reserve Debentures Loan from IDBI Loan from Holding Company Security Deposits Trade Creditors Amount 2840 10 1660 3730 280 140 530 420 6050 Assets (Rs in thousand) Amount

Gross Fixed Assets at cost 13470 (including Rev.Res.1660) Less Depreciation upto date 9430 Capital work-in-progress Investment Housing Loan to employees Advance to suppliers Deposits with NABARD Security Deposit Closing Stock 4040 310 230 420 480 160 180

36

Bills Payable Fixed Deposits from Public Bank borrowings Interest accrued but not paid Tax liability Proposed Dividend Unclaimed Dividend

440 1040 2300 60 1550 750 30

Raw materials Work-in-progress Finished goods Sundry Debtors (more than 6 months old ) Sundry Debtors (less than 6 months old ) Amount due from Holding Company Preliminary Expenses Cash in hand Cash at Bank

7050 1420 5010 130 1950 20 230 20 180 21,830

21,830 Note : 1) Out of total debenture, Rs.70,000 due for redemption within 12 months 2) IDBI Loan Rs.35, 000/-, due for repayment within 12 months.

3) Out of Fixed Deposit of Rs.10, 40,000, a sum of Rs.1, 40,000 will mature within 12 months. Abstracts of the above Balance Sheet as per format is given in Annexure- IV

37

Trading & Profit & Loss Account For the year ended 31st March, 200X To Opening Stock: Raw materials Work-in-progress By Sales : Less: Excise Duty 2910 46,550 10,920 Purchase of raw materials Wages including Bonus Carriage Inward Power, fuel, water Spares & Stores Repair plant Rent & Taxes Insurance Depreciation (Plant & Machinery etc.) Gross Profit 35,370 1,240 30 1, 890 360 220 320 20 470 9190 ----------60,030 By Gross Profit Interest & Dividend Miscellaneous Income Closing Stock Raw materials Work-in-progress Finished goods 51,680 5,130 46,550

6750 1260

7,050 1420 5,010

----------60,030

To Salaries Contribution to PF & Gratuity Welfare expenses Advertisement Carriage & Freight outward Commission & Brokerage Travelling Expenses Postage, Telegram & Telephone Printing & Stationery Interest Audit Expenses Provision for bad debt Taxes

1760 270 120 460 1580 260 350 130 50 1580 10 60 680

9,190 140 220

38

Net Profit transferred to Profit & Loss Appropriation Account

2240 -------9550

-----9550

An analysis of the above P/L A/c is given in Annexure- V CALCULATION OF RATIOS: Net Sales (a) Fixed Assets turnover ratio = Operating Fixed Assets Sales Excise duty Net Sales Net fixed assets Less Revaluation Reserve Operating Fixed Assets = = = = = = 51680 5130 46550 4040 1660 2380

46550 . . The Ratio = = 19.56 2380 Net sales is calculated by subtracting Excise Duty from Gross Sales. Operating Fixed Assets is arrived at by subtracting Revaluation Reserve from Net Fixed Assets. Any revaluation of fixed assets is to be ignored, because, it does not, in any way, augment the produceability of fixed assets. Capital expenditure made for partly completed plant etc. which are yet to be commissioned should also be excluded. The higher the ratio, the better is the efficiency of fixed assets or, in other words, the higher the capacity utilization. A low fixed assets-turnover ratio may be reflected in low profit and a low level of net working capital. A low and falling ratio indicates outdated technology. PBIT Return on Investment = Total Operating Assets (i.e.operating Fixed plus Current Assets)

(b)

asset

This is a combination of operating profit ratio and assets turnover ratio. Profit here means Profit before interest and taxes (PBIT), which should exclude non-operating income.

39

Net Profit Add Taxes Add interest Less Non-operating income PBIT The ratio = 4140 (2380+16110)

2240 680 1580 4500 360 4140 = 22.39%

This ratio is normally expressed in percentage. The ROI is the key factor of profitability of a business. It matches the operating profit with the assets which earn this profit. Efficient utilization of assets will have a relatively high return, while less efficient use will have a low return. Gross Profit Gross Profit Ratio = x 100 Net Sales This ratio is expressed in percentage. Gross Profit Net Sales - 9190 - 46550

(c)

9190 The Ratio - x 100 = 19.74% 46550 This is the standard method of calculation of this ratio. The branches may calculate the ratio with reference to cost of goods sold instead of Net Sales. This is better because by taking cost of goods sold, price fluctuation is neutralized to a great extent. Cost of goods sold = Opening stock of finished goods + cost of production closing stock of finished goods. Cost of production = Prime cost + Manufacturing expenses + opening stock of work-inprocess closing stock of work-in-process. Prime Cost = Opening stock of raw materials + purchase closing stock of raw materials + wages including Bonus. For a trading concern, Cost of goods sold = Opening stock of inventory + purchase closing stock of inventory + Expenses related to purchase. Prime Cost = 6750 + 35370 7050 + 1240 = 36310 Cost of Production = 36310 + 3310 + 1260 1420 = 39460

40

Cost of goods sold = 2910 + 39460 5010 = 37360 9190 The Ratio = 37360 = 24.59 % As the cost of goods sold consists mainly of variable expenses, the Gross Profit Ratio should be more or less stable from year to year. Any variation on the lower side is dangerous. Any downward movement in this ratio suggests that the cost of production is increasing but the same cannot be passed on to the consumers due to competition. (d) Inventory Turnover Ratio = Cost of Production/(Inventory of raw materials+ work in progress+ finished goods) = 39460/13480 = 2.93% (e) Operating leverage = = (Net Sales Variable Cost)/PBIT (46550 39460)/4140= 6979/3168 = 1.71 : 1 x 100

(f)

Long Term Outside Liability Debt-equity Ratio = Shareholders Fund Shareholders Fund (net of revaluation reserve) Long Term Outside Liability . . . 2165 6350 = = 6350 2165

Debt Equity Ratio =

= 34.09% or 0.34 : 1

The Debt-equity ratio has undergone much devolution both in respect of definition of debt and also the standard since the classical days of credit analysis. With the liberalisation of the financial sector, which provided a level playing field between the financial and real sectors of the economy, banks and financial institutions are working towards lowering the Debt- Equity Ratio to 1.5:1 to fall in line with present day international standards. This ratio of 0.34:1 signifies that the outside long-term creditors have only 34% stake in the long-term resources of the company. On the face of it, this is an extremely favourable situation. (g) Total outside liability to tangible networth ratio = Total Debt/Sareholders Fund Total outside liability = Long Term Debt + Current Liability

41

= Shareholders Fund = 6350 . . . The Ratio =

2165 +11425= 13590

13590 6350 = 2.14:1 This ratio of 2.14:1 means that the total debt is 114% higher than equity. In other words, equity and total debt have contributed 32 per cent *and 68 percent respectively towards the total resources of the company. Current Assets Current Ratio = Current Liabilities 16110 = 11425

(h)

= 1.41:1

This means that the current asset of every Rs.1.41 is financed through borrowings/other current liabilities to the extent of Re 1 and the balance through long term sources. Gross sales = Trade debtors

(i)

Debtors turnover ratio

The Ratio =51680/2080= 24.85 or 365/24.85 = 15 days (approx) The value of this ratio suggests that debtors turnover approximately 26 times in a year. On an average, the debt is realised within 14 days. This low holding of debtors suggests that the companys products are in good demand and /or the debt recovery machine is very efficient. (j) Loan to Value Ratio = Bank Borrowing/Working Capital Gap X 100% = 2300/(16110 9125) X 100 = 32.92% Working Capital Gap = (Current Liability Bank Borrowers) (k) Diversion Ratio : Net Working Capital = x 100 Working Capital Gap 4685 = x 100

42

9125 = 51.34% a) Debt Service Coverage Ratio = Profit after tax + Interest + Depreciation Interest + Annual repayment of term Loan

Annual Repayment: Debenture (remaining period of redemption = 4 years) Loan from IDBI (remaining period of repayment 4 years) Fixed Deposits = = = 245 2240 + 1580 + 470 The Ratio is = = 1580 + 245 4290 = 1825 70 35 140

2.35 : 1

Debt Service Coverage Ratio of the company is good. Higher is this ratio, better is the repayment possibility. DSCR in this case is high because the long-term fund of the company is low in comparison to the total liabilities.. Profit before interest & tax and depreciation Interest Coverage Ratio = Annual Interest Obligation 2240 + 1580 + 680 + 470 = 1580 4970 = = 3.14:1 1580 We have taken profit before depreciation, interest and tax because we want to know how many times the interest payment could be covered by cash profit. Tax has not been considered because interest is a deductible expenses under the Income Tax Act. A ratio of 3 or more is considered to be good. The ratio in this case is high because the company depends more on its net worth and current liabilities than on long-term loan and debenture. (c) Priority Obligation Ratio = Net Operating Cash Flow/Priority outflow Gross Sales Less : Increase in sundry debtors : : 51,680 Nil

(b)

43

Add : Decrease in sundry debtors (A) Operating Cash Inflow

: :

1,685 53,365 35,070 4,080 5,130 5,050 680 300 1,100 220 (-) 1,320 48,990 50,310

Consumption of Raw materials: : (Opening Stock of Raw materials + Purchase Closing Stock) Other manufacturing expenses (excluding depreciation) : Excise Duty Other General Expenses (Administrative + selling etc.) Income Tax Add: Increase in closing stock of raw materials Less : Increase in creditor Add : Decrease in creditor Less : Opening balance of Cash and Bank (B) Operating Cash Out Flow Note : : : : :

1) Opening balance of debtors was 3765. Hence difference between Opening Balance and Closing Balance of debtors comes to (-) 1685. 2) Opening Balance of creditors was 4,950. 3) Opening Balance of Cash was 220.

Net Operating Cash Flow (A B) 53365 - 48990 = 4375 Net Operating Cash Flow Priority Obligation Ratio = Priority outflow (i.e. Intt.+ T/L instalment +Redemption of Debenture+ FD Payment etc.) 4375 4375 = = (1580 + 35+ 70+140) 1825

= 2.39 Higher the ratio, the capacity to comply with the priority obligation is better and viceversa. 3.11 LIMITATIONS OF RATIO ANALYSIS: 1. Ratios are not standard formula for judging the performance. These are only guide, since management problems are so complex that they can not be reduced to a formula.

44

2.

Since the analysis is based on financial statements, this will have all the limitations which the financial statements themselves have (e.g. Balance Sheet is on a particular date and hence there is possibility of window dressing; it has distortion in value of assets acquired at different points of time; non-financial changes, though very important from the point of view of business, are not reflected etc.) No individual ratio will depict any picture and we have to select a group of ratios to make the analysis meaningful. While ratios are compared on a historical basis, the time period may be of equivalent duration, but price level changes between the periods may distort the results. Ratio based on profit, which is generally used as an indicator of effectiveness and efficiency, has certain limitations. For example, profit measures short term rather than long-run performance. There is also no reliable way of measuring the profit potential of a business so as to compare the reported profit with the profit that could have been earned under the circumstances. Generally accepted accounting principles give wide latitude in measuring profit as well as methods relating to depreciation, inventory, valuation, costs, expenses etc. in a company. This lessens the validity of inter-firm comparison. Unless the classification of various items in the balance sheet is properly done, the ratios arrived at are liable to be faulty. Nevertheless, ratio analysis is a useful aid and could be used along with other quantitative techniques in financial management to assess the financial health of an organisation.

3.

4.

5.

6.

3.12

COST VOLUME PROFIT ANALYSIS: Cost volume profit (CVP) analysis is popularly known as Break-even analysis. This analysis helps in answering questions like: How do costs behave in relation to volume? At what sales volume would the firm break-even? How sensitive is profit to variation in output? How much should the firm produce and sell in order to reach a target profit level? CVP analysis is based on several assumptions. These assumptions are: Costs of the enterprise can be divided into two components; fixed cost and variable costs. Fixed cost remains unchanged for a given period of time. Variable cost varies proportionately to volume. The unit selling price is constant over a given period of time. Volume of sales is equal to volume of production during the accounting period.

45

Variable cost: Variable cost per unit is fixed. It includes direct wages, raw materials power & fuel etc. All these expenses are dependant on volume of production. If there is no volume, these expenses would be nil. Fixed Cost: Examples of fixed cost are salaries, administrative expenses, rent, taxes and all other expenses that are not linked to production. These expenses will be incurred even if there is no volume. Contribution: This is a term used in calculation of break-even sales. Contribution is defined as sales minus variable cost. Contribution per unit is defined as Sales Price per unit minus variable cost per unit. Fixed Cost = x Sales Contribution Fixed Cost = Contribution per unit

Break-even sales

Break-even quantity

Break-even sales will give us a sale figure on attainment of which the enterprise will reach a position of no profit no loss where as break-even quantity is the number of units to be sold to attain such a position. Margin of safety = The margin of safety indicates the amount by which the volume of sales exceeds the break-even point. The margin of safety is a tool by which one can estimate the sensitivity of the business to variation in sales. It is calculated as Profit x 100 Contribution Profit-volume Ratio = This ratio indicates the intrinsic strength of a production. It is calculated as Contribution Sales

x 100

If this ratio is declining, the conclusion could be that the product is losing the market due to one or more reasons like general obsolescence, price etc. Let us take one example: 25 Units Per Unit 50 Units Per Unit

46

Sale price per unit Total sales Variable Cost Contribution Fixed Cost Total Cost Profit Break-even Sales Break-even quantity

Rs. 60 Rs.1500 Rs. 1000 Rs. 500 Rs. 400 Rs. 1400 Rs. 100 80% 20 Rs. Rs. 20 Rs. 16 Rs. 56 Rs. -

40

Rs. Rs. Rs. Rs. Rs. Rs. Rs.

60 3000 2000 1000 400 2400 600 40% 20 Rs. Rs. Rs. Rs. Rs.

40 20 8 48 12

As we can see, the break-even sales in percentage form will change on the basis of number of units produced. However, the break-even quantity will remain unchanged. In the first instance, the unit will earn profit if it achieves 80% of the sales target of Rs.1500/- whereas in the second instance, the unit will earn profit if it achieves 40% of the sales target of Rs.3000/- Both these amounts are one and the same i.e. Rs.1200/-. Profit Margin of safety = x 100 Contribution 100 = x 100 = 20% 500 600 1000

or

x 100 = 60%

It indicates that in case of 25 units produced and sold, if the volume of sales of the business falls by 20 percent, the company will be able to withstand it because it can still pay for the full cost without making a loss. In case of 50 units produced, the margin of safety is 60% and it means that the company will be able to withstand a fall in sales up to 60% without making a loss. A higher ratio is always preferable. 500 1000 = x 100, 1500 3000 = 33 1/3% When a company is producing more than one product, the profit volume ratio becomes a very useful tool to analyse the relative strength of a particular product. A Company should choose to increase the sales of the product having higher profit volume ratio.

Profit volume Ratio

x 100

47

3.13

FUND FLOW ANALYSIS Fund Flow analysis is another tool to evaluate the managerial efficiency of an enterprise. This analysis will tell us how funds were mobilised and its uses. In any business, funds come first and then come assets. Prudent use of fund is the key to success in any commercial activity. Fund means purchasing power which is either cash or credit. Hence fund flow is defined as flow of total purchasing power of the business arising out of cash or credit. Sources and uses of Funds 1. Capital = Capital is the primary source of fund. All the components of capital like subscribed capital, preference share, share premium account etc. will be considered. Any increase in the capital between two periods of time is a source of fund and any decrease is a use of fund. Term Loans and Debentures = Any increase in term loan or debenture is a source of fund even if no cash is received. Machinery purchased with term loan is an example of increase in term loan and it is a source of fund. Any decrease, like repayment of term loan or debenture is use of fund. Current Liabilities = Any increase in current liability is a source of fund even if there is no transaction of cash. Inventory purchased on credit is the use of source arising out of increase in creditors. Fixed assets and Non-current Assets = Acquisition of assets is use of fund and their disposal is source of fund. Any increase in long term assets is utilisation of fund. Current Assets = Any increase in current assets would mean utilisation of funds, and any decrease, source of fund. Even reduction of cash is source of fund. This may appear to be confusing but an example will clarify this. Cash is reduced and the amount is utilised to repay term loan. Reduction of cash is source of fund and the reduction of term loan is use of fund. Source and use of fund can be graphically presented as under: Source of fund Increase in liabilities Decrease in assets The following example will illustrate the fund flow: Liabilities Share Capital Reserve & Surplus Ist Year 1300 1250 2nd Year 1300 1380 Change + 130 Source/Use Source Use of fund Decrease in liabilities Increase in assets

2.

3.

4.

5.

48

Long Term Loans Current Liabilities Total Assets Net Fixed Assets Non-Current Assets Current Assets Total

670 1100 4320 Ist Year 1180 980 2160 4320

610 1190 4480 2nd Year 1140 1070 2270 4480

- 60 + 90 +160 Change - 40 + 90 + 110 + 160

Use Source

Source/Use Source Use Use

Changes can be grouped as sources and uses of funds as illustrated below: Sources Increase in Reserve & Surplus Increase in Current Liabilities Decrease in Net Fixed Assets = = = 130 90 40 260 Uses Decrease in Long Term Loan Increase in Non-Current Assets Increase in Current Assets = = = 60 90 110 260 From the analysis of the above mentioned fund flow statement, the following interpretations can be made: (a) (b) (c) (d) (e) There is increase in Reserve & Surplus; a part (or may be full) of the profit has been retained in the business. This will increase shareholders fund. There is increase in Current Liabilities; this may increase cost, if the increase is in Cash Credit/Overdraft, or may not be so, if the increase is in provisions or creditors. Reduction in Net Fixed Assets due to depreciation/disposal is a source of fund. The fund so mobilised has been utilised for repayment of long term loan. This will reduce cost and hence will increase profit. There is increase in Non-Current Asset; a look into the actual component will tell us whether it will increase income or not.

49

(f)

Increase in Current Assets may increase production if the increase is in raw materials. A look into the actual item and its interpretation will reveal whether this use of fund is beneficial.

Fund Flow analysis will depict the prudence of the management decision in mobilising fund and its uses. A Fund Flow Statement can be used for various purposes but the primary ones are as under: a) b) It recognises major financial decisions made by the company which is reflected in the uses of fund and the sources of fund to finance them. To evaluate the short-term and long-term implications of the financial decisions made by the company in terms of the change in net working capital. To note the extent of deviations between the plan and the actual.

c)

50

ANNEXURE- I

Balance Sheet of ...................................................... As at ........................................................................ LIABILITIES SHARE CAPITAL 1. Authorised _______ Shares of Rs.__________ each 2. Issued _________ shares of Rs. ____________ each 3. Subscribed _______ shares of Rs. _________ each ASSETS FIXED ASSETS Original cost Add additions less deduction less depreciation up to the end of the year INVESTMENTS (1)Investments in Government or Trust Securities (1)Investments in Shares, debentures or Bonds (2)Immovable properties (3)Investments in the capital of Partnership firms CURRENT ASSETS, LOANS AND ADVANCES (A) CURRENT ASSETS 1. Interest accrued on Investment 2. Stores & Spare Parts 3. Loose Tools 4. Raw materials 5. Stock-in-trade/ Work-in-process 6. Finished Goods 7. Sundry Debtors a) Debts outstanding for a period not exceeding six months.

RESERVES AND SURPLUS 1. Capital Reserve 2. Capital Redemption Reserve 3. Shares Premium Account 4. Other Reserves specifying the nature of each Reserve and the amount in respect thereof 5. Surplus, i.e., balance in profit and loss account after providing for proposed allocations, namelyDividend, Bonus or Reserves.

51

6. Proposed addition to Reserves

b) Other debts 8. a) Cash balance on hand b) Bank balancesa) With scheduled banks and b) With others

SECURED LOANS 1. Debentures 2. Loans & Advances from Banks FIs 3. Loans & Advances from Subsidiaries UNSECURED LOANS 1. Fixed Deposits 2. Loans & Advances from subsidiaries 3. Short term loans & advances from 4. Other loans and advances from (a) Banks (b) Others CURRENT LIABILITIES AND PROVISIONS A. CURRENT LIABILITIES (1) Acceptance (2) Sundry Creditors (3) Advances payments and unexpired discounts for the portions for which Value has still to be given (4) Unclaimed dividends (6) Other liabilities (if any) (7) Interest accrued but not due on loans. B. 1. 2. 3. PROVISIONS Provision for Taxation Proposed dividends For contingencies

B. LOANS AND ADVANCES 1. Advances & Loans to subsidiaries 2. Advances and loans to partnership firms in which the company or any of its subsidiaries is a partner 3. Advances recoverable in cash or in kind or for value to be received viz.., Rates, Taxes, Insurance etc. 4. Advance to customers/others, if any

MISCELLANEOUS EXPENDITURE (to the extent not written off or adjusted) 1. Preliminary expenses 2. Expenses including commission or brokerage on underwriting or sub scription 3. Discount allowed on the issue of shares or debentures 4. Interest paid out of capital during construction. 5. Development expenditure not adjusted. 6. Other items (specifying natures) PROFIT AND LOSS ACCOUNT (if loss)

52

4. For Provident Fund Scheme, if any 5. For insurance pension and similar staff benefit scheme, if any 6. Other provisions A foot note to the Balance Sheet may be added to show separately(1) Claims against the company not acknowledged as debt. (2) Uncalled liability on shares partly paid (3) Arrears of fixed cumulative dividends (4) Estimated amount of contracts remaining to be executed on capital account and not provided for (5) Other money for which the company is contingently liable

53

ANNEXURE- II ABSTRACTS OF BALANCE SHEET 3.6.1 Branches/offices may classify individual items into groups according to the following form of analysis of Balance Sheet. Analysis of Balance Sheet Name of Company : _________________________________ (Rs. in Lakh) Sl.No Item 200__ 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Share Capital Reserve & Surplus (Excluding Revaluation Reserves) Share Application Fund Intangible Assets Tangible Net Worth (1+2+34) Deferred Liabilities Net Block (excluding Revaluation Reserves, if any) Net Current Assets Current Assets Current Liabilities For the year ended on 200__ 200__ 200__

54

11. 12. 13. 14. 15. 16. 17. 18. 19.

Net Working Capital (9 10 ) Sales (Net of Excise Duty, if any) Profit (Pre-tax)/Loss Profit (Post-tax)/Loss Depreciation Cash Generation (14 + 15) Current Ratio (9/10) Total Outside Liability/ Tangible Net Worth (6+10)/5 Details of Current Assets (a) Cash & Bank Balance (b) Loan & Advances (c) Advance Tax paid (d) I.T. Deducted at source (e) I.T. Refundable (f) Sundry Debtors (upto 6 months)

Sl.No

Item 200__ (g) Raw materials (h) W.I.P. (i) Finished goods (j) Others

For the year ended on 200__ 200__ 200__

20.

Details of Current Liabilities (a) Sundry Creditors for goods (b) Sundry Creditors for expenses (c) Accrued interest in Term Loan (d) Instalment for T/L payable within one year (e) Provision for Tax (f) Provision for others (g) Adv.from customers (h) Others (i) Short Term Borrowing from Bank(s) TOTAL :

55

21.

Details of Non-Current Assets: (a) Security Deposit (b) Term Deposit against Bank Guarantee (c) Investment (i) In sister concern (ii) Others (d) Sundry Debtors more than six months (e) Others, if any

22.

Details of Deferred Liabilities: (a) Term Loan with Bank (b) Term Loan with Financial Institutions (c) Unsecured loan from Directors (d) Unsecured loans from others (e) Interest accrued and due on (c) and (d) above (f) Others, if any

23.

Details of Intangible Assets: (a) Accumulated Loss (b) Preliminary Expenses (c) Others, if any

56

ANNEXURE III Format for analyzing P/L A/c Name : As per audited Figure at the end of a year (Audited) 1. Gross Sales i) Domestic sales ii) Export sales Total Add: Export Inventory & others 2. 3. 4. Less Excise Duty Net sales (1 2) % age rise (+) or fall (-) in net sales as compared to previous year Cost of sales i) Raw materials (including stores and other items used in the process of manufacture) a) Imported b) Indigenous ii) Other spares a) b) iii) Power & Fuel Imported Indigenous

5.

57

iv) Direct Labour (Factory wages & salaries) v) Other mfg. expenses vi) Depreciation vii) Sub-Total (i to vi) viii) Add: Opening stock-in-process Sub-Total ix) Deduct : Closing stock-in-process x) Cost of Production xi) Add : Opening Stock of finished goods Sub-Total xii) Deduct Closing stock of finished goods xiii) Sub-Total (Total cost of sales) 6. 7. 8. 9. Selling, general and administrative expenses Sub-Total (5 + 6) Operating profit before interest (3 7) Interest

10. Operating Profit after interest (8 9) 11. i) Add : Other non-operating income a) Dividend offer b) Sub-Total (income) ii) Deduct other non-operating expenses a) Loss on sale of Fixed Assets/Mutual Fund b) Sub-total (expenses) iii) Net of other non-operating income/expenses (net of 11 (i) & 11 (ii) 12. Profit before tax/loss 10 + 11 (iii)

58

13. Provision for taxes 14. Net Profit/loss (12 13) 15. a) Equity Dividend paid & Dividend Tax b) Dividend Rate 16. Retained Profit (14 15) 17. Retained profit/Net profit (%)

59

ANNEXURE- IV Abstracts of Balance Sheet of XYZ Co. Ltd 31.3.2012 (Audited) 1. 2. Share Capital Reserve & Surplus (excl.Rev. Reserve) i) Share Premium ii) General Reserve 3. Less : Intangible Assets (Prel.Expenses) Net Worth(Tangible) TNW Deferred Liabilities NetBlock(incl.capital work- in-process but excl.Revaluation Reserve ) Non-Current Assets Current Assets Current Liabilities 10 3740 2840 3740

230 6350 2165

4. 5. 6.

2690 1140 16110 11425 4685 46550 2920 2240 470 2710 1.41

7. 8. 9.

10. Net Working Capital (8- 9) 11. Sales (net of excise) 12. Profit (Pre-tax)/(Loss) 13. Profit (Post-tax)/Loss 14. Depreciation 15. Cash Generation (Post-tax) 16. Current Ratio 17. Total Outside Liab/TNW (TOL/TNW)

2.14

60

Current Assets Raw material Work-in-progress Finished Goods Sundry Debtors (Less than 6 months) Advance to supplier Cash in hand & bank 7050 1420 5010 1950 480 200 16110

Current Liabilities Sundry Trade Creditor Bills Payable Tax Payable Proposed Dividend Unclaimed Dividend Accrued Intt. not paid Instalments payable to IDBI Debenture FD Bank borrowing 6050 440 1550 750 30 60 35 70 140 2300 11425

Non-current Asset

Deferred Liability Debenture 210 105 530 900

Housing Loan to Employees Deposit with NABARD Security Deposit Investment Debtors over 6 months Amount due for Holding Co.

420 160 180 230 130 20 ---------1140 ------------

Loan from IDBI Loan from Holding Co. Fixed Deposit

Security Deposit

420

------2165 ---------

61

ANNEXURE - V Analysis of P/L A/c of XYZ Corpn. Ltd (Rs.in thousand) Estimates for the year ended/ending Name : As per audited Figure at the end of a year (Audited) 1. Gross Sales iii) Domestic sales iv) Export sales Total 2. 3. 4. Less Excise Duty Net sales (1 2) Cost of sales i) Raw materials consumed (including stores and other items used in the process of manufacture) a) Imported b) Indigenous ii) Other spares a. Imported b. Indigenous iii) Power & Fuel iv) Direct Labour (Factory wages & salaries) v) Other mfg. expenses vi) Depreciation vii) Sub-Total (i to vi) viii) Add: Opening stock-in-process Sub-Total 360 1,890 1,240 590 470 39,620 1,260 40,880 35,070 51,680 51,680 5,130 46,550

62

ix) Deduct : Closing stock-in-process x) Cost of Production xi) Add : Opening Stock of finished goods Sub-Total xii) Deduct Closing stock of finished goods xiii) Sub-Total (Total cost of sales) 5. 6. 7. 8. 9. 10. Selling, general and administrative expenses Sub-Total (5 + 6) Operating profit before interest (5+ 6) Interest Operating Profit after interest (3 7) i) Add : Other non-operating income a. Dividend offer b. Sub-Total (income) ii) Deduct other non-operating expenses a) Lost on sale of Fixed Assets/Mutual Fund b) Sub-total (expenses) iii) Net of other non-operating income/expenses (net of 11 (i) & 11 (ii) 11. Profit before tax/loss 10 + 11 (iii) 12. Provision for taxes 13. Net Profit/loss (12 13) 14. a) Equity Dividend paid & Dividend Tax b) Dividend Rate 15. Retained Profit (13 14) 16. Retained profit/Net profit (%)

1,420 39,460 2,910 42,370 5,010 37,360 5,050 42,410 4,140 1,580 2,560 360

2,920 -

2,920 2,920 680 2,240 -

2,240 76%

63

64

CHAPTER IV

ADVANCE AGAINST GOVT. SECURITIES TOPIC 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 Government Securities Promissory Note Advance under Discretionary Power Endorsement on Promissory Note G. P. Notes Renewal of GP Notes into marketable lots Advance against Govt. Securities Precautions Margin, Rate of Interest, Repayment On repayment of the advance Annexure 1 PAGE NO.

65

CHAPTER-IV

ADVANCE (OVERDRAFT/LOAN) AGAINST GOVT. SECURITIES 7.1. GOVERNMENT SECURITIES: 7.1.1. Government Securities mean the borrowing of the Central and State Governments from time to time. These borrowings are popularly known as Public Debt and are managed by Reserve Bank of India. Govt. Securities are issued generally in the following two forms : (a) (b) 7.2. Promissory Note; Inscribed Stock (Stock Certificate).

PROMISSORY NOTE : 7.2.2.1.This is the most usual form in which Govt. Securities are issued both by the Central and State Governments. A promissory note contains a promise by the President of India or Governor of a State to pay a certain sum of money to a certain person or to his order either on a specified date or after a certain notice and to pay interest thereon at a certain rate half yearly on specified dates. A promissory note is transferable by endorsement and delivery. 7.2.2.2.The reverse of the Govt. Promissory Note is vertically divided into two portions. On the left hand portion, half yearly interest payments are recorded and the right hand portion is reserved for endorsements. The right hand portion is divided into rectangular cages, each cage being meant for only one endorsement. The Promissory Note on which all the rectangular cages have been utilised shall be renewed into a fresh Promissory Note by the last holder. The last holder has to complete the form of receipt at the bottom right hand corner (on the reverse side) of the Note and lodge it for renewal with the nearest Public Debt Office of the Reserve Bank of India. The request for renewal should be accompanied by the prescribed renewal fee. 7.2.3 INSCRIBED STOCK (STOCK CERTIFICATE) 7.2.3.1 It is issued by the same authorities in token of having registered the name of the owner as the proprietor of a certain amount of a specified loan of the particular Government. 7.2.3.2 The form of a Stock Certificate is different from that of a Promissory Note and is not a negotiable instrument. Therefore, the property contained therein cannot be transferred by mere endorsement and delivery. The holder of a

66

Stock Certificate is therefore required to execute a regular transfer deed which is printed in the reverse of the Certificate. The transfer deed is exempt from Stamp Duty. A new Stock Certificate will be issued by Public Debt Office of Reserve Bank of India, in the name of the transferee on receipt of the original Stock Certificate on which the transfer deed has been duly completed by the transferor and transferee. 7.2.3.3 Stock Certificate can be held by one or more persons jointly but not severally and any one or more of them can receive interest thereon under a joint holders power of attorney which is free of Stamp Duty. 7.2.3.4 Interest on Stock Certificate is always remitted to the registered holder directly by the Public Debt Office of Reserve Bank of India, by their Pay Order, at the place where the interest payment is enforced. 7.3 ADVANCE UNDER DISCRETIONARY POWER: Advances against Govt. Securities may be made by the authorised Officers within the limits of their individual discretionary power sanctioned by the Head Office from time to time. Such advances shall be restricted to well-known customers or to customers satisfactorily introduced to the Bank. Note : Concerned branches should get the powers of Attorney, together with specimen signatures of their officers registered at all Public Debt Offices so that any securities which such officers might endorse are not returned by any Public Debt Office on the ground that Power of Attorney are not registered with them. 7.4. ENDORSEMENT ON PROMISORY NOTE : To be acceptable as security for advance endorsements in the G.P. Notes shall be regular and in proper form. They should satisfy the following requirements: a) Each cage on the reverse of G.P. Notes shall contain a pay order in the name of the endorsee and signature of the endorser. The pay order may be worded as follows: Pay to .. Pay to .. or order Endorsement may be single, joint and alternatively payable to the order, or joint order or to the order of either or any one or more persons according to the wishes of the endorser.

67

b)

All endorsements shall be legible and agree letter for letter with the name of the payee written on preceding cage. The chain of endorsements, if any, should be regular, unbroken and shall not bear any cross endorsement i.e., endorsement other than on the allotted cage meant for the purpose. Endorsement in an Indian language other than that of the State should be attested by a Justice of Peace or a Magistrate under his Court Seal. Endorsement of limited companies, partnership firms and registered or unregistered firms or associations shall be certified by the Public Debt Office. In case of an illiterate person the endorsement must be signed by a magistrate in the presence of the holder and enter below his signature a certificate to the effect that the endorsement has been signed at the request of the holder after being read over to him and that he is satisfied that the effect of endorsement is fully understood by the holder. When a Promissory Note is held by two or more persons jointly, for purposes of transferring the note by endorsement, the signature of each of the joint holders is essential and their signatures should tally letter for letter with their names already appearing on the Promissory Note.

c)

d)

e)

f)

g)

7.5. G.P. NOTES : Lodgment of G.P. Notes as security against advance shall be made by a Take Delivery letter (Form No. D-9 Documentation Manual) (Annexure I). The G.P. Notes issued originally in the name of the customer shall be duly endorsed in favour of the Bank as Pay to United Bank of India or order and retained in the branch. In case the securities are endorsed in favour of the customer it must be seen that all previous endorsements are regular and verified, if necessary. In case of any doubt as to the validity of any endorsement the customer should be asked to renew the security in his own name and endorse it to the Bank. While accepting the securities, besides the scrutiny of endorsements, as stated above, the concerned officials must ensure: a) b) c) that interest has been collected up-to-date that the G.P. Notes are not amongst those which are in the stop list. That the upper and lower halves of the securities are firmly joined and none of them are mismatched. That there is a blank renewal cage and at least one blank endorsement cage for the use of the Bank. That interest is payable in the local office of RBI/SBI/Treasury

d)

e)

68

7.6. RENEWAL OF G.P. NOTES INTO MARKETABLE LOTS : In the case of large limit against G.P. Notes it is advisable to get the small denomination Notes consolidated into marketable lost of Rs. 25,000/- each at the time of renewal. When more than one note is required to be consolidated in one note at the time of renewal, the usual wordings in the renewal cage will be as follows: Received in lieu hereof a new note, payable to (Name of holder) for Rs. by consolidation with promissory notes Nos. . (mentioning the number and amounts of the other notes desired to be consolidated with it specifying the loan) with interest payable at . Treasury. Signature of the holder 7.7. ADVANCE AGAINST GOVT. SECURITIES-PRECAUTIONS Before granting such advance, the following points are to be kept in mind: i) No advance should be made against security of Promissory Note/Stock Certificate standing in the name of third party. The margin at the rate prescribed is to be maintained on the prevailing market rates and not on the face value of securities. No advance should be granted against Zamindari Abolition Bonds, Compensation Bonds or securities which are on the Stop list. Bearer Bonds presently are also not acceptable as security. Since Stock Certificate is not transferable by endorsement, it is necessary to get the stock transferred in the Banks name from the concerned Public Debt Office before an advance is granted there against. This is done by signing a special form of transfer printed on the reverse of the certificate both by the transferor and the transferee in presence of a witness. Alternatively intending Govt. Promissory Note to be subsequently endorsed in favour of the Bank before any advance is granted thereagainst. The Promissory Note should be in the name of the borrower as the original holder or endorsed to him by approved bank of standing. In all other cases, the borrower should be advised to have the securities renewed in his name before acceptance as security for advance unless the Bank has taken delivery of the securities directly from another bank under instructions from the borrower. Only in special cases as for example in brokers accounts, securities with prior endorsement may be accepted.

ii)

iii)

iv)

v)

69

vi)

Endorsements on Promissory Note should be in order and complete as specified in para 7.4.1 above. In case of cross endorsement, new Promissory Note should be got issued by Public Debt Office and then only advance should be made. The promissory Note should not be defaced or torn and two halves are not mismatched. If it is torn, defaced or two halves are mismatched, a new Promissory Note should be got issued from the Public Debt Office before any advance is made. In case of advance to a limited company against G.P. Notes it must be ensured that the power of attorney of the authorised signatories endorsing the securities on behalf of the company has been registered with the concerned Public Debt Office, treasury or subtreasury as the case may be. In the case of partnership firms the constitution and signatures of the partners and in the case of a proprietary firm, an affidavit in the form of sole proprietorship declaration shall be similarly registered. Acceptance of Promissory Notes as security against advance shall be made upon compliance of the provisions indicated at para 7.5 above. Besides usual advance documents, Letter of Lien should be obtained. Particulars of documents relating to advance and Promissory Note/Stock Certificate shall be entered in Security Register and Loan Ledger duly checked and initialled by the officer concerned. Details of Promissory Notes/Stock Certificates shall be entered in the Drawing Power Register. Value of Securities as per current market rate should be worked out and after providing stipulated margin, drawing power is to be ascertained. It should be checked and initialled by an authorised officer. A regular watch should be kept on the price fluctuation of securities. All the securities in any advance should be revalued once in a month in the Drawing Power Register and if the stipulated margin falls short, necessary amounts should be arranged for deposit to maintain the required margin. Valuation should also be done forthwith, if at any time there is a steep fall in prices of securities owing to adverse political, economic factors or for any other reasons. A due date diary for collection of interest on securities held at the Branch should be maintained and interest should be collected promptly and regularly on due dates. An interest collection register should be maintained to keep records on the particulars of securities sent for collection of interest, encashment, renewal etc Where interest warrants are received from Reserve Bank of India, the amount less tax should be credited to the account of the borrower(s) under advice to him/them. The relative Income Tax Deduction Certificate should be delivered to the borrower(s).

vii)

viii)

ix)

x) xi)

xii)

xiii)

xiv)

xv)

xvi)

70

7.8.

MARGIN, RATE OF INTEREST AND REPAYMENT: As may be prescribed by the Head Office from time to time.

7.9.

ON REPAYMENT OF THE ADVANCE When the advance is repaid, the Branch shall endorse the Promissory Note in favour of the borrower and deliver the same to him against proper acknowledgement. In case of Stock Certificate, the transfer form on the reverse of it should be completed and signed and delivered to the borrower against proper acknowledgement.

71

ANNEXURE I TAKE DELIVERY LETTER Address ____________________ Date _______________________ The Manager United Bank of India _________________ Branch Dear Sir, I/We hand you herewith the undernoted securities, which please hold as cover against my/our indebtedness to the Bank from time to time. Yours faithfully, ______________________________________________________________________________ _________________________________________________________________________________ _______________________________________________________________

72

CHAPTER V Advance against Shares, Bonds & Debentures TOPIC 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 8.9 Eligibility Purpose of advance Type of advance Basis for accepting shares as security Precautions to be taken in accepting shares as security Eligibility Margin Valuation of Shares Repayment Period PAGE NO.

8.10 Taking of Security 8.11 Blank Transfers 8.12 Transfer of Shares 8.13 Ceiling on total holding of Shares of any one Company 8.14 Drawing limit 8.15 Third Party Shares 8.16 Authority to collect Dividend 8.17 Shares in Private Limited Companies 8.18 Interest 8.19 Penalty Clause 8.20 Office Record and Book keeping 8.21 Drawing Power Register 8.22 Ex-custody Register 8.23 Custody of Securities 8.24 Delivery of securities 8.25 Enforcing of security 8.26 Reporting 8.27 Conclusion Annexure I Annexure II

73

CHAPTER-V

ADVANCE (OVERDRAFT/LOAN) AGAINST SHARES, BONDS & DEBENTURES 1. (a) To be eligible for advance against quoted shares the customers should be well known or satisfactorily introduced to the branch. Advances against security of shares/debentures /bonds may be given to individuals, share and stock brokers and market makers and Corporate Houses. b) While considering grant of advances against shares / debentures /bonds the Bank must follow the normal procedures for the sanction, appraisal and post sanction follow-up. c) Advances against the primary security of shares / debentures / bonds should be kept distinct, separate and not combined with any other advance. d) The Bank should be satisfied about the marketability of the shares / debentures and the networth and working of the company whose shares / debentures / bonds are offered as security. e) Shares / debentures / bonds should be valued at prevailing market prices when they are lodged as security for advances. f) Bank should exercise particular care when advances are sought against large blocks of shares by a borrower or a group of borrowers. It should be ensured that advances against shares are not used to enable the borrower to acquire or retain a controlling interest in the company/companies or to facilitate or retain inter-corporate investments.

g) No advance against partly paid shares shall be granted. h) No loans to be granted to partnership / proprietorship concerns against the primary security of shares and debentures. i) j) Bank should not undertake financing of Badla transactions. Bank should not extend credit facilities directly or indirectly to stockbrokers for arbitrage operation in Stock Exchanges.

k) Advances against share/debenture in physical form to be discontinued.Securities are held in dematerialised form, the requirement relating to transfer of shares in bank's name will not apply. However, the Bank should avail of the facility provided in the depository system for pledging securities held in dematerialised form, under which the securities, pledged by the borrower, get blocked in favour of the Bank In case of default by the borrower and on the bank exercising the option of invocation of pledge, the shares and debentures get transferred in the bank's name immediately. l) Bank should not be a party to transactions such as making advances or issuing back-up guarantees favouring other banks for extending credit to clients of Indian nationality / origin by some of their overseas branches, to enable the borrowers to make investments in shares and debentures / bonds of Indian companies.

74

Advances against the Security of Shares, Debentures or Bonds to Individuals A. Purpose For meeting contingencies and needs of personal nature or for subscribing to rights or new issue of shares / debentures / bonds or for purchase in the secondary market, against the security of existing shares / debentures / bonds held by an individual in dematerialized (demat) form. B. Eligibility Any individual customers (existing / new) with proper introduction and complying KYC norm can avail the loan either singly or jointly. A large group of individuals belonging to the same corporate or their inter-connected entities shall not be allowed to take multiple loans in order to support particular scripts or stock-broking activities of the concerned firms. A declaration from the borrower is to be obtained mentioning the following: (a) details of loans availed by him from other banks/branches against security of shares/ debentures/bonds (both in physical and demat form); (b) such accommodation/s from different banks/ branches is/are not obtained against shares of a single company or a group of companies; C. Facility & Tenure: Loan against security of shares, debentures, or bonds in demat form may be in the form of Overdraft (to be reviewed/renewed once in every 12 months) or Term Loan for a maximum period of 12 months. D. Loan Amount For securities under Capital Market exposure Aggregate loans of the borrower (including proposed one) against the shares, convertible bonds, convertible debentures and units of equityoriented mutual funds from the banking system should not exceed the limit of Rs. 20 lakhs per individual if the securities are held in dematerialized form. (The components of Capital Market Exposure are detailed in Para 11.21.3 of Vol.1 of the Lending Policy) For securities under non-Capital Market exposure Aggregate loans of the borrower (including proposed one) against preference shares / nonconvertible debentures and bonds should not exceed the limit of Rs. 20 lakhs per individual if the securities are held in dematerialized form. (The components of Non-Capital Market Exposure are detailed in Para 11.21.4 of Vol.1 of the Lending Policy) In case of existing loan/advance against securities in physical form, immediate arrangement should be made to convert such securities into demat form. E. Security: Pledge of the equity shares/debentures/bonds (in demat form) held in the name of the borrower/s only against which the loan is granted.

75

Transfer of securities (in demat form) in banks name may not be insisted upon provided it is ensured that the securities pledged by the borrower get blocked in favour of the bank by availing the facility provided in the depository system for pledging securities held in demat form. Although collateral security is not mandatory for sanctioning loan, sanctioning authority may stipulate, if felt necessary, additional security subject to availability and enforceability. G. Eligible Securities i. The shares/ debentures/ bonds offered as security should be listed with NSE/BSE. ii. The shares/ debentures/ bonds offered as security should be in dematerialized (demat) form. iii. Securities which are under lock in period will not be eligible. iv. Shares, debentures, bonds offered as security should be fully paid. v. Equity shares should be listed under BSE 100 &/or Nifty 50 Index and/or Bank Nifty Index vi. Debentures/Bonds/Preference Shares must have AA or higher rating by CRISIL/ICRA/CARE/ FITCH. vii. Before sanction, approval of the I&FM Department &/or Treasury Branch at H.O. is to be obtained on acceptability of the proposed securities along with valuation of the securities. viii. Substitution of security during the tenor of the facility may be allowed, if requested by the borrower, subject to compliance with the norms stated under i-vii above and maintenance of margin. H. Margin a. For securities held in demat form under capital market exposure for existing loan only: Minimum margin of 25% of the market value of the securities and the stipulated margin is to be maintained throughout the tenure of the loan. b. For securities held in physical form under capital market exposure: Minimum margin of 50 percent of the market value (for existing loans only) and the stipulated margin is to be maintained throughout the tenure of the loan. Early arrangement for conversion of such securities in physical form to demat form should be initiated. c. For securities, not under capital market exposure, held in demat form: Minimum margin of 20% of the market value and the stipulated margin is to be maintained throughout the tenure of the loan. d. For all above categories, Availability of stipulated margin is to be ascertained on fortnightly based on valuation of the securities to be obtained from the I&FM Department &/or Treasury Branch, H.O. However, it should be topped up immediately in case the price of the securities moves in adverse direction by more than 10%. The borrower will be given one days notice for topping up as required or to bring down the outstanding balance within the eligible drawing power. In case the borrower fails to top up or bring down the outstanding balance as above, the Bank shall sell the securities on next day and adjust the proceeds with the loan. I. Repayment In case of Overdraft facility, unless the limit is reviewed and renewed, outstanding amount is to be liquidated at the end of the tenure.

76

In case of term loan, the principal amount is to be repaid in monthly/quarterly/half-yearly instalments or by bullet payment at the end of the tenure. Interest is to be serviced on monthly basis. In case the borrower defaults in servicing interest and/or repayment of loan instalments, on due dates the securities are to be sold and proceeds to be appropriated with the overdues. J. Sanctioning Authority: Branches headed by Scale-IV and above officers, RLCC and HLCC as per H.O. Circular on Delegation of Financial Power to be issued by the CPPMI Department, H.O. from time to time.

Financing of Initial Public Offerings (IPOs)

Banks may grant advances to individuals for subscribing to IPOs. Loans/advances to any individual from the banking system against security of shares, convertible bonds, convertible debentures, units of equity oriented mutual funds and PSU bonds should not exceed the limit of Rs.10 lakh for subscribing to IPOs. The corporates should not be extended credit by banks for investment in other companies IPOs. No finance should be provided to NBFCs for further lending to individuals for IPOs. Finance extended by a bank for IPOs should be reckoned as an exposure to capital market. A uniform margin of 50 per cent shall be applied on all advances / financing of IPOs Bank Finance to assist employees to buy shares of their own companies: Bank may extend finance to employees for purchasing shares of their own companies under Employees Stock Option Plan(ESOP)/ reserved by way of employees' quota under IPO to the extent of 90% of the purchase price of the shares or Rs.20 lakh, whichever is lower. Finance extended by the bank for ESOPs/ employees' quota under IPO would be treated as an exposure to capital market within the overall ceiling of 40 per cent of its net worth. Note: These instructions will not be applicable for extending financial assistance by the bank to its own employees for acquisition of shares under ESOPs/ IPOs, as banks are not allowed to extend advances including advances to their employees / Employees' Trusts set up by them for the purpose of purchasing their own banks shares under ESOPs / IPOs or from the secondary market. This prohibition will apply irrespective of whether the advances are secured or unsecured. A declaration should be obtained from the borrower indicating the details of the loans / advances availed against shares and other securities specified above, from any other bank/s in order to ensure compliance with the ceilings prescribed for the purpose. Follow up Public Offer (FPO) shall also be included under IPO

Advances against shares to Stock Brokers, Market Makers:

Advances to Share and Stock Brokers (a) The Bank shall grant advances only to entities registered with SEBI as share and stock brokers and who comply with capital adequacy norms prescribed by SEBI / Stock Exchanges.

77

However, advance against primary security of shares can only be granted to corporate entities not to proprietorship/partnership firms. Total credit facilities (fund+ non-fund) should normally not exceed the tangible net worth of the broker as per the balance sheet of the last accounting year of the borrower. (b) Track record, credit worthiness of the broker and financial position, operations on his own account and on behalf of clients, income earned, the average turnover period of stocks and shares and the extent to which the broker's funds are required to be involved in his business operations are also to be carefully assessed. A status report (issued by Exchange) indicating dealings of the brokers account must be obtained.

(c)Credit Facilities
i) Overdraft/Line of Credit against Stock in Trade Share and stock brokers may be provided need based overdraft facilities / line of credit against shares and debentures held by them as stock-in-trade. A careful assessment of need based requirements for such finance should be made taking into account the financial position of the borrower, operations on his own account and on behalf of clients, income earned, the average turnover period of stocks and shares and the extent to which the broker's funds are required to be involved in his business operations. Large scale investment in shares and debentures on own account by stock and share brokers with bank finance, should not be encouraged. The securities lodged as collateral should be easily marketable. Please also refer Lending Policy clause no.11.21.6(h) page 132 Working Capital Facility for DVP Transaction Banks may grant working capital facilities to stock brokers to meet the cash flow gap between delivery and payment for DVP transactions undertaken on behalf of institutional clients viz. FIs, Flls, mutual funds and banks. The duration of such a facility will be short and would be based on an assessment of the financing requirements keeping in view the cash flow gaps, the broker's funds required to be deployed for the transaction and the overall financial position of the broker. The utilisation of loan fund under the limit is to be monitored on the basis of individual DVP transactions as under: The borrower furnishes details of the scrips to be purchased on behalf of his client under DVP basis (e.g. total no. of scrips, estimated purchase price per scrip and total value, brokerage payable and date of payment by the client to the broker) backed by the contract between the borrower and its client in this regard. The borrower shall ensure that the full consideration amount from its clients related to each DVP transaction, financed by the Bank, should be credited directly to the borrowers designated account with the Bank. The borrower submits requirement of fund for purchase of such scrips under DVP duly supported by the instruction of the concerned clearing house to the borrower for remitting funds to the specified bank account along with the settlement status report. Funds are to be remitted only to the specified bank account only. The outstanding loan amount under each DVP transaction is to be liquidated as soon as the whole lot of scrips under a particular DVP transaction stands transferred in the name of the client or latest by the date of payment by the client to the broker as per the contract. If the particular DVP transaction outstanding is not liquidated within the stipulated period, the collateral securities held by the Bank will be sold to the extent required and proceeds will be adjusted in the loan account.

ii)

78

iii) Bank Guarante Banks may issue guarantees on behalf of share and stock brokers/commodity brokers in favour of stock exchanges in lieu of security deposit to the extent it is acceptable in the form of bank guarantee as laid down by stock exchanges. Banks may also issue guarantees in lieu of margin requirements as per stock exchange regulations. The bank should assess the requirement of each applicant borrower, observe usual and necessary safeguards including the exposure ceilings. Maximum tenure of BG will be 12 months. (d) While processing proposals for loans to stock broker, the details of facilities enjoyed from other bank by the broker and all his connected accounts should be obtained. (e) The general guidelines on advances against shares/debentures/bonds are also to be followed as far as applicable. (f) To any single stock broking entity, including its associates / inter-connected companies, the fund based advance shall not exceed Rs.100 lakh and non-fund based facility shall not exceed Rs.1000 lakh. (g) Total credit facility (fund & non-fund based) to all stock brokers/ market makers shall not exceed 0.50% of the total advance as on 31st March of previous year. Aforesaid 0.50% subceiling shall be within the overall ceiling of 40% of the net worth of the Bank as on 31st March of the previous year. (h) Pricing: For fund based facilities, at applicable interest rate as per Banks extant interest rate circular. Deviations may be allowed by the competent authority as per the provisions of the Lending Policy. For non-fund BG facility, as per H.O. Circular on Service Charges issued by CPPI Department, H.O. from time to time. (i) Security: (i) Overdraft/Line of Credit To be fully secured by way of primary security in the form of shares/debentures/bonds held by the borrower as stock-in-trade and hypothecated to the Bank. Collateral @ 50% of the fund based limit in the form of eligible shares/debentures/bonds (in demat form) pledged to the Bank which should be easily marketable and/or any other tangible security with easy liquidity. (ii) DVP Transaction To be fully secured by collaterals in the form of eligible shares/debentures/bonds or any tangible securities with easy liquidity acceptable to the Bank. (iii) For Bank Guarantee Bank guarantee is to be secured in full by collaterals in the form of eligible shares/debentures/bonds and/or any tangible securities with easy liquidity acceptable to the Bank. Counter guarantee of the company. (iv) Personal Guarantee of promoter(s) covering entire limit would be preferred (v) Eligible Shares/Debentures/Bonds

79

Shares listed under BSE 100 Index and/or Nifty 50 Index and/or Bank Nifty Index; Debentures/Bonds having CRISIL AA rating or equivalent rating from CARE, ICRA, FITCH, Brickwork or any SEBI approved rating agencies.

(j) Margin: A uniform margin of 50 per cent shall be maintained on fund based and non-fund limits during the tenure of the facility/ies. Minimum cash margin of 25 per cent (within the margin of 50%) shall be maintained in respect of guarantees issued by banks for capital market operations. (k) Drawing Power (D.P.): D.P. for Overdraft/Line of Credit/DVP limit will be allowed only on the eligible shares/debentures/bonds. Drawing Power (D.P.) will be computed on Second and Last Friday of each month. In case there is shortfall in margin/D.P., the borrower is to be advised immediately to make good the shortfall in the next 2 working days, failing which the security shall be invoked / enforced and adjusted against the outstanding. For outstanding BG, the proceeds out of sale of securities is to be kept in FD under lien as security for the BG till expiry. No fresh BG will be issued until the shortfall in margin is made good. (l) Valuation of Securities Valuation of shares (both primary as well as collateral) are to be valued on Second and Last Friday of each month at closing price or current market price, whichever is lower. Debentures/Bonds (both primary as well as collateral) are to be valued on Second and Last Friday of each month based on valuation available on FIMMDA website. Valuation of securities is to be done by the Banks I&FM Department &/or Treasury Branch at H.O. and intimated to the concerned Branch. The concerned departments at H.O. may arrange for a system for daily notification of previous days closing price for the eligible securities. (m) The requirement relating to transfer of shares in bank's name in respect of shares held in physical form mentioned at Sl. No. (xi) of paragraph 11.21.6 shall not apply in respect of advances granted to share and stock brokers provided such shares are held as security for a period not exceeding nine months. In the case of dematerialised shares, the depository system provides a facility for pledging and the bank may avail themselves of this facility and in such cases there will not be need to transfer the shares in the name of the bank irrespective of the period of holding. The share and stock brokers are free to substitute the shares pledged by them as and when necessary. In case of a default in the account, the bank should exercise the option to get the shares transferred in its name. (n) Sanctioning Authority: At Head Office level and operation through designated branches.
11.21.8.2 Bank Finance for Market Makers

(a) A company approved by stock exchange as Market Maker will only be eligible for grant of advances by the Bank for the purpose of its market making activities. (b) Market Making may be for equity and/or debt securities including State and Central Government securities. Bank should exercise commercial judgement in determining the genuine need based working capital requirements of Market Makers by taking into account their Market Making Operations. Assessment of need based requirements for such finance should be made taking into account the track record, credit worthiness of the Market Maker and its financials. (c) The general guidelines on advances against shares/debentures/bonds are to be followed as far as applicable.

80

(d) Market Makers may be provided with overdraft facilities / line of credit (fund-based) facilities and non-fund bank guarantee on behalf of market makers, for a tenure upto one year. (e) To any single market maker entity, total fund and non-fund based limits shall not generally exceed Rs.50.00 crores. (f) Total credit facility (fund & non-fund based) to all market makers / stock brokers shall not exceed 0.50% of the total advance as on 31st March of previous year. Aforesaid 0.50% sub-ceiling shall be within the overall ceiling of 40% of the net worth of the Bank as on 31 st March of the previous year. (g) Pricing: For fund based facilities, at applicable interest rate as per Banks extant interest circular. Deviations may be allowed by the competent authority as per the provisions of the Lending Policy. For non-fund BG facility, as per H.O. Circular on Service Charges issued by CPPI Department, H.O. from time to time.

(h)

Security: The total limit (fund / non-fund) to Market Makers is to be secured by way of collateral in the form of scrips other than the scrips in which the market making operations undertaken. Eligible Securities: Shares listed under BSE 100 Index and/or Nifty 50 Index and/or Bank Nifty Index; Debentures/Bonds having CRISIL AA rating or equivalent rating from CARE, ICRA, FITCH, Brickwork or any SEBI approved rating agencies. Such collateral securities should be in demat form and duly pledged in favour of the Bank. The securities lodged as collateral should be easily marketable. Counter guarantee of the company for BG. Personal Guarantee of promoter(s) covering entire limit would be preferred. (i) Margin: Uniform margin of 50% on all advances / financing of IPOs / issue of guarantees on behalf of Market Makers. A minimum cash margin of 25% (within the margin of 50%) shall be required to be maintained in respect of guarantees issued by banks for capital market operations. (j) Drawing Power/margin computation: Drawing Power (D.P.) for Overdraft/Line of Credit will be allowed only on the eligible shares/debentures/bonds. Drawing Power (D.P.) will be computed on Second and Last Friday of each month. In case there is shortfall in margin/D.P., the borrower is to be advised immediately to make good the shortfall in the next 2 working days, failing which the security shall be invoked / enforced and adjusted against the outstanding. For outstanding BG, the proceeds out of sale of securities is to be kept in FD under lien as security for the BG till expiry. No fresh BG will be issued until the shortfall in margin is made good. (k) Valuation of Securities Valuation of shares are to be valued on Second and Last Friday of each month at closing price or current market price, whichever is lower. Debentures/Bonds (both primary as well as collateral) are to be valued on Second and Last Friday of each month based on valuation available on FIMMDA website.

81

Valuation of securities is to be done by the Banks I&FM Department &/or Treasury Branch at H.O. and intimated to the concerned Branch. The concerned departments at H.O. may arrange for a system for daily notification of previous days closing price for the eligible securities. (l) It is to be ensured that advances provided for Market Making are not diverted for investment in shares other than the scrip earmarked for Market Making purpose. For this purpose, before each drawal, it is to be ensured that The borrower furnishes details of the scrips on which market making operation will be undertaken. Funds are released only for those scrips selected for market making operations after the borrower submits requirement of fund duly supported by (i) the instruction of the concerned clearing entity to the borrower / to the borrowers broker (if the borrower itself is not a broker) for remitting funds to a specified bank account. Funds should be remitted to said specified bank account only; (ii) the settlement status report issued by the concerned clearing agency for such scrips. The borrower furnishes monthly statement on its position of holding scrips including market making scrips supported by copy of the statements issued by the exchange/s.

(m) Sanctioning Authority: At Head Office level and operation through designated branches.
On the basis of the above broad guidelines, the Banks CPPI Department at H.O. shall formulate detail operative guidelines on Advances to Market Makers covering, inter alia, mechanism for monitoring utilization of individual transactions, maintenance of margin, creation of security, substitution of security, sale of securities, designated branch, etc. The CPPMI Department at H.O. shall put up, at least on a half-yearly basis, to the Board of Directors a review note on the aggregate portfolio, its quality and performance.
11.21.9 Advances to other borrowers against shares/debentures/bonds

Granting advances against primary security of shares and debentures including promoters shares to industrial, corporate or other borrowers should not normally be there. However, such securities, only in dematerialized form, may be accepted as collateral for secured loans granted as working capital or for other productive purposes from borrowers other than NBFCs. In the course of setting up of new projects or expansion of existing business or for the purpose of raising additional working capital required by units other than NBFCs, there may be situations where such borrowers may not be able to find the required funds towards margin, in anticipation of mobilizing long-term resources. In such cases the Bank may obtain collateral security of shares and debentures by way of margin. However, such arrangements would be of a temporary nature and shall not continue beyond a period of one year. Before granting such facility the capacity of the borrower to raise the required long-term funds and to repay the advance within the stipulated period (max. 1 year) is to be ensured. Such type of advances shall be considered only at H.O. level.
11.21.10 Bank finance to individuals against shares to joint holders or third party beneficiaries: While granting advances against shares held in joint names to joint holders or third party beneficiaries, it should be ensured that the objective of the RBI regulations is not defeated by granting advances to other joint holders or third party beneficiaries to circumvent the above limits placed on loans/advances against shares and other securities specified above. 11.21.11 Finance for Margin Trading

82

i)

Banks may extend finance to stockbrokers for margin trading, subject to the following parameters: The finance extended for margin trading should be within the overall ceiling of 40% of net worth prescribed for exposure to capital market.

ii) A minimum margin of 50 per cent should be maintained on the funds lent for margin trading. If the stock broker fails to meet the margin calls, the Bank should liquidate the collateral / shares purchased immediately and adjust the loan. iii) The shares purchased with margin trading should be in dematerialised mode under pledge to the lending bank. It should be ensured that 50% margin is maintained on an ongoing basis. iv) Margin trading should be spread out by the bank among a reasonable number of stockbrokers and stock broking entities. Stock brokers availing of margin trading facilities from the Bank is prohibited from lending, directly or indirectly, to their own connected entities, relatives or business associates or to Directors of the Bank through this facility. v) The end-use of funds lent under margin trading is to be monitored by way of ensuring submission of appropriate monthly statement by the stock broker to the sanctioning authority / controlling Region and to the Branch. The audit Committee of the Board should monitor periodically the Banks exposure by way of financing for margin trading and ensure that the guidelines formulated by the Banks Board are complied with.

83

8.3

Type of Advance Bank may allow loan or overdrafts against shares on merits on being satisfied about the end use of funds. The advances should be generally payable on demand or on short term basis subject to a repayment programme.

8.4

Basis for accepting Shares as security While accepting the shares as security, the net worth position of the company alongwith the following points are to be considered: i) Marketability of shares whether the shares are quoted in a recognised stock exchange or not ; Dividend record of the company; Range of price fluctuations in its shares The details of the managements caliber and integrity; The assets and the product line of the company; Age of the company; Intrinsic or break up value of the share concerned.

ii) iii) iv) v) vi) vii)

Granting advances against shares forming a security composite with any other security is prohibited. Where an advance has been granted or renewed against the composite security of shares and other types of securities, the advance limit against shares will require to be segregated from the advance limit against other types of securities. However, when shares are held as co-lateral security and no specific limit is fixed thereagainst, the question of segregation of limits shall not arise. 8.5. Precautions to be taken in accepting shares as surety: 8.5.1. No advance shall be made: (i) (ii) (iii) against shares which are not quoted on any recognised stock exchange against shares where the right to transfer is restricted against temporary receipts or letters of allotment unless these are exchanged for share certificates and scripts; against shares held in safe custody account unless they are first transferred to advance account;

(iv)

84

(v) (vi) 8.5.2

against shares in private limited company; against partly paid shares.

Care and caution should be exercised when advances are sought against large block of shares by a borrower or a group of borrowers from the point of view of borrowers capacity to repay such advances and also from the point of view to ensure that such advances are not utilised for other than short term productive purposes and genuine business needs or meeting immediate genuine and urgent personal needs. It should also be ensured that loans/advances against shares are not used to enable the borrowers or a group of borrowers to acquire or to retain the controlling interest in company/companies or to facilitate or retain inter corporate investment.

8.5.3. The bank shall ensure while granting advances against shares that there is no restriction imposed as to the exercise of voting rights by the bank or requiring the bank to issue proxies in respect of such shares. 8.6. Eligibility : 8.6.1. Advances to individuals : i) Purpose : Loans against shares, debentures and bonds of Public Sector Undertakings (PSUs) may be granted to individuals to meet contingencies and personal needs or for subscribing to rights or new issues of shares/debentures/bonds or for purchase in the secondary market. Amount of Advances : a) The advances to individuals against security of shares and debentures shall not exceed Rs. 10 lac against physical shares and Rs. 20 lac against dematerialised shares. b) The maximum amount of finance to an individual for Initial Public Office (IPO) is Rs. 10 lac. No loans to be granted against partly paid shares. No loans to be granted to partnership/proprietorship against the primary security of shares and debentures. 8.6.2. Advance to share and stock brokers : i) Purpose: Advances to share and stock brokers may be provided by way of needbased overdraft facilities/line of credit against shares and debentures held by them as stock-in-trade. A careful assessment of need based requirement for such finance should be made taking into account the financial position of the borrower, operation on his own account and on behalf of clients, income earned, the concerns

ii)

85

average turnover period of stocks and shares and the extent to which the brokers funds are required to be involved in his business operation. ii) Amount: To any single stock broking entity, the fund based advance shall not exceed Rs.20 lac and non-fund based limit shall not exceed Rs. 30 lac.

8.6.3. Loan/Advance against shares to corporate for meeting promoters contribution: i) For existing corporate borrowers/deposit holders : a) The account, where advance is sought, should be under the category of Standard Assets based on the latest available information which should not be older than 6 (six) months. b) The credit rating of the corporate should be minimum of UBICR3 based on latest available Balance Sheet and other performance parameters as per banks credit rating policy not older than one year. c) The corporate have good track record as regards financial performance and its financial position based on the latest available Balance Sheet should be satisfactory. d) General conduct of the corporate borrower should be satisfactory and there should not be any major adverse inspection comments pending in the account. e) Profile of the new company to be promoted by the corporate borrower/promoter should be submitted to the bank for scrutiny and should be found satisfactory. The name of the promoter should not appear in RBIs latest published defaulters list. ii) For new corporate borrowers: a) The name of the corporate must not appear in RBIs latest published defaulter list. b) Credit report from the corporates existing bankers, if any, does not indicate any adverse comment. c) Profile of the new company to be promoted by the applicant corporate/promoter should be submitted to the bank for scrutiny and should be found satisfactory. d) The company should submit its audited Balance Sheet for the last three years and on its scrutiny it should be ensured that current ratio has been maintained at minimum 1.33:1 and TOL/TNW at not more than 2:1.

86

iii)

In case of both categories of corporate borrowers mentioned under (i) and (ii) above, they have to satisfy the bank about their capacity to raise the required funds to meet their Promoters contribution towards equity of the new company, about the source of such funds and that they will be able to repay the advance, if granted, within the stipulated time. Amount of loan : The loan amount to be guided by instructions from Head from time to time.

8.7.

Margin : i) To individual : Minimum 50% of the market value of equity shares/convertible debentures held in physical form and 25% in case of dematerialised form. To share and stock brokers: This will be decided in the Banks policy to be formulated for this type of advance from time to time. Corporates: 50% of the market value of the shares proposed to be lodged/transferred.

ii)

iii)

Note : Bank may stipulate higher margin for shares whether held in physical form or dematerialised form depending upon the quality of shares ; margin requirements for advances against preference shares/non convertible debentures and bonds shall be determined by the bank depending upon the merit of the proposal and the nature of such securities. 8.8. Valuation of shares : 8.8.1. Shares/Debentures/Bonds lodged as security for advance shall be valued at prevailing market prices on the basis of the lowest of last 52 weeks quoted price. For the purpose of valuing quoted securities reference should be made to newspapers which give market quotations of Govt. securities, shares and debentures dealt in on stock exchanges. Fluctuations in prices should be periodically recorded in Market Report Register Book No.175. In making advance, a mixed portfolio of shares in leading Companies forms the most acceptable security. The price should be updated every fortnight on the basis of published list of stock exchange or published in standard papers like Economic Times/Business Standard/Financial Express and other reputed and authentic News dailies and journals. 8.9. Repayment period : i) Individuals and share/stock brokers: To be repaid within a period of 3 years commencing from the date of availment of the loan along with accrued interest. Repayment instalments may be decided in consultation with the borrowers.

87

ii)

Corporates : The loan will be repayable within a period of one year OR within such time the borrower is able to raise funds equivalent to Promoters Contribution whichever is earlier.

8.10. Taking of Security 8.10.1.Lodgment of shares by way of security against advance shall be made in the Take Delivery Letter signed by the borrower. The shares offered as security shall be scrutinized to ensure: 1) 2) that the shares stand in the name of the borrower; that the transfer endorsements on the back of the share scrips are duly authenticated with date; that the shares are lodged in the marketable lots; that the certificates bear the common seal of the company, the certificate number and the distinctive number of shares and there is no sign of tampering; that the shares are not partly paid up; that the shares are accompanied by adequate number of blank transfer deeds duly signed by the borrower and witnessed; That the share are prima facie in order and they are not in the list of shares reported lost, stolen or forged That the time limit for transfer has not expired.

3) 4)

5) 6)

7)

8)

8.10.2 Branches should send and obtain confirmation of securities held by them from the concerned borrowers at the end of each half-year and compare the details of securities with those appearing in the Security Register. A suitable note should be made in the register and the confirmations be kept alongwith the documents. It should be ensured that the borrowers return the confirmation letters duly signed. 8.11. Blank Transfers When taking shares as security it is customary to obtain the borrowers signature in the blank transfer deed duly witnessed. The following matters are filled in details of shares concerned the borrowers name as transferor and the name of the Bank as transferee. The deed shall be undated and unstamped. The object is to get the securities transferred in the name of the Bank without recourse to the borrower. Blank share transfer deeds may be witnessed by an Officer of the Bank or by a person who is known to the Bank. The complete address of the witness shall

88

be given in the form. Witnessing the signature of the husband by the wife or vice versa should be avoided. In case the transfer deed is signed by an attorney on behalf of the borrower the power of attorney shall be called for and verified.

8.12. Transfer of Shares : i) Individuals: If the shares/debentures are in physical form and the shares and debentures are held by the bank beyond 3 months, then it should be ensured that the shares and debentures are transferred in the name of the bank. Shares/stock brokers: If the shares/debentures are in physical form and the shares and debentures are held by the bank beyond 9 (nine) months then it should be ensured that the shares and debentures have been transferred in the name of the bank. Corporates: If the repayment schedule is more than 3 months, the shares should be transferred in the banks name without exception.

ii)

iii)

8.13. Ceiling on Total holding of shares of any one company Under Section 19 (2) of the Banking Regulation Act, 1949 the Banks total holding of shares in a company whether as a pledgee, mortgagee or absolute owner shall not exceed 30% of the companys paid-up capital or 30% of the Banks own paid-up capital and reserve whichever is lower. To avoid any infringement of this provision large blocks of shares of one company should not be accepted without the prior approval of Head Office/Regional Office. Periodical returns for advances against shares whether they are held as direct security or collateral security excluding shares covered under documentary bills purchased or discounted (unless dishonoured) or shares held in safe custody should be submitted to H.O. for consolidation and putting a check to any infringement to the holding restrictions. 8.14. Drawing Limit : Drawing limits should always be calculated up-to-date on the basis of valuation as stated under item 8.8. Any deficiency in margin or shortfall shall be at once demanded and made good. 8.15. Third Party Shares : Advances against third party shares shall be limited to share brokers only. Third party shares which are received against payment on behalf of a customer should be promptly transferred to the borrowers name or Banks name. 8.16. Authority to collect Dividend :

89

8.16.1. In case of advance against shares where there is no stipulation to get the shares registered in the name of the Bank, a letter of mandate to collect dividend on the pledged shares and to credit the dividends to the borrowers account with a request that where share are to be registered in the name of the Bank as per terms of sanction or directives from Head Office, collection of dividend is an automatic procedure. 18.6.2. The branches shall keep watch over the company notices regarding declaration of dividend and apply for dividends as and when the concerned companies declare dividends. The dividends when collected shall be credited to borrowers loan/overdraft account under the usual advice. 8.17. Shares in Private Limited Companies : The shares of private limited companies due to their limited marketability and transfer restrictions are not acceptable as securities. In exceptional cases when it is considered necessary to accept such shares as collateral security, proposal may be sent to the Regional Office with copies of the balance sheets of the company for the past three years. The paid-up value, market value (if available) and the break up value should be stated in the proposal. The break up value of the shares is arrived at by deducting the companys liabilities from the assets on a break-up basis and dividing the resultant figure by the number of shares. In cases it is decided to accept the shares, a resolution by the Board of Directors of the company must be obtained undertaking to transfer the shares in the name of the Bank. Such shares if at all accepted by the Bank are regarded as evidence of means, rather than as a security which can be readily turned into cash. 8.18. Interest : For all categories of borrowers, the rate of interest will be declared by Head Office from time to time. 8.19. Penalty Clause If there is any default in payment of any instalment towards repayment of loan dues against shares and if the default amount is not cleared within 15 days even after issuance of notice (to be issued within 7 days of the due date), then that default amount will carry a penal rate of interest of 2% over the stipulated rate of interest subject to maximum of PLR + 4% till the default amount is liquidated. 8.20. Office Record and Book-keeping 8.20.1 Lodgment of all securities whether G.P. Notes, debentures or shares must be made under cover of delivery letters in the prescribed form (appendix- I), Form No.Z(3), Documentation Manual). The delivery letters shall be serially docketed and filed partywise.

90

8.20.2. The securities shall then be recorded in the Security Registers (Party-wise) Book No.123 in the respective accounts of the borrowers. The rulings of the security Register (Party-wise) as under: Name ..........................Nature of a/c Sanctioned limit Address... Account No.................... Margin.. Interest ..
Date of Receipt Particulars Distinctive of securities Numbers of or documents Shares, G.P. Notes etc. Folio No. of To whom Security Stock delivered Register or company-wise register Initials Remarks

They will also be entered in the Security Register (Company-wise) Book No.126 in separate openings according to the name of company or dates of maturity as per rulings given hereunder. Name of Securities
Date of Receipt Distinctive No. Face Value Place of enfacement If Signature Date of How Signarenewed Disposal dispos- ture in the ed of name of the Bank

8.21. Drawing Power Register Daily price fluctuations shall be observed and the securities frequently valued. Limits shall be marked in the Drawing Power Register against security along with each delivery, lodgment and revaluation. The drawing limit must always be kept ready for convenience of all concerned. 8.22. Ex-custody register When securities or shares are taken out for collection of interest, transfer, sub-division, inspection for realising dividend or for any other purpose they shall be recorded in the

91

Security/Shares Ex-custody Register (Book B, 129). When the securities are received back they are kept back in the security portfolio after recording the date of return in the Register. Securities outstanding in the ex-custody Register and the securities in the security portfolio shall agree with the total securities in the Security Register. 8.23. Custody of Securities : The shares, G.P. Notes shall remain in the separate security portfolio in the name of each customer in the strong room or fire resistant safes under the joint custody of two authorised officers.

8.24. Delivery of securities : Delivery of shares, G.P. Notes lodged as security against advances may be given to the customer or his authorised representative under his written instructions only provided the position of the account permits such delivery. The borrowers letter shall be docketed duly authenticated and shall be filed party-wise. Delivery of shares/G.P. Notes shall be made through the Securities Delivered Day Book under the authentication of the authorised Officerin-Charge against the recipients signature in the Day Book. The delivery shall be marked off in the Security Register under proper authentication and the drawing limit suitably revised. Delivery to the customers broker shall be effected through messenger against receipt. 8.25. Enforcing of Security : In case the Branch has to resort to forced selling of securities to realise the outstanding dues in the account, due notice should be given to the borrower preferably through banks lawyers. The security should be sold after the expiry of the notice through a respectable broker of a recognised Stock Exchange or through approved broker of the bank (list of approved brokers of the bank can be obtained from I&FM Department). It is important to ensure that no further security in lieu of repayment is accepted during the period. This acceptance makes the demand notice ineffective and unless fresh notice is given, sale of security cannot be enforced. Forced sale of security to square up an existing advance shall always require prior approval of one step higher authority. 8.26 Reporting Bank should submit in the enclosed Format (Annexure-II) details of advances granted by them against shares and debentures as on the last Reporting Friday of each Quarter viz. March, June, September and December. The Returns should be submitted to the concerned Regional Office for onward transmission to Head Office so as to ensure submission of the consolidated Return for the bank as a whole to Reserve Bank of India, DBOD, Central Office not later than the 15th of the succeeding month of the Quarter to which it relates.

92

Advance against Shares/Debentures/Bonds to the borrowers should be dealt with keeping in mind the following points in addition to the general guidelines indicated in the preceding paragraphs 8.27. Conclusion : General guidelines applicable to advances against shares/debenture/bonds. 1) Statutory provisions regarding the grant of advances against shares contained in sections 19(2) and (3) and 20(1) (a) of the BankingRegulation Act, 1949 should be strictly observed. Shares held in dematerialised form should also be included for the purpose of determining the limit under Section 19(2) and 19(3) ibid. Branch should be concerned with what the advances are for rather than what the advances are against. While considering grant of advances against shares/debentures banks must follow the normal procedures for the sanction, appraisal and post-sanction follow up. Advances against the primary security of shares/debentures/bonds should be kept distinct and separate and should not be combined with any other advance. Branch should satisfy themselves about the marketability of the shares/debentures and the networth and working of the company whose shares/debentures/bonds are offered as security. Shares/Debentures/bonds should be valued at prevailing market prices based on the lowest of last 52 weeks price when they are lodged as security for advances. Branch should exercise particular care when advances are sought against large blocks of shares by a borrower or a group of borrowers. It should be ensured that advances against shares are not used to enable the borrower to acquire or retain a controlling interest in the company/companies or to facilitate or retain inter-corporate investments. No advance against partly paid shares shall be granted. Whenever the limit/limits of advances granted to a borrower exceed Rs.10 lac, it should be ensured that the said shares/debentures/bonds are transferred in the banks name and that the bank has exclusive and unconditional voting rights in respect of such shares. For this purpose the aggregate limits against shares/debentures/bonds granted by a bank at all its offices to a single borrower should be taken into account. Where securities are held in dematerialised form, the requirement relating to transfer of shares in banks name will not apply and banks may take their own decision in this regard. Bank should however avail of the facility provided in the depository system for pledging securities held in dematerialised form under which the securities pledged by the borrower get blocked in favour of the lending bank. In case of default by the borrower and on the bank

2)

3)

4)

5)

6)

7)

93

exercising the option of invocation of pledge, the shares and debentures get transferred in the banks name immediately. 8) Bank may take their own decision in regard to exercise of voting rights and may prescribe procedures for this purpose. Branch should ensure that the scrip lodged with them as security is not stolen/duplicate/fake/benami. Any irregularities coming to their notice should be immediately reported to controlling office. The Board of Directors may decide the appropriate level of authority for sanction of advances against shares/debentures. They may also frame internal guidelines and safeguards for grant of such advances. Bank should not be a party to transactions such as making advances or issuing back-up guarantees favouring other banks for extending credit to clients of Indian nationality/origin by some of their overseas branches to enable the borrowers to make investments in shares and debentures/bonds of Indian companies.

9)

10)

11)

94

Annexure I TAKE DELIVERY LETTER Address : _________________ Date _______________ 200__ The Manager United Bank of India ____________________ Branch Dear Sir, I/We hand you herewith the under noted securities, which please hold as cover against my/our indebtedness to the Bank from time to time.

Yours faithfully,

....

95

CHAPTER VI

OPINION SHEET TOPIC 10.1 Purpose of Opinion Sheet 10.2 Where detailed Opinion Sheet need not be maintained 10.3 Opinion Sheet in Loose Leaves 10.4 Components of Opinion Sheet 10.5 Sources of Credit Information 10.6 Market Reports 10.7 Managers Opinion 10.8 Periodical Check-up and Revision of Opinion Sheet 10.9 Need of constant vigilance 10.10Withdrawal of Opinion Sheet 10.11Annexure PAGE NO.

96

CHAPTER VI

OPINION SHEET 10.1. PURPOSE OF OPINION SHEETS: Proposals for advances shall ordinarily be entertained from proponent borrower(s) who have been properly introduced and whose creditworthiness has been properly established. In assessment of creditworthiness the financial solvency, earning capacity, standing and integrity of the intending borrowers, whether individuals or partnerships or corporate bodies are all taken into consideration by the Branch Managers and judged in their proper perspective. Opinions formed by such assessments are usually recorded systematically in precise manner in Opinion Sheets (Annexure I). It is the responsibility of the Branch Manager to prepare opinion sheets relating to all customers who are either direct borrowers or co-obligants or on whose behalf Bank enters into financial commitments or executes guarantees and keep them up-to-date by periodical revisions. 10.2 WHERE DETAILED OPINION SHEETS NEED NOT BE MAINTAINED: The risk involved in advances granted against readily realisable securities with adequate margins being marginal, detailed opinion sheets need not be maintained for advance against: i) ii) iii) iv) v) vi) vii) Banks own Fixed and other Term Deposits. Surrender value of Life Policies. Gold ornaments. G.P. Notes and other Trustee Securities Approved shares and debentures upto Rs.50,000/Post Office Savings Certificates. All other advances upto Rs.25,000/-

For convenience of branch administration and records a brief opinion of the Manager may be recorded in such cases in the credit appraisal note. 10.3 OPINION SHEETS IN LOOSE LEAVES : The Opinions shall be recorded in loose leaves with dates and signature of the Manager. The Opinion Sheets shall be indexed alphabetically in the names of the parties reported on e.g. A1, A2, B1, B2 etc. and to be kept in the binder known as Opinion Book. If the proposal has to be referred to Regional Office/Head Office for sanction, one copy of the opinion sheet should accompany the proposal forwarded to the higher authority.

97

Branches shall not be required to send copies of Opinion Sheets to the Head Office or the Regional Office on borrowers to whom advances have been made under the Managers discretionary powers. 10.4 COMPONENT OF OPINION SHEETS 10.4.1. Constitution, duration and other particulars of business: The Opinion Sheet shall be compiled with adequate and reliable information about the constitution, duration and nature of business. In the case of newly established firms length of experience of the proprietor or each individual/partner/director and the qualification he possesses for the business undertaken by the firm shall be brought out. In other cases the manner in which the firms business has been conducted in the past shall be stated on the basis of available credit information collected from independent sources. Generally the Opinion Sheet shall contain i) In case of an individual/proprietorship (a) The name and address of the individual/firm (b) (i) The bio-data i.e. parentage, age, education and /or technical qualifications etc. of the individual/proprietor; (ii) His experience in the trade, or industry, business integrity etc; and (c) The particulars of trade licence, if any. ii) In the case of a partnership (a) The names and addresses of the partners including working partners, if any, and relationship between the persons, if any, constituting the firms. (b) The bio-data of each partner, capability and reputation. (c) The date of partnership letter. (d) The age of the minor, if any, admitted to the benefits of partnership and how he is represented.

(e) If the firm is registered, the particulars of registration and (f) The extent of the partners respective interests in the firm. iii) In the case of Hindu Joint Family the names of the Karta and other members of the family including the minors with their dates of birth and date of Hindu family letter obtained. In the case of a limited company (a) the names of the directors

iv)

98

(b) the bio-data of the Managing Director and where possible other prominent directors, as well as management set-up. (c) The names & addresses of major share-holders & percentage of their holding N.B. If the borrower is in service, the name of his employer with address, his designation and salary should be recorded. 10.4.2. Head office, branch office, associates: The address and style of Head Office and the year of establishment shall be indicated. In case of branch firms or associate firms, if any, their respective addresses as also the style under which business is carried on and the years of their establishments shall be specifically brought out. Credit reports on the associate firms and if possible of the individual branches shall be obtained from their respective bankers and contents of the reports incorporated in the opinion sheet. N.B. Associate firms are firms where some (not all) of the partners are common and which have separate net estimated means. Firms are said to be identical or Branch firms where all the partners are common to both. 10.4.3 Particulars of immovable properties: If the customer owns any immovable property whether in the name of the firm or in the individual name or names of the proprietor and partners, a full description of such property stating address, particulars of municipal record and of registration, size, number of storey, construction as well as valuation and mode of valuation thereof shall be recorded in the opinion sheet. Specific mention shall also be made whether the property is free from encumbrances or not and if encumbered, to what extent. In the case of Partnership or Joint Hindu Family the ownership between the partners or the copartners shall be clearly indicated. In the case of a limited company, a description of the properties owned by the Managing Director and other important directors should be noted separately. The Manager shall endeavor to inspect the properties personally and make his own conservative estimate of the value which should be noted in the opinion sheets. 10.4.4. Total liabilities: The amount of total liabilities shall be arrived at on a liberal basis. Besides other things the amount should usually include i) ii) Limits sanctioned to the customer by the branch or any other branch of the bank. Limits granted by other banks where such information is available.

99

iii)

Liabilities of others for which the borrower is directly or indirectly liable as a coobligant. Taxation liabilities Other liabilities, if any.

iv) v)

10.4.5. Net estimated worth of individuals /firms: In case of individuals the net worth shall be arrived at by deducting total liabilities from the aggregate of assets. The break-up of the assets into cash and bank balances, business investments, long term investments and landed properties should be given. In case of firms both proprietorship and partnership the total worth of the proprietor or partners represents the worth of the individual firms. The financial statements do usually indicate the position of investments in a particular trade or industry by the proprietor or partners thereof and not their individual or combined worth. The assets and liabilities of the firm should not be mixed up with the individual worth of the proprietor or partners. A separate report on the worth of each individual should be drawn up exclusive of his personal share of investment in the firm and their associates. The total worth of a firm is, therefore, the net worth as reflected from statement of financial position plus the net worth of the individual proprietor or partners after allowing for all liabilities. N.B. : i) If minor is a partner, his share of worth should be excluded. ii) In computing the liquid assets of firms, the value of shares in private limited limited companies held by the partners, proprietors etc. of these firms should not be included at face value particularly if the scrip is not quoted on the stock exchange and/or is not readily marketable. While calculating net worth the value of investment should be considered at market price or book value whichever is lower. iii) Self acquired properties of individual co-paraceners should not be taken into account in arriving at the net means of a joint Hindu Family firm. These properties may be detailed in the particulars of the firms assets indicating that they belong individually to the members concerned but the value thereof should be deducted at the end when arriving at the net worth of the firm. iv) Before including the immovable properties standing in the individual names of coparceners in the means of joint Hindu Family firms, Branch Managers should satisfy themselves, after making the necessary enquiries that the properties in question are in fact family properties. In addition, they should obtain a declaration from the concerned co-parceners in the form appended below and make an

100

appropriate note to that effect in relative opinions. In this connection, it is quite conceivable that the co-parceners of a joint family may acquire certain property out of their independent means without intending it to be a part of the joint family property. In such an event the property will not form part of the joint family property but the independent property of the co- parceners. We. (here state the names of the persons making the declaration). declare that the following property/properties standing in our names and in the name(s) of our minor male co-parcener(s) and included in the assets of the joint family firm .. (here state the name of the firm) is/are the absolute property/properties is/are held by us as some of the co-parceners of the joint family for and on behalf of and for the benefit of ourselves and all other members of the family. We further declare that no interest of a widow or any other limited interest holder, which would mature into an absolute interest by virtue of the provisions of the present Hindu Succession Act or otherwise exists in respect of this/these property/properties. 10.4.6. Net worth in case of limited companies : In case of limited companies, net worth is made up of (a) Paid up capital, plus (b) free reserve and (c) surplus (i.e. undistributed profits) minus (d) intangible assets. A report on the personal worth of the Managing Director and other prominent directors should also be drawn up specially when they are made personally liable for the advance of the company. While compiling opinions on a company director, whose guarantees are obtained for an advance granted to a company, his investments in the company should be ignored, as such investments will form part of the companys tangible net worth. 10.5. SOURCES OF CREDIT INFORMATION : 10.5.1 In compiling an Opinion Sheet, all the relevant information shall be collected in the first instance from the customer himself and or his co-obligant if there be any. Success in lending is to a large extent dependent on the assessment of character of the borrower. Personal interview with the customer not only facilitates discussion about the advance proposal but also paves the way for gaining an insight into the character of the customer himself. It is with these two-folds ends in view, discussions shall be made in a cordial atmosphere exercising discretion and tact and without in any way irritating or hurting his susceptibility 10.5.2 The information obtained from the customers shall be verified with the information collected through other independent sources by the Manager and if so authorised by him, by the Deputy Manager or any other official of the branch. If the borrower or his coobligant already has business connection and/or borrowing arrangement with any other

101

branch of the Bank, the credit report from the Branch concerned shall be obtained for brief record in the Opinion Sheet. In case the customer is a new introduction, information shall be obtained from the introducer as also from his/their bankers, if any. Confidential reports from other bankers shall be recorded in the Opinion Sheet as a matter of course. 10.6. MARKET REPORTS : At least two reports regarding the net estimated worth and credit of the party shall be obtained from independent sources preferably in the same line of business uninfluenced by the customers. Such reports may reasonably differ or at times may even be contradictory in nature but they are to be endorsed on the Opinion Sheet mentioning the source of information. 10.7. MANAGERS OPINION : It is the duty of the Manager to collect all the credit information received from various sources, with them independently and form his own balanced opinion on a conservative basis which shall be reflected in the opinion sheet. 10.8. PERIODICAL CHECK UP AND REVISION OF OPINION SHEET Opinion Sheets shall be kept upto-date by periodical revision and check up say once a year or earlier if warranted by circumstances. Fresh checking should, as a rule, be made whenever a review or renewal of a proposal is recommended. A fresh credit report should be prepared only if there have been significant changes in the means and the standing of the borrower. Otherwise, a remark should merely be recorded on the earlier opinion sheet stating that the borrowers position remains substantially unchanged or briefly indicating the minor changes that have occurred. A suitable remark to the identical effect shall be communicated to the Regional Office in the proposals for revision or renewal. A fresh opinion sheet should, however, be prepared at least once in two years. 10.9. NEED OF CONSTANT VIGILANCE : In order to ensure that the position of borrowers or their co-obligants is not adversely affected the Branch Manager shall remain in constant touch with the market and in addition peruse the local Govt. Gazette or newspapers for notices of insolvency, changes in the constitutions of firms etc. and ascertain from local enquiry or periodical searches in the Registrars Office as to whether any of partners under credit obligation with the Bank have been mortgaging or selling their properties. In other words, it is the duty of the Branch Manager to keep the information about such constituents always upto date. 10.10. WITHDRAWAL OF OPINION SHEET:

102

When an advance account is closed the opinion sheet maybe withdrawn from the Branch opinion book under intimation to the Regional Office and other Offices concerned stating the reason for such withdrawal.

103

Annexure SPECIMEN OPINION SHEET Branch 1. Name of the party 2. Head Office & Style 3. Branch firms with Address 4. Associate Firms with Address 5. Partners with Address 6. Nature of Business of the firm 7. 7. 7. 7. 8. 8. 8. a) b) c) d) Assets of the firm Immovable property of the firm (Land & Building) Less : Total Liabilities of the firm Net Worth of the firm Date of Report INDEX NO.:

a) Assets of the partners b) Less : Liabilities of individual partners (other than the business of the firm) c) Net estimated individual worth of the partners after allowing for all Liabilities a) Assets disclosed as per wealth Tax Return b) Income-tax paid

9. 9.

10. Combined net worth [column No. 7 (d) & 8 (c)] Rs.. 11. Manner in which the firms business has been conducted in the past 12. Credit in which the firm is held 13. Remarks 14. Through whom report verified 15. (a) Branch Reports : 15. (b) Bankers report on associate firm

104

CHAPTER VII

Advance/Loan against Gold and Gold Ornament TOPIC 9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8 9.9 General Policy Advances under discretionary power Eligibility for advances Purpose of advance Security Appraisement Guidelines on Appointment of Tester-cum-Assessor Basis of valuation Margin & Rate of Interest PAGE NO.

9.10 Form of Advance 9.11 Documents 9.12 Disbursement 9.13 Terms of Repayment 9.14 Procedure of Gold Loan & Book Keeping 9.15. Precaution to be observed for lending against gold ornaments 9.16 Advance against gold & silver bullion 9.17 Handing over charge 9.18 Final Notice 9.19 Intimation to the borrower on completion of sale 9.20 Balance in the account on application of sale proceeds. Annexure I Annexure II

105

Chapter VII

ADVANCE (LOAN) AGAINST GOLD AND GOLD ORNAMENT (GOLD LOAN SCHEME)
(Other than Direct Agriculture Loan by pledging of gold Ornaments under Swarna Krishi yojana)

9.1

GENERAL POLICY : Advance against gold ornaments which are likely to be utilised for non-productive purposes are generally discouraged by the Bank. Advances should not be given against primary gold (gold in any unfinished or semi-finished form and includes ingots, bars, slabs, billets, shorts, pellets, rods, sheets, foils and wires) and gold articles (gold other than ornaments like gold coins and gold biscuits).

9.2

ADVANCES UNDER DISCRETIONARY POWER : Advances against gold ornaments upto a specified limit as imposed by Head Office from time to time are extended under the discretionary power of the Manager of a Branch and other named officers to whom such powers have been delegated. The policy of Head Office and the restrictions imposed in the matter of such advances shall always be kept in view.

9.3

ELIGIBILITY FOR ADVANCES : To be eligible for advance any well introduced customer of the Branch and the following categories of existing borrowers will get preference over others. It should be ensured that the loan is for productive purposes or medical expenses and meeting unforeseen liabilities. i) ii) iii) iv) v) vi) Small and marginal farmers; Village Artisans; Persons engaged in cottage industries; Small Traders; Road Transport Operators; Professionals and self-employed persons.

9.4

PURPOSE OF ADVANCE 9.4.1 Advances shall be granted to the above borrowers under priority sector for all productive purposes viz. Agriculture, Village and Cottage Industry, Village Artisan, Small Business, Road Transport Operator and Self Employed Enterprise upto a ceiling limit prescribed in Discretionary Power circulated by Head Office from time to time

106

9.4.2

Consumption credit to all categories of well introduced customers towards medical expenses, educational needs, marriage ceremonies, funerals etc. can be extended against the security of gold ornaments subject, however, to a ceiling limit per borrower. to be fixed up by the Bank from time to time .

9.5 9.5.1

SECURITY : Security shall only be in the form of pledge of gold ornaments. Customers title to the ornaments and right to pledge shall be verified. Advance can be made only to the true owner or a true owner and another individual jointly. Advances against ornaments which are Stridhan should not be allowed unless the owner i.e., wife/daughter is made a co-borrower. A declaration that the ornaments are his/her own property shall be signed by the true owner as borrower in the Banks standard form (Form No. 425, Annexure 1). Advances against gold coated ornaments and also against ornaments which are hollow with infillings and jewellery settings should also be avoided. It has to be ensured that the name(s) if any other than the borrower(s) are not inscribed in the gold ornaments to be kept as security. In the case of money lender or a shroff, no advance shall be made against re-pledge of ornaments held as security against loans made by him.

9.5.2

9.5.3

9.6

APPRAISEMENT : The Gold/Gold ornaments offered as security is to be weighed assessed and valued by the approved tester-cum-Assessor in the presence of the authorised bank officer (Branch Manager/ Dy Manager) and the borrower. A certificate is to be given by him (Assessor) stating description, number of ornaments, type of metal (i.e., Carat) and estimated value as per prevailing market price of gold. The draft certificate containing the Tester-cum-Assessors Certificate is in Annexure 1. It should be signed by the borrower (offering for pledge), Testercum-Assessor and to be counter-signed by the Branch Manager/Dy Manager/Authorised Officer in whose presence testing was carried out.

9.7

OPERATIONAL GUIDELINES ON APPOINTMENT OF TESTER-CUM-ASSESSOR : 9.7.1 Every branch should appoint at least three Testers-cum-Assessors. The branch shall invite applications from reputed and registered gold-smiths residing or having their place of business close to the Branch to be appointed as Tester-cum-Assessors of Gold. 9.7.2 The appointment of the Tester-cum-Assessor will be made by the concerned Regional Manager on the basis of recommendation of the Branch Manager. The approved Tester-cum-Assessor should be a licensed Gold-smith/Assessor and shall execute a

107

deed of agreement to the effect to safeguard banks interest, till the currency of the loan. 9.7.3 In case where three registered Gold-Smiths are not available for appointment as Tester-cum-Assessor, reputed Gold-Smiths of the area may be appointed with the approval of the Regional Managers (as per H.O. Circular No. P&D/SB/GL/35/78 dated 10.5.78). The appointment of Tester-cum-Assessor shall be made as per the guidelines of Head Office in the matter and the appraisal fees which will be 0.5% of the loan subject to a minimum of Rs.50/- to be paid to the Tester-cum-Assessor at the prescribed rates are to be realised from the borrower. 9.8 BASIS OF VALUATION : In making advance against ornaments the value of net weight of gold contents shall only be taken into consideration. Value of jewels or stones inset in the ornaments shall be ignored. The value of gold offered as security shall be estimated on the basis of the extent of purity assessed as against the value of 24 carat gold. The valuation shall be made at the market price or the ceiling price as may be prescribed by Head Office from time to time, whichever is lower. 9.9 MARGIN AND RATE OF INTEREST : The margin to be maintained and interest to be charged shall be fixed by Head Office from time to time. The money lent shall not exceed a fixed percentage of value assessed subject to ceiling limit prescribed by Head Office. 9.10 FORM OF ADVANCE : Advance against gold ornaments shall ordinarily be in shape of loans with fixed repayment terms. 9.11 DOCUMENTS : The following documents shall be obtained prior to disbursement of loan : i) ii) iii) iv) 9.12 Promissory Note Pledge of Gold Ornaments Stamped Letter of Lien Declaration as per Annexure 1

DISBURSEMENT :

108

9.12.1 Disbursement may be made in cash or as agreed upon with the borrower to ensure the end-use of loan for productive purposes as far as practicable as enumerated under para 9.4.2. 9.12.2 Declaration of purpose in the loan application form can be considered sufficient as far as the end-use of the loan is concerned. 9.13 TERMS OF REPAYMENT These loans are repayable in equal monthly instalments commencing from the third month of the date of disbursement and the entire loan with interest will be repaid within a maximum period of 3 years. 9.14. PROCEDURE OF GOLD LOAN AND BOOK KEEPING : 9.14.1 An application as per standard application-cum-processing sheet vide Annexure- II and the documents as prescribed shall be obtained duly signed by the borrower(s). 9.14.2 Gold ornaments offered for pledge to bank should be put in a cotton bag along with a copy of the assessment certificate in original from the assessor in standard form. The Gold Loan A/c Number shall be distinctly marked on the body of the bag. The bag shall be tied with good quality thread. A tag (made of thick paper to ensure durability) bearing the name of the borrower and the Gold Loan A/c No. shall be tied with the bag. The bag and the tag should together be properly sealed. On the other side of the tag, the Manager and the borrower will sign towards satisfaction of sealing the bag. 9.14.3 These sealed bags are to be kept in the drawer at the bottom of the cash safe. Custody of such bags will remain jointly with the officer in-charge of cash and the Head Cashier. Where the number of such bags is more in respect to the space available in the drawer, a separate fireproof steel Almirahs with double lock facility should be placed in the strong room for safe keep of such bags. In that event, the custody of the bags containing gold ornaments will remain jointly with the Manager and another officer as may be decided by the Manager. In single officer branches, the Manager will be the sole custodian. 9.14.4 When ornaments are offered as security, three sets of assessment certificate are to be obtained in the standard form. One copy of the certificate is to be kept along with the ornaments in the respective cotton bags, one copy shall be retained along with the documents and the third copy should be retained by the borrower. The joint custodians of the bag should sign the borrowers copy towards receipt 9.14.5 All usual entries should be made in the loan Register. A detailed description of ornaments/number of ornaments/weight of each ornament is to be properly recorded in the Security Register duly authenticated by the Branch Manager. The name and

109

address of the Tester and Assessor, date of assessment and date of release of the loan should also be entered in the Loan Register. The loans should be shown as priority sector advances and reported in statements under Agriculture, Small Scale Industry, Road Transport Operator, Retail Traders, Professionals and Self-employed persons as the case may be. If the bags are kept in cash safe, a register of ornaments in safe is to be maintained by the Cashier like the Cash-in-safe register and the same should be entered and counter-signed by the Branch Manager or in-charge of advance as authorised by the Branch Manager after every in and out. The insurance cover for the ornaments in safe should also be increased or decreased accordingly. When such bags are stored in the Almirah, the joint custodian other than the Manager will maintain the Register of Ornaments. 9.14.6 Periodical revaluation of the pledged ornaments shall be made depending upon the price fluctuations in gold prices. 9.14.7 Delivery should generally be made to the borrower only on liquidation of the loan and on production of requisition along with the Assessors certificate. The borrower must sign in the disposal column in the security register and all the three copies of assessors certificates should be cancelled, kept in the closed loan accounts file and retained. Delivery should be effected in presence of the Branch Manager. No part delivery shall be allowed. 9.15 PRECAUTION TO BE OBSERVED FOR LENDING AGAINST GOLD ORNAMENTS : i) The identity of the borrower and the introducer is to be ascertained and more specially when any one of them is not known to the Branch Manager; Members of the staff of the Bank are not eligible for such advances irrespective of purposes whatsoever may be, unless otherwise sanctioned by Head Office; No advance should be made against primary gold (i.e., standard bar, billets, blocks, slabs, rods etc) and such ornaments where name has been inscribed other than that of the borrower.

ii)

iii)

9.16

ADVANCE AGAINST GOLD AND SILVER BULLION : The Bank should not give any advance against bullion/primary gold. The Bank should desist from granting advances to the silver bullion dealers which are likely to be utilized for speculative purposes.

9.17

HANDING OVER CHARGE 9.17.1 When an incoming Manager will take over the charges of the branch he will ensure that the number of bags are equal to the number of loan accounts as per Gold Ornament Register and Gold Loan Ledger. He will also see and verify that all the bags are sealed

110

and there is no evidence of tampering. He will countersign on the tag in presence of the outgoing Manager as a token of verification and satisfaction. If any of the tags is found to be tampered or misplaced the borrower should be called and a fresh seal to be obtained like at the time of giving the loan. If the borrower does not co-operate, a fresh tag is to be sealed under the joint signature of the incoming and the outgoing Managers without removing the old seal and the remaining part of the old tag. 9.17.2 When it is considered to recall the loan due to non-payment of interest and/or instalments a demand notice shall be served on the borrower or each of the borrowers if the account stands in the joint names of more than one person. 9.17.3 In the event of the borrower failing to comply with the requirement contained in the notice (issued as per 9.17.2) on the expiry of the notice period the branch shall proceed to dispose off the securities in the following manner: Notice Offers are invited for purchase of the under noted articles pledged to the bank, which may be inspected by appointment. Offer should be made to the undersigned in writing, to be kept at least 15 days and for the entire quantity of each item. Sale will be on AS IS WHERE IS basis according to the Banks record and the purchaser is to make his own arrangement for weighing and verification. The undersigned reserves the right to withhold sale of the whole or part of the articles and to accept or decline to accept any offer without assigning any reason. Delivery will be made only against advance payment for the entire lot purchased by the buyer. Other terms and conditions will be as per discussion with the undersigned. Description of Goods 9.18 FINAL NOTICE After obtaining the offers, if they are found to be reasonable., final notice will be served on the borrower by registered mail with acknowledgement due on the following lines : Your ..A/C Further to our letter No. . Dated we advise having received offer for purchase of the undernoted items of articles pledged on your account at prices noted thereagainst. If you do not repay your dues in the account within four days from the date hereof we shall be at liberty at our absolute discretion to proceed to sell these articles at the said rates if still available or at such rates as will be available on the date or dates of sale. You will be informed further in the matter if and when the sale is effected. Description Price offered

111

9.19

INTIMATION TO THE BORROWER ON COMPLETION OF SALE If the borrower still fails to pay, the pledged gold are to be sold to the highest bidder and the sale proceeds less all expenses of sale, will be credited to the borrowers account. Only such part or portion of the pledged gold are to be sold as will cover the banks dues. Full details of the sale are to be recorded in the appropriate register of the Bank. Thereafter the borrower shall be written on the following lines: Your .A/C. Further to our letter No. . Dated we advise having credited your captioned account with Rs as detailed below being the sale proceeds of your pledged goods. After the above credit, the balance in your aforesaid account stands at Dr/Cr Rs.. with interest charged up to .. Memo Less Expenses for sale 3

Description of goods 1

Sale price realised 2

Amount Credited to youre a/c 4

Date on which credited 5

9.20

BALANCE IN THE ACCOUNT ON APPLICATION OF SALE PROCEEDS If the account turns into a credit balance the borrower may be allowed to take delivery of the unsold goods, if any, and withdraw the credit balance only after he confirms in writing the final balance in the account and the sales effected. If there is a shortfall in the account the position shall be reported to the Regional Office in details informing in particular the other assets of the borrower, if any, which could be attached.

112

Annexure- I Form G (Gold Delivery & Appraisers Certificate) ___________________ 200__ Address : __________________________ The Manager United Bank of India ______________________ Branch Dear Sir, Please take delivery of the following Gold Ornament(s) etc. which please hold as Security for all moneys now owing or which shall at any time hereafter be owing from me/us at any manner whatsoever : Description Gross Weight in Gms. Net Weight of Gold contents in Gms. Valuation Rate per Gms. Market Value

I certify that this/these Ornament (s) etc. is/are my/or bonafide property and no other person has any claim against it/them.

Yours faithfully, ___________________________ (Borrower) Certified that the within written weights and valuation rate(s) have been verified by me and are correct.

____________________________ (Appraiser) F.No.425

113

Annexure- II Form - A APPLICATION FOR LOAN/OVERDRAFT AGAINST FIXED AND OTHER DEPOSITS, G.P. NOTES, BULLION, GOLD OR GOLD ORNAMENTS, SHARE, LIFE POLICIES,ETC. (Not for those dealing in G.P. Notes, Shares or other Securities) To The Manager United Bank of India _______________________ Branch Dear Sir, I/We shall be obliged if you kindly grant me/us a loan/overdraft of Rs. ________________ Rupees __________________________) only, against pledge of undernoted securities for a period of ___________months to be duly repaid in full with interest at the rate of _______% over Bank Rate minimum _______% with ________rests and incidental charges on demand by your Bank. 1. Name in full _________________________________________________________________ 2. Names of partners, in case of a firm and names of the Directors, in case of a Joint Stock Co. i) __________________________________________________________________________

ii) __________________________________________________________________________ iii) __________________________________________________________________________ 3. Fathers/Husbands name _______________________________________________________ 4. Occupation of the applicant _____________________________________________________ 5. Permanent Address____________________________________________________________ 6. Present Address _____________________________________________________________ 7. Whether the applicant is indebted to any other Branch of the Bank, if so particulars_______ ____________________________________________________________________________ 8. When and how repayment is proposed ____________________________________________ ____________________________________________________________________________ 9. Particulars of securities offered __________________________________________________ ____________________________________________________________________________ ____________________________________________________________________________

114

10. Purpose of the Loan/O.D. ______________________________________________________ 11. Name of Depositor, G.P. Notes holder, owner of bullion, gold or gold ornaments__________ ____________________________________________________________________________ 12. Whether the securities or security are free from any prior charges and under the sole and unencumbered properties of the applicant(s) ______________________________________ ____________________________________________________________________________ Yours faithfully, Address _______________________________________ ______________________________________________ ______________________________________________ Date : _______________ _________________________________________________________________________________ In case of Govt.Papers, mention the nature of the papers, date of redemption, rate of interest, denomination of papers, when interest was last collected. In case of F.D. Receipts name of the issuing Branch for what amount beneficiarys name at what rate and the date of maturity. In case Bullion, gold or gold ornaments full particulars thereof giving the weight (gross and net) in case of share Name of the Co., face value, paid up value and present market value in case of Life Policy, name of the beneficiary, nature of Policy whether whole-life or endowment, Date of maturity, whether age admitted, present surrender value etc.

115

CHAPTER VIII

ADVANCE AGAINST DOCUMENTS OF TITLE TO GOODS TOPIC 11.1 Documents of Title to Goods 11.2 Bills of Lading 11.3 Railway Receipt 11.4 Motor Transport Receipt 11.5 Delivery Order 11.6 Advances against PDOs 11.7 Advance against Tea Delivery Order 11.8 Warehouse Receipts Notified Commodities 11.9 Advance against Warehouse Receipts issued by Central and State Warehousing Corporation. PAGE NO.

116

CHAPTER VIII

ADVANCE AGAINST DOCUMENTS OF TITLE TO GOODS 11.1 DOCUMENTS OF TITLE TO GOODS : 11.1.1 A document of title to goods, according to the Indian Sale of Goods Act, 1930, includes : (a) (b) (c) (d) (e) (f) Bill of Lading Dock Warrant Warehouse Keepers Certificate Warfingers Certificate Railway Receipt Warrant or Order for the delivery of goods

11.1.2 And any other document used in the ordinary course of business as proof of the possession or control of goods or authorising or purporting to authorise either by endorsement or by delivery, the possessor of the documents to transfer or receive goods thereby represented. 11.1.3 Though almost all documents used in mercantile transactions are covered under this definition; between those documents there are some that give title to the goods by endorsement and delivery and other documents are mere receipts acknowledging lodgement of goods in a warehouse and are not transferable as such. Delivery Orders, Warehouse Receipts come under the latter category, where the goods covered under them must be registered in the name of the pledgees in the books of warehouse authorities. Mere possession of such documents without registration of charge is of no avail in case of insolvency of the customer, as in that event the goods covered under the documents are regarded in possession of the warehouse keeper on behalf of the insolvent as reputed owner and vest in the official assignee. 11.1.4 While some procedural matters relating to advances against principal documents of title to goods are explained below it must always be remembered that the real security lies in the goods themselves covered by the documents and usual precautions with regard to advance against goods must be observed at every stage. Above all, honesty, integrity, experience and credit of the customer must always come in the forefront in entertaining any proposal for advance against documents of title to goods.

117

11.2. BILLS OF LADING : In case of advance against bills of lading, the following precautions shall be usually taken : i) All the parts of the bills of lading constituting the complete set should be obtained by the Branch from the borrower. In case this is not possible the concerned shipping company or the captain of the ship shall be notified about the Banks charge over the goods as pledge as soon as the advance is made. The insurance policy or certificate of insurance shall always accompany the bills of lading and the description of the goods in the bill of lading shall tally with that in the policy. The policy shall be taken out in the name of the Bank duly assigned. The bill of lading shall be endorsed in blank and deposited with the branch along with a letter of pledge. The Branch must be satisfied before making an advance that there are no onerous conditions in the documents prejudicial to the interest of the bank.

ii)

iii)

iv)

11.3

RAILWAY RECEIPTS Advance against the security of Railway Receipts can only be made by a Branch provided it is located at the destination where the goods are booked. In making advance against railway receipts, the following precautions are considered necessary : i) The railway receipt shall be in the name of the consignor endorsed in blank and shall be deposited along with a letter of pledge. A notice of lien shall be sent to the concerned Station Master in Form No. 457 by registered post with acknowledgement due and the acknowledgement slip then received back shall be duly preserved in the security folder. The Railway Receipt should not be stale.

ii)

iii) 11.4

MOTOR TRANSPORT RECEIPTS : Motor Transport receipts, whether they can be regarded as documents of title to goods or not, are by usage accepted as security for advances to a limited extent provided they conform to the conditions laid down by the Indian Banks Association which are as follows : i) The Transport companies shall be in the recommended list of the Indian Banks Association as circulated by Head Office from time to time. The Lorry Receipts shall be in the Special Form with the Code Numbers of the Transport Companies printed thereon.

ii)

118

iii)

Only the Consignee Copy of the Lorry Receipt with the Bank shown as the consignee shall be accepted. The Lorry Receipts shall contain the Endorsement and Notice in red within two parallel lines as follows : Endorsement It is intended to use the Consignee Copy of this set for the purpose of borrowing from the consignee Bank

iv)

v) 11.5

The Lorry Receipts shall contain the prescribed conditions of carriage.

DELIVERY ORDER A Delivery Order is a document in writing addressed to the proprietor of the Warehouse where the goods are lodged conveying owners instructions to deliver to the order of a person named therein a specific quantity of the goods. Such delivery orders are generally issued on warehouses belonging to third parties such as shipping companies, dock companies etc. but at times may be issued by the owners on their own warehouses as well as in the case of Pucca Jute Delivery Orders in Calcutta. Pucca Jute Delivery Orders or P.D.O.s as they are commonly known are issued by Jute Mill Companies in Calcutta on their own warehouse and are considered as documents to title by local custom and usage. The delivery orders are transferable by endorsement and delivery. Unless attornment is made by the warehousemen, mere possession of such documents by the Bank as pledge will not give title over the goods in the event of insolvency of the customer.

11.6 ADVANCE AGAINST P.D.O.s Advance against P.D.O.s covering specified quantity of hessian, gunny, jute bales etc., issued by approved jute mills may be made with the prior approval of the Regional Office. While taking such documents as security, the Branch Manager must ensure that they have been issued in respect of goods actually stored with the warehousekeeper and the orders stand registered in the names of the pledgor. Before any advance is made the relative P.D.O.s shall be registered in the books of the mill company in the name of the Bank as pledgee. No advance against P.D.O. shall be allowed to remain outstanding for more than six months. A P.D.O. once released should not be accepted as a security for further advance either in the same account or in a different account. The market report should be verified regularly to ascertain the drawing limit or margin. 11.7 ADVANCE AGAINST TEA DELIVERY ORDER Advance against Tea Delivery Order issued by Tea Brokers in the approved list of the Bank in respect of tea sold at auction may be made by the Calcutta Main Branch or any other office selected by Head Office. Immediately on making an advance against Tea Delivery Order, the

119

Tea Broker concerned is to be notified and the delivery order be registered in the name of the Bank with the Tea Warehouse. Such advance shall be generally for a short period not exceeding a month or two. Valuation of tea should be made on the basis of the tea market report from time to time to ensure cover for the advance with requisite margin. 11.8 WAREHOUSE RECEIPTS NOTIFIED COMMODITIES 11.8.1. A Warehouse Receipt is a document issued by a warehousekeeper certifying that certain goods described in the receipt are held in the warehouse at the disposal of the named depositor. Advance against warehouse receipts issued by warehouses established by the Central and State Warehousing Corporations covering Notified Commodities may be made by the Branches subject to restrictions imposed under selective credit control of the Reserve Bank of India from time to time provided of course they are in the approved list of commodities and produce of the Bank. The following are some of the notified commodities eligible storage in the warehouses of the Warehousing Corporation : Foodgrains Oil Seeds Edible oils Fertilisers 11.8.2 The Wasrehousing Corporation classifies all goods stored with them into Grade I to IV. Grade-I represents good quality whereas Grades II, III and IV represent fair, average and poor quality respectively. Only such stocks which have been given Grade-I and marked accordingly in the receipts should be considered eligible for advance. 11.9 ADVANCE AGAINST WAREHOUSE RECEIPTS ISSUED BY CENTRAL AND STATE WAREHOUSING CORPORATION In making advances against warehouse receipts issued by Central and State Warehousing Corporation, the precautionary measures outlined below, in addition to those indicated in para 11.8.1. and 11.8.2. above, should be observed by the Branches. (a) Warehouse Receipts should be of recent dates. This is necessary to avoid advance being made against old stocks. The stocks which have been lying in the warehouse for long periods should not be taken as security. Where warehouse receipts are not transferable by endorsement or in case of transferable receipts if they stand in the names of third parties, which are duly endorsed, fresh receipts shall be issued in the name of the Bank before making any advance.

(b)

120

(c)

Where the warehouse receipt offered as security has not been made out in the Banks name, the particulars of the receipt shall be reported to the warehouseman with a request to note the Banks charge on the relative goods. It is necessary to obtain an attornment from the concerned warehouseman that the goods are being held by him on account of the Bank and that no duplicate receipt would be issued without the written consent of the bank. No duplicate warehouse receipt shall be ordinarily accepted as security for advance except without proper search and enquiry from the warehouse authorities. Part deliveries of goods covered by warehouse receipts as security for advance shall be made by the warehouseman against delivery orders issued by the Bank. The relative receipts shall be sent to the warehousemen for suitable endorsements thereon before effecting deliveries and return to the Bank. Periodical inspection of the warehouse should be made to ensure that the goods covered under the relative receipts are in order and kept properly. Goods deposited in a Warehouse are generally insured by the Warehousing Corporation. In that event no separate insurance need be taken but a letter stating the amount of cover earmarked for the goods pledged to the Bank be obtained from the Warehousing Corporation. The stocks are required to be insured for full cost price or market value whichever is higher. On repayment of the amount of advances the warehouse receipts shall be released to the borrower and the warehouseman should be suitably advised about the cancellation of the Banks charge thereon. Besides usual documents, Agreement of pledge of goods (Manual of Documentation Appendix I Form E, Form No. 338) should also be obtained. In addition to the above instruction, the Branches should take usual precautions required for advance against pledge of goods.

(d)

(e)

(f)

(g)

(h)

(i)

(j)

121

Chapter IX Credit And Risk Rating

PRICING OF ADVANCE ACCOUNTS AND CREDIT RISK RATING 12.1. Pricing of advance accounts A. General a) Bank shall charge interest on loans/advances or discount usance bills in accordance with directives on interest rates on advances issued by RBI/Bank from time to time. b) As per RBI guidelines (vide Master circular on Interest Rates on Advances dated 1st July 2011) the interest at the specified rates should be charged at monthly rests and rounded off to the nearest rupee. Charging interest at monthly rest shall not be applicable to agricultural advances. Charging/compounding of interest on agricultural advances shall continue to be linked to crop seasons. Interest on advances for long duration crops shall be at annual rests. As regards other agricultural advances in respect of short duration crop and allied agricultural activities such as dairy, fishery, piggery, poultry, aviary, etc, the interest shall be charged at half-yearly rest/aligned with harvesting/marketing season, as circulated by CPPMI Dept from time to time. B. a) Base Rate System For fixing interest rates the Base Rate system has replaced the BPLR system w.e.f.1 st July 2010. The information on Base Rate should be disclosed transparently at all branches and also on website. The Base Rate should be reviewed at least once in a quarter with the approval of the Board of Directors or Asset Liability Management Committee (ALCO). For loans sanctioned upto June 30, 2010 BPLR will be applicable. Existing loans sanctioned upto 30th June 2010 based on BPLR system may run till their maturity as per contracts, unless the Borrowers want to switch over to new system, before expiry of existing contracts, exercising option given by Bank, on mutually agreed terms. However, for those loans sanctioned upto 30th June 2010, which come up for renewal/reset from July 01, 2010 onwards, Base Rate would be applicable. If in the existing contract reset parameter is defined in relation to BPLR, to switch over to Base Rate at the time of reset consent from Borrower is required. From 1st July 2010 all categories of loans shall be priced only with reference to Base Rate except (i) DRI advances (ii) loans to Banks own employees and (iii) loans to Banks depositors against their own deposits. The Base Rate will be the minimum rate for all loans [except the exempted categories listed at c.(i)(ii) & (iii) above]. Accordingly, the existing stipulation of BPLR as the ceiling rate for loans upto Rs.2 lacs stands withdrawn. Even after introduction of Base Rate system, Bank can offer all categories of loans on floating or fixed rates. Where loans are offered on fixed rate basis, notwithstanding the quarterly review of the Base rate, the rate of interest on fixed rate loans will continue to remain the same during the contract/till next contractual reset of interest, subject to the condition that such fixed rate should not be below the base rate prevailing at the time of sanction. If the Base Rate is revised upward thereafter and in the process the fixed rate falls below the new base Rate, it would not be construed as a violation of the guidelines on Base Rate. At the time of reset, fixed rate 122

b)

c) d) e)

f) g)

h) i)

j)

for the next tenure till subsequent reset shall not be below Base Rate prevailing at the time of reset. Where loans are offered on floating rate apart from Banks Base Rate, external market benchmark rates/other banks base rates can also serve as reference benchmark rates. The floating interest rate based on external market benchmark rates/other banks base rates should, however, be equal to or above the Banks prevailing Base Rate at any point of time during the contract. In case of existing loans of longer/fixed tenure, the Bank should reset the floating rates according to the above method at the time of review or renewal of loan accounts, after obtaining the consent of the concerned borrowers. For better interest management in fixed rate products under Base Rate regime, provision for periodical reset may be kept, wherever possible. The rate of interest (floating/fixed) on all types of advance, including rupee export credit but excluding the exempted three categories, should be linked with Base Rate. For advances over Rs.10 lacs (over Rs.25 lacs in case of micro-enterprise/small-enterprise/agriculture) the rate shall be linked with Base rate with reference to internal Credit Risk Rating. However, rates for certain advances, e.g. rupee export credit, advance against shares, etc, irrespective of limit, may be fixed without reference to Credit Risk Rating. CPPMI Department, H.O. will continue to circulate rate of interest for different categories of advance on every change/review of Base Rate. The interest under DRI Scheme continues to be 4% as per RBI guidelines. The interest rate on rupee export credit (both pre-shipment and post-shipment) shall be at or above Base Rate. CPPMI Department will continue to fix rate of interest for rupee export credit based on the volume of export turnover routed through Bank, LC coverage, etc. For export credit in foreign currency the Bank was permitted to stipulate any rate with reference to ruling LIBOR, EURO LIBOR or EURIBOR, wherever applicable, subject to all cost ceiling of 350 bps over LIBOR, EURO LIBOR or EURIBOR as prescribed by RBI (DBOD No.DIR. 91 /04.02.001/2011-12 dt.30.03.2011). However, to increase the availability of foreign currency to the exporters RBI, vide circular DBOD.DIR.No. 100/ 04.02.001 /2011-12 dt.04.05.2012, has deregulated the interest rate on export credit in foreign currency with effect from May 5, 2012 and the Bank is now free to determine the interest rates on export credit in foreign currency. In case of restructured loans if some of the WCTL, FITL, etc need to be granted below the Base Rate for the purpose of viability and there are recompense etc clauses, such lending will not be construed to be violation of the Base Rate guidelines.

k) In those cases where subvention is available to the borrowers, it is clarified that i. Interest Rate subvention on crop loans 1 In case of crop loans upto Rs.3 lacs, for which subvention is available, Bank should charge farmers the interest rates stipulated by the Government. If the yield to the Bank (after including subvention) is lower than the Base Rate, such lending will not be construed to be violation of the Base Rate guidelines; 2 As regards the rebate provided for prompt repayment, since it does not change the yield to the Bank [mentioned at (1) above] on such loans, it would not be a factor in reckoning compliance with the Base Rate guidelines. ii. Interest Rate subvention on Export Credit Interest rates applicable for all tenors of rupee export credit advances will be at or above the Base Rate. In cases where subvention is available, Bank will have to reduce the interest rate

123

chargeable to exporters as per Base Rate system by the amount of subvention available. If as a consequence the interest rate charged to exporters goes below the Base Rate, such lending will not be construed to be violation of the Base Rate guidelines. iii. Government of India, Ministry of Renewable Energy has formulated a scheme on financing of Off-Grid and decentralized Solar (Photovoltaic and thermal) applications as part of the Jawaharlal Nehru National Solar Mission (JNNSM). Under the scheme Bank may extend subsidized loans to entrepreneurs at interest rates not exceeding 5 percent where refinance of 2 percent from GoI is available. Such lending at interest rate not exceeding 5 percent per annum where refinance of GoI is available, would not be considered to be a violation of the Base Rate guidelines. iv. Under Micro Credit Scheme of the National Scheduled Tribes Finance & Development Corporation (NSTFDC) the Bank may extend subsidized loans to elligible beneficiaries/SHGs for undertaking self employment ventures/activities at interest rates not exceeding 6% / 8% where refinance at 3% / 5% from NSTFDC is available. Similarly, the Bank may extend subsidized loans to eligible beneficiaries under the various schemes of National Handicapped Finance & Development Corporation (NHFDC) at interest rates prescribed therein where refinance from NHFDC is available. Such lendings to the extent refinance is available, even if it is below the Base Rate, would not be considered as a violation of the Base Rate guidelines. However, interest rate charged on the part not covered under refinance should not be below Base Rate. l) In case of consortium/multiple banking arrangement, where interest rate is aligned with lead /principal /other lenders rate, such rate shall not be below our Banks Base Rate and suitable covenant to that effect should be incorporated in terms & conditions of sanction. For flexibility, suitable exit option may be considered by incorporating Put and Call option. Continuation of BPLR system for loans sanctioned upto 30.06.2010 Interest rates under BPLR system will continue to be applicable to all existing loans sanctioned upto 30 June, 2010 till maturity of contract &/or till come up for renewal/reset unless the borrower(s) give consent for switch over to Base Rate system from BPLR system before maturity &/or before the time of reset. In view of this, the guidelines for rate of interest with reference to BPLR, as existing, will continue for loans sanctioned prior to 1 July 2010 and the Bank will have to declare its Benchmark Prime Lending Rate as well as applicable interest rates with reference to BPLR from time to time. The Asset Liability Management Committee (ALCO) of the Bank fixes the BPLR from time to time computed on the basis of (i) actual cost of fund, (ii) operating expenses and (iii) a minimum margin to cover regulatory requirement of provisioning / capital charge and profit margin. After deregulating rates of interest on advance in general, under BPLR system RBI continues to control the rate in respect of (i) advances to small borrowers with limit upto Rs.2 lacs (ii) advances under Differential Rate of Interest (DRI) Scheme and (iii) export credit upto specific tenor. In terms of RBI guidelines under BPLR system the rate of interest for loans to small borrowers with limit up to Rs. 2.00 lac should not exceed the Benchmark Prime Lending Rate (BPLR); interest under DRI scheme is 4 percent per annum and a ceiling rate of 2.5% below BPLR is set for all categories of pre shipment credit up to 270 days, post shipment export credit up to 180 days and

C. a)

b)

c)

d)

124

post-shipment export credit up to 365 days for Gold Card holders. Such ceiling is also applicable for pre & post shipment credits against incentives receivable from Government (covered by ECGC Guarantee) upto 90 days, post shipment credit upto 90 days against undrawn balance as also against retention money (for supply portion) payable within one year from the date of shipment. e) The rates of interest on advances above Rs.2 lacs upto Rs.10 lacs (for agriculture upto Rs.25 lacs) are presently fixed with relation to BPLR (without relating to Credit Risk Rating) by CPPMI Dept from time to time. For advances with limit over Rs.10 lacs (for agriculture upto Rs.25 lacs), rates shall be fixed on the basis of credit risk rating (UBICRR) with reference to BPLR. f) As per extant RBI guidelines (vide Master Circular on interest rates on advances dated 1st July 2011) under BPLR system the Bank is free to determine rates of interest without reference to BPLR and regardless of size in respect of the following loans; Loans for purchase of consumer durables Loans to individuals against shares and debentures/bonds Other non-priority sector personal loans including credit card dues Advances / overdrafts against domestic / NRE / FCNR(B) deposits with the bank, provided that the deposit(s) stands/ stand either in the name(s) of the borrower himself / borrowers themselves, or in the name of the borrower jointly with another person Finance granted to intermediary agencies (as mentioned in RBI Master Circular on Interest Rates on Advances dated 1 July 2011) for on-lending to ultimate beneficiaries and agencies providing input support; Discounting of bills Loans/advances/cash credit/overdrafts against commodities subject to Selective Credit Control Loans to co-operative banks or to any other banking institution Loans to its own employees Loans covered by refinance schemes of term lending institutions. D. a) b) c) Other guidelines Interest on advances to tea, rice mill, cold storages, will be as per extant guidelines issued by the bank from time to time. Interest on advances to Agriculture & MSME sectors will be guided as per HO circular to be issued from time to time Interest rate for foreign currency loans shall be set/reset by the sanctioning authority with written concurrence from the General Manager in charge of IBD considering availability of foreign currency fund, cost of fund, LIBOR, hedging cost, etc. In cases of the accounts under powers of MCBOD/CAC, the rate on FC loans can be set/reset by HLCC-1 on the basis of written observations from the General Manager in charge of IBD on the proposed rate considering all related factors. All consortium advances where our bank is not a leader, rate of interest charged shall be as per decision of the consortium, subject to the floor ceiling at Banks Base Rate. In all multiple banking arrangement cases rate of interest shall be in line with other banks / institutions, but not below Banks Base Rate, subject to the approval of the competent authority. In case of new accounts coming to us and which are availing credit facilities from other banks, interest rates lower than that being charged by those banks may be considered to bring the business to our bank provided other criteria for taking over of accounts are fulfilled and approved by the competent authority.

d)

125

e)

As per extant RBI guidelines, proviso enabling the Bank to charge the applicable interest rate in conformity with the directives issued by RBI from time to time, should be incorporated in the loan agreements of all advances, including term loans. f) Relaxation of interest rates To fall in line with the industry rate and going market scenario the Bank may allow relaxation in rate of interest below applicable rate to exporters or other creditworthy borrowers including public enterprises on the lines of a transparent and objective policy approved by the bank. All proposals for reduction in the rate of interest [except for advances against Banks own Term Deposit (including 3rd party deposit)] below the applicable rate will continue to be considered at the Head Office only. Authority to approve relaxation in interest rate i) Under Base Rate system CAC : Upto Base Rate HLCC-1 : Upto Base Rate +1.00% HLCC-2 : Upto Base Rate +2.75% ii) Under BPLR system Reduction of rate below BPLR : MCBOD : Reduction by more than 5% below BPLR CAC : Upto BPLR-5%; (3% below MCBOD approved rate, subject to maximum BPLR-5%) HLCC-1 : Upto BPLR-4%; (3% below MCBOD approved rate, subject to maximum BPLR-4%) HLCC-2 : Upto BPLR-1%

Reduction of applicable rate upto BPLR : Such reductions in respect of all credit proposals (i) within the power of MCBOD/CAC/HLCC-1 will be considered by HLCC-1; (ii) within the powers upto HLCC-2 will be considered by HLCC2. Relaxation of rate for limits above Rs.2 lacs & upto Rs.1 crore in Priority sector & Retail Credit Any reduction in the rate upto 1.5% below the applicable rate (except for United Housing Loan), will be decided by the HLCC-2. Any reduction beyond 1.5% will be considered by HLCC-1.

Any reduction in the rate of interest prescribed for the United Housing Loan will be decided by HLCC-1. iii) In case of advances against Banks own Term Deposit (including 3rd party deposit) discretionary power for reduction of spread in interest will be as follows: RLCC 0.50% below applicable rate HLCC-2 0.75% below applicable rate Depending on money market condition, liquidity, etc, reduction beyond 0.75% may be allowed by HLCC-1 In case of advance against 3rd party deposit interest rate cannot be below Base Rate. iv) In case of LC backed bill discounting, HLCC-1, is authorized to reduce the card rate upto Base Rate. v) Concession in the rate of interest may also be allowed in certain potentially viable units under approved rehabilitation packages drawn up on basis of RBI parameters or BIFR directives or CDR mechanism. However, the possibility of recompensing such sacrifices by the borrowers once it turns around may be explored in deserving cases. Concessional rates for sick SSI (now MSE), non126

sick SSI (now MSE) and sick/weak other units (including Medium) will be given in interest rate circular from time to time keeping the extant RBI guidelines in view. Any reduction from such applicable concessional rate shall be allowed only at H.O. level as under; HLCC-2: upto 1% below applicable concessional rate, with a floor of Base Rate. HLCC-1: more than 1% below the applicable concessional rate with a floor rate of 0.50% below Base Rate (in WCTL, FITL, etc for restructured accounts provided such reduction below Base Rate is required for viability, subject to stipulation of recompense clause) CAC: any reduction below Base Rate, in cases as stated above, exceeding 0.50% but not exceeding 1.50%. g) Penal rates of interest As per RBI guidelines the policy on penal interest should be governed by well accepted principles of transparency, fairness, incentive to service the debt and due regard to genuine difficulties of customers. In view of the above guidelines Bank may stipulate terms for levying penal interest @ 1% p.a. at monthly rest per default for the period of default, subject to a cumulative maximum of 3% p.a. at monthly rest, over and above normal interest rate for (a) default in repayment of loan instalments and/or servicing of interest; (b) overdrawing/excess drawing in CC/OD account beyond the drawing power or sanctioned limit including ad hoc/ temporary sanctions, whichever is lower; (c) nonperfection of security as per stipulated terms within stipulated time frame without any valid reason acceptable to the competent authority of the Bank; (d) non-submission of Stock/Book Debt Statements within the stipulated time period; (e) non-submission of QIS/MSOD Statements, wherever applicable, within the stipulated time period without any valid reason acceptable to the competent authority of the Bank; (f) non-submission of Balance Sheet & P/L accounts (audited wherever applicable) within 6 months from the date of Balance Sheet without any valid reason acceptable to the competent authority of the Bank and (g) non-compliance to any financial covenant, if specifically mentioned in terms of sanction that such non-compliance would attract penal interest. [Competent authority means respective sanctioning authorities. However, CAC shall be the competent authority for sanctions accorded by MCBOD] The Borrower should be communicated terms of sanction containing a suitable clause defining each type of default attracting penal interest and rate of penal interest. No penal interest should be charged for loans up to Rs.25,000/-. It may be ensured that charging penal interest is not treated as a routine source of revenue, but as a tool for implementing discipline in the account. 12.2.
i)

Credit Risk Rating & Pricing As per RBI guidelines on Risk Management Systems, bank has since introduced loan pricing mechanism based on risk return principle. Under the risk return principle, borrowers with weak financial fundamentals are categorised in relatively higher risk category attracting higher rate of interest.

ii) Credit Risk Rating should be computed based on latest audited balance sheet and other available nonfinancial data including conduct of the account (in case of existing ones). However, while examining a credit proposal during the interim period between closure of a financial year and publication of audited financials, rating exercise may also be done, if possible, on provisional/unaudited financial data beside rating based on last audited financials for judging the actual risk perception on the basis of performance during just concluded year.

127

iii)

Presently the Bank is following a manual system of computing Credit Risk Rating with a 0-8 rating scale for above Rs.10 lacs upto below Rs.1 crore as well as a software based Credit Risk Rating model (IMaCS) with the technical know-how of M/s ICRA for accounts with limit of Rs.1 crore and above. The existing system will continue. The IMaCS model has been developed for generation of the Credit Risk scoring for borrowal accounts / proposals pertaining to six segments namely Large Corporates (LCs), SMEs, Large / Infrastructure projects. Green field projects, NBFCs and projects on Agro Industries and Food Processing Units. The model evaluates a borrower by generating risk score in the range of 01 to 10. The risk score of 01 is assigned to borrowal accounts with the least likelihood of default and risk score of 10 is assigned to the firms having most likelihood of defaults. The Risk Score generated by the model on scale of 01 to 10 has been mapped to our in-house risk rating scale of UBICR 0 -5 (for Standard Assets) as stated under point v below. RBI, vide its circular DBOD.BP.BC.No.76 /21.04.103/2011-12 dt.02.02.2012, has advised that the banks should evaluate the risks arising out of unhedged foreign currency exposure of the corporate and price them in credit risk premium. The IMaCS model for credit risk evaluation takes care of exchange volatility risk by factoring the corporates foreign currency exposure parameters in repect of its hedging status vis--vis volatility of the market. Hence, pricing based on such risk rating includes credit risk premium related to unhedged foreign currency exposure of the corporate.

iv)

v)

The manual as well as IMaCS scoring vis-a-vis Credit Risk Rating with Risk description along with extant Rating related pricing (the mark up spread over Base Rate(BR)/BPLR is subject to change from time to time) are given below

128

IMaCS Score (Rs. 1 core & and above) 1.00 2.00 >2.00 3.50 >3.50 5.00 >5.00 6.00 >6.00 8.00

Manual Credit Score Risk (Rs.10 lacs Rating to below Rs.1 crore) UBICR 0 UBICR 1 80% and UBICR 2 above 70% to less UBICR 3 than 80%

Risk Description

60% to less UBICR 4 than 70% >8.00 10.00 Below 60% UBICR 5

Substandard asset Doubtful asset Loss asset

1

UBICR 6 UBICR 7 UBICR 8

Minimum Risk Moderate Risk Acceptable Risk Acceptable risk with care Tolerable risk Risk requires managemen t attention Very high risk Very high risk Very high risk

Applicable Rate of Interest* Base Rate BPLR System System Over Over Rs.10 lacs Rs.25 to Rs.25 crores crores BR+4.00% BR+3.75% BPLR BR+4.50% BR+4.25% BPLR+ 0.50% BR+5.00% BR+5.00% BPLR+1.50% BR+5.50% BR+5.50% BPLR+ 2.50% BR+5.75% BR+5.75% BPLR+ 3. 25% BR+6.00% BR+6.00% BPLR+ 3.50%

* Note Rating wise applicable rates for Micro and Small Enterprises including Retail Trade upto Rs.20 lacs, Agriculture and other Prisecs are guided by extant circulars, issued by CPPMI Dept, H.O. from time to time. As per Manual Risk Rating system highest rating, for accounts having limits above Rs.10 lacs to below Rs.1 crore, is UBICR2 (score 80% & above). Accordingly, for such accounts rates related to UBICR0 & UBICR1 will not be applicable. The existing manual rating format for above Rs.10 lacs to below Rs.1 crore is to be used.. The broad parameters considered for the purpose of ascertaining the risk involved are shown below:

vi)

129

ITEM 1. Business Risk 1.1) Financial Risk 1.2) Operational Risk 1.3) Sales Risk 2 . Borrower Risk 2.1) Management Capability 2.2) Conduct of the account TOTAL

WEIGHTAGE 45 20 10 15 55 25 30 100

vii) Categories of advances exempted from computing risk rating: Out of total credit portfolio of the bank, the following categories of advances are presently exempted from computing risk rating: (a) Schematic and structured loans (b) Staff loans (c) All standard Advances having credit limit up to Rs.10 lakh and below (reasons being that it is difficult to compute risk rating for small accounts since authentic financial statements are usually not available in such cases. viii) Irrespective of credit limits (subject to ceiling limit under the respective scheme): a) Advance against Bank's own term deposit, NSC, KVP, RBI Bonds and LIP and advance guaranteed by the Government shall be rated at UBICR-0 i.e. Minimum Risk. b) Advance of any sort sanctioned to employees of the Bank shall be rated at UBICR-0 i.e. 'Minimum Risk'. c) Advance to Landlord for Bank premises shall be rated at UBICR-0 i.e. 'Minimum Risk' d) Advance under the Bank's Retail Credit products shall be rated at UBICR-2 e) Advance under all schematic lending like PMEGP, SGSY etc. under Government Sponsored programmes shall be rated at UBICR-3 i.e. 'Acceptable Risk with Care' Assigned Credit Risk Rating of accounts (other than those mentioned above) having credit limit upto Rs. 10.00 lacs): a) All Priority Sector advances (other than Schematic lending and Retail Credit Products of the Bank) shall be rated at UBICR-3. b) Advances through PACS/ LAMPS/ FSS shall be rated at UBICR-3 c) All other standard advances having limit up to Rs.10.00 lacs shall be rated at UBICR-3. x) For advances to Agriculture and MSME sectors, limits up to Rs.25.00 lacs will be rated as UBICR-3. Rating exercise should be undertaken in accounts with credit limit of above Rs.25.00 lacs as per applicable rating model. xi) The interest rates in the accounts with assigned ratings as stated above shall be guided by interest circulars issued from time to time. xii) For advance classified as NPA shall be rated at UBICR6, UBICR7 and UBICR8 as per risk rating scale as stated above.
ix)

130

12.3. External Bank Loan Rating Under Basel II norm Bank is to assign risk weights to each credit exposures for the purpose of computing Capital Adequacy. As per RBI guidelines on Prudential Guidelines on Capital Adequacy and Market Discipline, vide Master Circular dt.01.07.2011, claims on corporates, exposures on Asset Finance Companies (AFCs) and Non-Banking Finance CompaniesInfrastructure Finance Companies (NBFC-IFC), shall be risk weighted as per the ratings assigned by the rating agencies registered with the SEBI and accredited by the Reserve Bank of India. Claims on corporates will include all fund based and non-fund based exposures other than those which qualify for inclusion under sovereign, bank, regulatory retail, residential mortgage, non performing assets and Specified categories (viz. Fund based and non-fund based claims on Venture Capital Funds, Consumer credit, including personal loans and credit card receivables but excluding educational loans, Capital market exposures, Non-deposit Taking Systemically Important Non-Banking Financial Companies (NBFC-ND-SI), other than AFCs and NBFC-IFCs and any other high risk exposure which may be identified by RBI from time to time). Initially, in Master Circular dt.01.07.2008, RBI prescribed a threshold limit of Rs.10 crores for unrated claims on corporates with reference to single counter party for the bank as a whole with effect from April 1, 2009. Accordingly, the Bank decided to rate all corporate exposures exceeding Rs.10 crores by external rating agencies for allocating risk weight for computing capital adequacy w.e.f.01.04.2009. However, subsequent master circulars dt.01.07.2009, 01.07.2010 and 01.07.2011 did not contain the respective clause in relation to the threshold limit for unrated claims on corporates. Accordingly, the system of external bank loan rating by CARE/ CRISIL/ ICRA/ FITCH/ Brickwork Ratings India Pvt Ltd (Brickwork)/ any other rating agencies accredited by RBI from time to time will continue for all exposures on corporates, as defined above, /NBFC-AFC/ NBFC-IFC. To be eligible for risk weighting purposes, the rating should be in force and confirmed from the monthly bulletin/website of the concerned rating agency. The rating agency should have reviewed the rating at least once during the previous 15 months. Capital charge on individual counterparty exposures is presently guided by RBI Master Circular on Prudential Guidelines on Capital Adequacy and Market Discipline dt.01.07.2011. However, capital charge on exposure to banks will be determined by capital adequacy of the respective banks. Hence external rating of exposures to banks may not be a must. Exposures to central/state governments attract a Zero risk weight. Counterparty exposures fully guaranteed by Central Govt / State Govt will attract zero / 20% risk weight respectively. Hence external rating of such exposures may not be a must.

131

132

CHAPTER X TERM CREDIT AND FINANCING PROJECT TOPIC 13.1 13.2 General Coordination between Banks and Financial Institutions in extending Term Finance Application for Term Finance Project Appraisal Management Commercial Technical Financial Estimated Cost of the Project Means of Financing Project cost of Production and Profitability Break Even Point Projected Fund Flow Statement Projected Balance Sheet Important Ratios for Project Appraisal Sensitivity and Risk Analysis Economics Decision Disbursement, supervision and follow-up Annexure I : Questionnaire for Financial Assistance Annexure II : Example on Break-Even analysis Annexure III : Pre-sanction Inspection Report PAGE NO. 13-2 13-2

13.3 13.4 13.5 13.6 13.7 13.8 13.9 13.10 13.11 13.12 13.13 13.14 13.15 13.16 13.17 13.18 13.19

13-3 13-4 13-4 13-6 13-8 13-11 13-11 13-14 13-15 13-15 13-15 13-16 13-16 13-16 13-17 13-18 13-19 13-21 13-26 13-27

133

Chapter X

BANK FINANCE : TERM CREDIT AND PROJECT APPRAISAL 13.1. GENERAL: 13.1.1 Banks are permitted to provide term finance/loans for technically feasible, financially viable and bankable projects including projects involving creation of infrastructural facilities. 13.1.2 The basic set up of an industrial project comprises of land, building, plant and machinery and utilities. For acquisition of these fixed assets, financial institutions and banks provide them finance which forms an important/major component of the means of finance of the project. Banks (and some financial institutions) also issue deferred payment guarantees for procurement of indigenous plant and machinery on credit terms offered by the manufactures/suppliers and also in respect of foreign currency loans provided by foreign banks for import of plant and machinery, equipment, technical know-how etc. Term Loans granted by the banks normally fall in the following two broad categories: (a) (b) Loans granted for setting up new units. Loans granted for expansion/modernisation/backward or forward integration (including acquisition of balancing equipments /diversification/ rehabilitation).

13.2. CO-ORDINATION BETWEEN BANKS AND FINANCIAL INSTITUTIONS IN EXTENDING TERM FINANCE/LOANS : 13.2.1. RESERVE BANK OF INDIA GUIDELINES: (a) Extent of Banks participation : The stipulation regarding the ceiling/sub-ceiling on the quantum of term finance/loan that banks individually or in consortium/syndicate for a single project has been dispensed with vide RBI, IECD Circular dated 2nd September, 1997 and Banks now have the discretion to sanction term finance loans to all projects within the overall ceiling of the prudential exposure norms prescribed by the Reserve Bank of India as given under item 4.6. of Chapter IV. (b) For lending to public sector units, banks are to ensure that such public sector undertakings are registered under the Companies Act, 1956, or are established as corporations under the relevant Acts, Further, such public sector undertakings must be run on commercial lines and repayment of term finance/loans should be

134

made out of the income to be generated by the project and not out of subsidies made available to them by the Government. (c) For infrastructural development projects, banks must additionally ensure that these are being implemented without the support of budgetary allocation i.e. projects funded out of budgetary resources, or where a firm commitment has been made for tie-up of the financial arrangement. Banks must evolve an appropriate debt-equity ratio for each project. Rates of interest to be charged by Bank should be in conformity with the Banks Lending Policy. Banks are free to decide on the maximum period of term finance/loan keeping in view the maturity profile of their liabilities. Duration of the term loan should not normally be over 7 years except in case of infrastructure and project finance where it may extend upto 15-20 years. Housing loans are part of long term loans and in some cases it may extend up to 25 years. (g) Banks should ensure that they have the requisite expertise for appraising the technical feasibility, financial viability and bankability of the project with particular reference to risk analysis and sensitivity analysis. Banks, if they so desire may take assistance of consultants approved by the IDBI for appraisal of the project. Banks may also undertake such appraisal jointly with an All India Financial Institution (AIFI). (h) Banks must ensure that sanction of higher quantum of term finance for such project which have a comparatively longer gestation period does not lead to any asset-liability maturity mis-match.

(d) (e)

(f)

13.3

APPLICATION FOR TERM FINANCE The prospective borrower should be required to submit the following: (a) (b) (c) (d) (e) (f) (g) Loan application in standard form. In case of existing units, Financial Statements of Accounts for the last three years. Technical Feasibility Report Market Survey Report Estimated Cost of Project and Means of Finance Projected Cost of Production & Profitability Projected Funds Flow Statement

135

(h)

Projected Balance Sheet.

A questioner as may be required to be filled in by the borrower at the time of approach is furnished in Annexure I. NOTE : In case the borrower has submitted application for Term Finance assistance (Term Loan/DPG) to All India Financial Institutions in their prescribed Format, a copy of the same shall be obtained and the same shall generally cover the information/particulars mentioned above. Broad guidelines in regard to the appraisal and follow-up of term loans are given in this chapter. These guidelines are also applicable to deferred payment guarantees and guarantees covering foreign currency loans obtained from foreign banks etc. as such guarantees constitute long term commitment of funds on the part of the banks though contingent in nature. 13.4. PROJECT APPRAISAL : 13.4.1 Project appraisal is necessary for evaluation of the project from different angles namely, management, commercial, technical, financial and economic. With such an evaluation the bank could justify the long term investment made in a project. The relative importance of the feasibility study stated above may vary from project to project depending upon its nature and size. There is no standard criteria for appraising a term loan proposal and each one has to be decided on merits setting weak points against the strong points and with striking a balance, an integrated view has to be taken by a banker. 13.4.2 An illustrative list of important check-points with a brief explanation of different analytical methods, ratios, formulae etc. generally adopted is furnished below: 13.5. MANAGEMENT : 13.5.1 The most vital input for success of a project is an able management which has the capacity to optimise the total benefits of investment and tie together the various inputs to achieve the desired levels of production, sales and profit. Evaluation of the management calls for qualitative and intuitive judgement and the following aspects, inter-alia, has to be covered. The Promoter and Management of the Company must have not only willingness to pay but also ability to pay. 13.5.2 The Promoter : i) ii) Whether the promoter is new or established one ; Background of the promoter educational, economic and experience. If the promoters are established one, the history of evolution, financial position, style of management, adherence to financial discipline, capacity to withstand adverse

136

developments, performance of associate/sister concern have to be studied and analysed. Information from market sources, bankers, stock exchanges, published reports of consultants/merchant bankers etc. have to be collected and studied. iii) Character: The honesty and integrity of the promoters have to be critically examined. This could be gauged from the compliance of financial discipline, commitment kept to financial institutions/banks, transparency of operations, willingness to provide the bank correct/factual information, disclosure of personal property/holdings, due payment of income-tax and wealth tax etc. Entrepreneurial traits like initiative and drive, self-confidence, perseverance etc. Whether the names of promoters/directors appear in the list of defaulters published by RBI/Bank/CIBIL/SAL have to be checked. Capacity: This ability of the promoter is of vital importance as it would determine whether he would be in a position to optimise use of all resources of men, materials and machinery. It should also be evaluated whether he has the capacity to implement and manage successfully the nature and size of the project undertaken and to take moderate risk. His financial soundness to meet any effect of time and cost overrun and to mobilise resources for completion of the project in adverse circumstances has to be critically examined. Involvement in the Project: It is to be examined whether the promoters will have full involvement in the project. Whether the project would ultimately become a flagship/major company of the group (if applicable) is also to be looked into. The involvement in the project shall be gauged from the extent of promoters contribution, representation in the Board, participation in the day to day management of the company etc. In case the project is promoted by any Group, the performance of the group companies, their financial position, track record have to be analysed.

iv) v)

vi)

vii)

viii)

13.5.3 The Company, Organisation and Share-holding Pattern : i) The company : Board of Directors : The composition of the Board, the background and professional experience of the directors, representation of promoters in the Board etc. are to be looked into. The Board should be broad-based with a balanced and homogenous composition of full time and other directors. Will the Board be capable of acting as a well motivated consultative group comprising of well-knit multi-disciplinary team of professionals ?

137

ii)

Organisational structure : Whether the organisational structure is adequate and appropriate to meet specific requirements of the project during implementation and operational stages taking into account process, procurement, production, marketing, training etc. have to be looked into. The Chief Executive should possess requisite knowledge and experience in the field. Delegation of adequate responsibility and authority to various levels of management and accountability aspects should also be looked into. The internal control system proposed to be adopted in the areas of production, inventory controls, personnel etc. should be examined. The proposed accounting and management information system should be adequate.

iii)

Share-holding pattern : The distribution of total equity shares amongst promoters/group, public institutions etc. and the list of top ten shareholders have to be obtained and looked into.

13.6. COMMERCIAL : 13.6.1 The commercial viability of a project involves a thorough market analysis and getting answers to the three basic questions : i) ii) iii) How large is the market ? How much the market is likely to grow in future ? How much the project is expected to capture ?

With a view to enable the Bank to assess the commercial soundness, the following aspects should be analyzed and the degree of emphasis to be laid on each of the aspect and the depth of analysis would, however, depend upon the nature of project, product-mix and size of the market. 13.6.2 Demand : i) The reputation of the organisation which has conducted the market survey should be looked into. The nature of product whether it is manufactured for final consumption (e.g. foodstuff, edible oils, fans, refrigerators etc.) or for intermediate use (e.g. basic chemicals like soda ash, HDPE or cement etc.) or capital goods (like machine tools, earth moving equipments, turbines etc.) has to be ascertained. The volume of past and present demand for the product. What would be the likely future demand of the product and the basis of growth assumed. The data should cover a reasonably long period say, 7 to 10 years, depending upon the nature of the product and the product life.

ii)

iii) iv)

138

v) vi)

What are the substitutes for the product proposed to be manufactured? All alternative methods for forecasting the aggregate demand by various models and by different organisations are to be compared and the most appropriate demand forecast has to be accepted.

Some of the methods available for demand forecast are past trend method based on past data and future macro-level projections, end-use method (generally adopted in respect of many consumer goods/intermediate products), comparisons of consumption levels and trends, export possibilities or import substitution requirement using different techniques such as Econometric Methods to measure the effect of price variation, income variation or both on demand, co-relation and regression (whether demand is related to some other line of activity, e.g. demand for cement or tiles depending on construction activity) etc. The forecast of demand made by National Council for Applied Economic Research, Planning Commission, Development Councils are sources of market information for comparison with the demand projections made in the project report. 13.6.3 Supply: i) From the same, the current volume of supply of the product taking into account both domestic production and imports have to be ascertained. For certain products diversion towards captive consumption has also to be looked into. Information on the major manufacturers in the country for the product, their installed capacity, capacity utilisation and production for last 3 or 4 years have to be collected. The projects under implementation and the fresh licenses issued for new capacity out of which capacities likely to be installed and their output have to be viewed and the sum total of output from the existing units as well as new units should be worked out for future 7 to 10 years. The Govt. Policy on imports has to be looked into. The supply made out of imports should be added to the domestic production to arrive at expected future supply position.

ii)

iii)

13.6.4 Consumers : i) The list of potential buyers and consumers and intermediate users has to be looked into. The consumer preference in regard to brand, quality, product range etc. should also be seen. The geographical, sectoral or seasonal consumption pattern have to be ascertained.

ii)

iii)

139

13.6.5 Market and Market Share : i) The gap between present and projected demand (including exports) and supply (including imports) for 7 to 10 years should be assessed. The ability of the project to face competition in the spheres of quality, pricing, terms of sale and after sales service should also be looked into. Considering the total market size, gap between demand and supply, the realistic share in the market the project is expected to capture could be assessed.

ii)

iii)

13.6.6 Market Environment : The licensing and fiscal policy of the Government in relation to the industry, incentives provided such as subsidies, exemption from duties, taxes etc. available for the project have to be looked into. 13.6.7 Other Commercial Aspects : The marketing plan, pricing policy and distribution policy of the project should also be examined. 13.7 TECHNICAL : 13.7.1 Process Technology : i) The reputation, qualification and experience of the consultants who have prepared the technical feasibility report have to be looked into. While preparing the technical feasibility study whether the consultants have taken all possible alternative production processes and uses of alternative raw materials and the reasons behind the final choice of the technology has to be examined. It has to be found out whether the manufacturing technology proposed to be adopted has taken into account the various factors such as location, climate, availability of inputs and utilities, availability of standard plant and machinery, quality of the product and product-mix. Whether the technology is conventional or modern has to be seen. If modern technology is proposed to be adopted, the degree of obsolescence, as also whether such technology has been used in the country successfully have to be seen.

ii)

iii)

iv)

13.7.2 Technical know-how/consultancy :

140

i)

The arrangement for securing technical know-how (both process and engineering) and consultancy services has to be evaluated; the background of technical collaborators both Indian/foreign, their experience in operating standard of other projects where they were associated are to be verified. The technical collaboration agreement should be comprehensive and the following points are to be covered to the satisfaction of the Bank : a) Mode of transfer of technology and upgradation of the same for the future. b) Scope of services to be rendered for implementation and operation of the project. c) Training of personnel in India/abroad in similar plants. d) Performance guarantees covering quality of engineering, per- formance of the plant, operating level, output/input quality of raw materials and utility. e) Wastage factors for raw materials and rejection rate of finished products. f) Provision of penalty for delayed commissioning and adverse input-output performance.

ii)

13.7.3 Size of the plant : i) It is to be carefully ascertained as to whether the size of the plant is economic (smaller plant size may make the plant unviable because of higher cost of production while an extra-large plant may not be able to sell the output), considering the type of industry, technology adopted, availability of standard/proven plant size operating in the country/abroad etc. The flexibility of the plant in respect of forward or backward integration, expansion, use of alternative inputs (i.e. use of natural gas or naphtha for fertiliser production) and variation in product-mix have also be looked into.

ii)

13.7.4 Plant & Machinery : i) The basis of selection of plant and machinery and other equipments have to be examined. Whether such selection have been made after competitive bidding taking into consideration capacity, price, quality and overall suitability for the process technology proposed to be used and scale of output specified should be evaluated. Section/division-wise capacity of various items of plant and machinery should be ascertained and it should be seen that capacity of various sections are balanced. The procedure for procurement of plant and machinery and other equipments, whether on turn-key basis or by placing orders with different manufacturers have to be looked into.

ii)

iii)

141

iv)

Whether the list of machinery and other equipments is comprehensive and whether all the auxiliaries and equipments for utilities have been included are also to be seen. The reputation of the suppliers of indigenous/imported machinery and timely delivery are also important. Whether the agreement or contract, inter-alia, include penalty clauses for late delivery and replacement conditions/uninterrupted supply of spares and performance guarantee for workmanship, quality, output/input are to be looked into.

v)

13.7.5 Location : The suitability of the size of the project should be examined with reference to its locational advantages such as infrastructural facilities, availability of raw materials, skilled labour, nearness to the market, climatic conditions of the location, soil topography, transportation facility proneness to the natural calamities. Social infrastructural facilities such as housing, schools, hospitals, recreation etc. are also to be looked into. The aspect of effective effluent disposal and pollution control etc. have to be ensured. It should be seen that the site selected is the best one after taking into the various factors stated above vis-a-vis other alternative sites. 13.7.6 Lay-out : As to whether the plant outlay proposed by the consultants have taken into consideration aspects of smooth process flow and minimum manufacturing time, economic movement of man and materials, suitability of the buildings and structure, proper utility service systems, adequate storage and handling facilities at the production point, overall integration and safety factors. The scope for future expansion should be embodied in the plant lay out. 13.7.7 Raw materials and other inputs : a) It has to be ensured that the raw materials and consumable in required quantity and acceptable quality should be available for smooth production. If the raw materials are agricultural products (for example, sugarcane, bamboo, rice bran etc.) the procurement zones should be looked into and arrangements for development of cultivatiion in the procurement zone should be taken into account. If the raw materials are minerals, the estimated quantity of proven reserves have to be ascertained and the same should be based on the reports of GSI, ONGC etc. The arrangement for proposed lease of mines, quarries etc. should be satisfactory.

b)

c)

13.7.8 Utilities : The requirements, sources, availability, reliability and cost of all the utilities such as power, water, fuel etc. are to be ensured. Necessity for making provision for alternate source of supply of vital utilities (say captive power plant/diesel generating set for power) should be examined.

142

13.7.9. Labour : The availability of skilled and supervisory manpower in the vicinity of the proposed site is definitely advantageous. In case the technical and skilled manpower have to be brought from distant places, accommodation and other infrastructural facilities for their stay have to be provided. 13.7.10. a) Effluent disposal/pollution control : The arrangements for disposal of effluents whether liquid or gaseous particularly if the proposed project is a chemical plant have to be ensured. It has to be ensured that adequate arrangement for pollution control has been made to the satisfaction of statutory authorities. Project scheduling and monitoring :

b)

13.7.11.

The timing and sequencing of various activities involved in project implementation i.e. from the concept stage to the final commissioning should be properly planned and scheduled. Adequate arrangement for monitoring and implementation of the project should be drawn up.The company should adopt Project Evaluation and Review technique (PERT) , Critical Path Method (CPM), barchart etc so that implementation of the project remains on projected schedule and no time-overrun (and consequential cost-overrun) takes place as the same may jeopardise the viability of the project altogether. 13.8. FINANCIAL : 13.8.1 General : The examination of the financial viability of a project is done with the following objectives : (a) (b) To ascertain that the cost estimates of the project are realistic. To ascertain that right type of finance in required quantity will be available at the right time. To ascertain the likely earnings of the project from operations based on the projected cost of production and profitability. To fix up the time limit after which the repayment should commence and the total period of repayment in view of the cash accruals of the unit.

(c)

(d)

13.8.2 While examining this aspect, the following points should be looked into. (a) (b) Cost of Project. Means of Financing.

143

(c) (d) (e)

Projected Cost of Production and Profitability. Projected Funds Flow. Projected Balance Sheet.

13.9. Estimated Cost of the Project : The cost of the project submitted by the party should be examined to see that it is as realistic as possible and that nothing is left out which has got a bearing on the cost structure. A realistic assessment of the project cost estimates at the initial stage is essential to ensure that the forecasts of profitability and cash flow do not go astray. Experience has shown that very often projects suffer from sizeable cost overruns, the one that is common in majority of the cases is the adoption of adhocism at the time of working out the estimates. The various items to be taken into consideration for estimation of the project cost are given below : 13.9.1 Land In case the entire land is purchased as a free hold property, the cost including Conveyance charges should be taken into account. In case the land is taken on lease, premium payable on the land together with the Conveyance charges as also the rental to be paid till the period of construction is over (i.e. until the operation starts) should be taken into the consideration. Under this head, other costs with regard to development and levelling of land, construction of approach road inside the factory, fencing gates etc. should also be included. 13.9.2 Building It should include cost of i) ii) Factory buildings for the main plant & equipment ; Building for auxiliary services like steam supply, water supply, laboratory, workshop etc ; Administrative buildings, godowns, warehouses and stores ; Miscellaneous non-factory buildings like canteen,guest house, time office, quarters for essential staff; Silos, tanks, wells, chests, garage etc ; Sewers, drainage, All other civil engineering works excluding the foundation of machinery; and

iii) iv)

v) vi) vii)

144

viii)

Architects service

The entrepreneur should be required to provide information in respect of type of buildings, type of construction, numbers of floor, built up area, rate per sq. feet and estimated cost. It is also desirable to go through the contracts entered into with different contractors in respect of the construction of the buildings which may contain escalation clauses which affect the cost of estimation at a later stage. 13.9.3 Plant & Machinery : In case of imported machinery, the FOB value of the machinery together with ocean freight, insurance, loading and unloading and inward freight to the site should be taken into consideration. In case of indigenous machinery, the cost and octroi and other taxes/charges, if any, and inward freight to the site should be taken into consideration. Adequate provision for the stores and spares should be made. Foundation and installation charges on the imported as well as indigenous machinery should be provided. While examining the plant and machinery cost, tenders/quotations received from the suppliers should be gone through to ascertain the extent of firm and non-firm estimates. 13.9.4 Technical know-how fees : In case the company has entered into any technical collaboration with foreign or Indian company, the fees to be paid and the expenses on the drawings etc., payable to the collaborators should be taken into consideration. 13.9.5 Expenses on Foreign Technicians : Expenses to be incurred on retaining the foreign technicians for installation of machinery and commissioning of the plant and the expenses to be incurred on the Indian technicians to get them trained either within India or abroad should be included in the project cost. 13.9.6 Miscellaneous Fixed Assets : Miscellaneous Fixed Assets usually include the items like furniture, office machinery and equipments; miscellaneous tools and equipment including erection tools, cars, trucks etc; railway siding; power requirement including cabling for distribution of power and lighting for factory and colony, equipment and piping for supply and treatment of water including cost of installation; as also for supply of steam and air etc; laboratory equipment, workshop equipment, fire equipment and other fixed assets.

145

The expenditure on all the above accounts should be shown separately and included in the project cost. 13.9.7 Preliminary and Capital Issue Expenses : Brokerage and commission on capital issue and other capital issue expenses like legal, advertisement, printing and stationery etc. and other initial expenses for floating the company should be taken into consideration while arriving at the total cost of the project. 13.9.8 Pre-operative Expenses : The expenses which are incurred till the plant goes into production are called preoperative expenses and include interest during pre-operative period and commitment charges on borrowings, insurance during the construction, mortgage expenses., interest on deferred payment,if any, and start-up expenses. It should be ensured that all these expenses have been provided for in the cost of project. 13.9.9 Provision for Contingencies : It would be observed from the above that all the expenses proposed to be incurred are only estimates except for the one for which firm offers are obtained. In some cases, the promoter company gets firm offers to which extent no contingency need be provided. In case, contracts entered into by the company contains escalation clause, adequate provision should be made towards contingency on non-firm estimates. Provision for contingency on a judicious consideration may be made depending upon the inflationery trend in the market and the period of project implementation. 13.9.10Margin Money for Working Capital : Margin money has to be provided for availing of working capital facilities from the bank and such margin money should be taken into account in the project cost. Estimated requirements of the working capital should be based on realistic assumptions concerning the amount of stock of raw materials, consumable stores, spares, goods-inprocess, finished products and receivables. 25% of the total current assets should be financed by long term sources and included in the capital cost of the project. 13.10. Means of Financing : 13.10.1After appraisal of the cost of the project, the financing pattern proposed by the promoters/entrepreneur has to be examined. The usual sources of financing of the project are : (a) Share Capital

146

(b) (c) (d) (e) (f) (g) .

Internal Accruals for existing undertakings. Foreign Currency or Rupee Term Loans from Financial Institutions/Banks. Deferred Credit. Public Deposit Convertible/Non-convertible Debentures Capital Subsidy or development loans/sales taxes loans

13.10.2The various sources could be broadly classified into two categories-equity capital and borrowed capital. The ratio between the two categories of funds may vary considerably depending on the nature of the project, project size, expected profitability and the background/financial resources of the promoter/group which should comply the benchmark level as enumerated in the Lending Policy.It is also to be seen whether the internal accruals (in case of existing companies) as also availability and cost of funds vis--vis profit earning capacity of the project have been kept in view while preparing the financing plan. The promoters contribution as percentage of cost of the project should be acceptable to the Bank. In the matter of raising capital by issue of share capital/debentures/bonds, it is to be examined whether SEBI guidelilnes and listing requirements of the Stock Exchanges would be fulfilled. Where foreign currency loans are to be raised, the same should be adequate to meet the foreign exchange cost of the project. 13.10.3An undertaking from the promoters of the project should be obtained to the effect that they will meet the cost overrun, if any, during implementation of the project and its commissioning. The sources from where they would meet the overrun has also to be ascertained. 13.11. Projected Cost of Production and Profitability : 13.11.1 While preparing the projected cost of production and profitability, various assumptions are made by the entrepreneur/promoter. The Bank should first see that the basic factors taken into consideration to arrive at the production figure, such as installed capacity per annum, number of working days in a year, number of shifts per day, capacity utilisation level during initial years till optimum output of the projects reached, are realistic and where applicable are comparable with the performance of similar industries located in the country.

13.11.2While examining the cost of production, it should also be ensured that a realistic assessment of the cost of various inputs like raw materials, consumables, powers,

147

water and fuel, wages and salaries, repairs, maintenance, other manufacturing expenses has been made. Wastage factor for raw-material and rejection rate for finished goods, where applicable should be assumed. There should also be provision of say 5% to take care of possible increase in the various items of cost. Further, in respect of Wages and salaries a provision of say 5% increase at the end of each year should be made to take care of the normal increase in wages. 13.12 BREAK EVEN POINT 13.12.1While looking into financial viability of the project, it is also desirable to look into the Break-Even Point. Break even point indicates the production or price level at which the project would balance its expenditure and sales. An illustrative example about calculation of break even point is given in Annexure II. 13.12.2Break even point enables the project appraiser to determine the in-built margin of safety in the project to take care of any fall in demand and/or fall in unit selling prices. A project with a lower break even point in terms of capacity utilisation will have greater chances of success than a project with a very high break even point. In other words, the project with a low break even point is less riskier than a project with a very high break even point. 13.12.3 While examining the profitability aspect, it should also be ensured that there will be sufficient profit commensurate with the capital employed, the capability of the project to cover the payment of interest and loan instalment should also be ascertained by calculating the Debt Service Coverage Ratio and Priority Obligation Ratio (Explained in detail in Chapter III: Financial Statements, their Analysis & Interpretation). 13.13 Projected Funds Flow Statement: Funds flow projections help in keeping a track of the sources and uses of funds. It is important to ensure that funds will be available when they are needed, be it during the construction period of a project or the operation period. The quantum of share capital to be raised may have been decided upon and the loan assistance may have been sanctioned by the financial institutions; but if there is not sufficient flow of funds to meet the various claims as and when they arise, the entire project may be in jeopardy resulting in delay, overruns and litigation. Likewise, a project may be in danger of technical insolvency during the operational period if the proper estimates of the receipts and disbursements of cash and the provision of their timely and adequate supply is not made. 13.14 Projected Balance Sheet : Based on the projected cost of production and profitability and funds flow statement, the projected Balance Sheet is drawn. The position of share capital, term loans, sundry creditors,

148

bank borrowings, fixed assets, inventory, sundry debtors and the preliminary expenses (after deducting the amount already written off) are ascertained at the end of each year.

13.15 IMPORTANT RATIOS FOR PROJECT APPRAISAL (1) Promoters contribution as Percentage of Project Cost : The contribution made by the promoters by subscribing to the equity capital of the company as percentage of cost of the project should be worked out. A minimum promoterss contribution of 20% of the project cost is normally expected. (2) Break-even Analysis : This is an important tool to assess earning capacity of the project. Break-even point can be expressed in terms of volume of production or sales value or percentage of installed capacity. For purpose of project appraisal, however, banks/financial institutions generally calculate the break-even point in terms of percentage of installed capacity. i)BEP in unit = Fixed Cost/Contribution per unit ( sales- variable cost per unit) II) BEP (sales) = BEP (unit) x sales price per unit iii)BEP (unit)/Installed capacity x 100 The capacity utilisation should be above BEP level for the project to earn profit. (3) Debt-Equity Ratio, (4) Fixed Assets Coverage Ratio, (5) Debt Service Coverage Ratio, (6) Priority Obligation Ratio, (7) Current Ratio, (8) Other Operating Ratios are to be calculated and interpreted (For details, please see the Ratio Analysis in Chapter III).

13.16 SENSITIVITY AND RISK ANALYSIS : 13.16.1Sensitivity Analysis : The various items entering the cost-benefit stream of the project whose viability is being appraised on the basis of estimates and forecasts are subject to various uncertainties. Sensitivity analysis is a process by which the effects of assumed changes in the values of key variables such as revenues, cost, size of outlays etc on the present value of the project is worked out. The objective is to assess the risks and uncertainties involved in the investment decision of the Bank so that necessary corrective steps could be taken by the promoters or the bank/financial institution assisting the project. The effect on breakeven point (BEP) and/or debt-service coverage ratio (DSCR) due to variation/change of a major item could be ascertained through sensitivity analysis. For instance, if there is

149

any increase in the project cost say by 5%, the additional resources that have to be mobilised and whether the same should by way of equity or funding through raising additional term loan or a suitable mix of the two could be decided by the promoter/bank looking at the changes in the break-even point or the DSCR so that these important indicators remain within the acceptable level. Similarly, sensitivity analysis may be made for ascertaining likely impact on viability arising out of some uncertain factors like fall in demand and/or selling price, along with increase in the cost of production etc. For Example, in a sugar project of 1,250 tonnes a day of crushing capacity, the profitability projections might be made on the basis of availability of say 2 lacs tonnes of cane with 11% recovery. The possibility of resistance from the farmers to switch over to sugar cane cultivation, inadequate availability of irrigation facilities, lower recovery and of diversion of cane towards the manufacture of jaggery etc., cannot be ruled out. Consequently, parameters assumed for working out the profitability may not be achieved and it would be desirable to prepare sensitivity study on the basis of reduced availability of sugar cane and lower recovery etc. From the point of view of the bank, while appraising a project, the sensitivity analysis is of particular importance as the promoters of the project seeking financial assistance are generally keen to establish high profitability of the project based on assumptions made on a rather optimistic basis. The soundness of the project should, therefore, be subjected to the scrutiny of sensitivity analysis to assess the effect of unfavourable circumstances/factors thereon. 13.16.2Risk Analysis : The main element of project-risks and the manner in which the promoters have addressed their mitigation have to be studied. The list is only indicative and would vary depending upon nature and size of the project. For detail guidelines the latest lending policy of the bank to be followed. 13.17. ECONOMIC : While appraising the project from economic aspect, the following points may be looked into i) Does the project belong to a sector which has been accorded priority in the National Development Plan ? Will the project save/contribute to foreign exchange earnings through import substitution/exports ? What social benefits will accrue from the project ? What are the ecological hazards to be produced by the project? What are the preventive and safety measures proposed?

ii)

iii) iv) v)

150

13.18 DECISION : 1. The decision of the Manager about the credit request should be based on sound analysis of factors mentioned in the foregoing pages and also subject to pre-sanction inspection (Format for which is enclosed in Annexure III. It should be noted that the above description represents comprehensive appraisal of the project. The depth and dimension shall vary depending upon nature, size and outlay of the project. The Manager shall have to decide on the points on which proper emphasis has to be laid. In case the Manager feels difficulty in appraising the project, he may seek advice and guidance from his Regional Head. If the Manager decides favourably about the credit request then next step is to determine the quantum of advance which should always be need based. The aspect of dispersal of risks in case of consortium/multiple Banking arrangement should also be kept in mind. As mentioned earlier, the requirements of an industrial unit falls into two categories : (a) (b) 4. Term Loan or Deferred Payment Guarantee Facility Working Capital Facility.

2.

3.

Term Loan or Deferred Payment Guarantee Facility is extended to finance the acquisition of fixed assets. Therefore, quantum of term loan can be worked out by deducting the margin amount from the cost of acquiring the fixed assets to be financed. Generally, a higher margin in case of buildings and machinery may be insisted. Term Loan should be subjected to a repayment programme which should be based upon the fund flow statement. For large projects assisted by the All India Financial Institutions/Banks jointly, uniformity in approach may be called for . The assessment of need based working capital requirement of the unit may be made carefully and reference may be made to Chapter XIV on Bank Finance/Working Capital. If the amount involved is large, it is necessary to stipulate conditions regarding ploughing back of earnings, restriction on dividends, strengthening the managerial competence etc. The conditions are to be tailor-made depending on background and financial soundness of the promoters, nature, size and outlay of the project, proposed exposure of the Bank, security available etc. with a view to exercise proper control on the account and safeguarding Banks interest. Branches are advised to refer to the terms and conditions and covenents generally stipulated by the Bank in handling of Credit proposals and to take a view on proposal specific terms and conditions and covenants suitably.

5.

6.

13.19. DISBURSEMENT, SUPERVISION AND FOLLOW-UP

151

13.19.1It is needless to emphasize that credit discipline in appraisal, sanction, monitoring and end-use of bank finance has to be ensured. Even when a comprehensive appraisal has been made and sanction accorded judiciously the same would be of no avail unless the branches ensure post sanction close supervision and follow-up both during implementation period and operative years.

13.19.2 Once sanction is accorded on a proposal, the branch shall advise the sanction to the borrower alongwith stipulated terms and conditions and obtain acceptance of the terms and conditions by the borrower and keep the same along with the documents. The next stage would be completion of documentation formalities, creation and registration of charges etc. which have been dealt with in details in other Chapters. Disbursement should commence only after sanction stipulations are duly complied with. The Branches through periodical visits and obtention of information/data should ensure that : (a) the loan is disbursed according to the programme/in phases as approved by the Sanctioning Authority after the pre-disbursement terms and conditions regarding tie-up arrangements with other financial institutions/banks, broad-basing of the Board, strengthening of the management set-up, etc. are complied with and the promoters contribution stipulated is actually brought in at each stage, and that the disbursement of instalments is related to the progress of implementation of the Project. In general, pro-rata disbursement should be made by the Bank in case of projects assisted jointly by All India Financial Institutions and banks ; The loan is used for the purpose for which it is intended, and incase of deviation in respect of any aspect of the scheme, approval of the appropriate authority is obtained ; The progress made in implementation and operation is according to the time schedule drawn, deviation, if any, is for valid reasons and appropriate steps are taken to reduce delays ; The cost incurred on the project is kept within the estimate and reasons for overrun, if any, are examined carefully; The land, building, machinery etc. mortgaged/hypothecated are maintained in good order by the borrower ; The inventory position is satisfactory; Required margins are maintained in the account at all times;

(b)

(c)

(d)

(e)

(f) (g)

152

(h)

The stipulated instalments/interest are paid regularly and promptly (in case of defaults or delay in payment, the reasons should be looked into); The borrowing unit is functioning properly (to ensure this, the branch should have a proper procedure of obtaining and scrutinising quarterly progress reports, startement of expenditure incurred (with sources) and assets created out of the same at quarterly intervals annual financial statements etc. as also maintaining personal link with the management of the unit through periodical postdisbursment inspection etc); and The difficulties/deficiencies, if any, experienced by the unit in the course of implementation of the scheme or in the smooth functioning of the unit after the scheme has been implemented and any deviation from the stipulations made by the Sanctioning Authority (major deficiencies could be absence of proper organisational set-up, inadequate maintenance of plant and machinery, absence of effective controls on purchase of raw materials, rejections, etc., lack of appraisal of market potential, market fluctuations and other environmental factors affecting sales).

(i)

(j)

13.19.3

In the event of any act of misfeasance/malfeasance on the part of the units management coming to notice, the bank should safeguard its position by obtaining additional security e.g., shares including shares of the company held by the promoters, immovable property, personal guarantees of directors/third parties, etc. The main purpose of supervision and follow up outlined above is to see whether the project is progressing as originally scheduled and the working of the unit on commissioning is satisfactory.

13.19.4

153

ANNEXURE -I QUESTIONNAIRE FOR FINANCIAL ASSISTANCE 1. General : 1.1. Name of Industrial Concern : (BLOCK LETTERS) 1.2. Location : i) Regd. Office ii) Head/Controlling Office iii) Existing/Proposed factories : Constitution : Date of Incorporation: Brief History of the concern : Lines of manufacture : (Furnish details for each division If there are more than one) 1.7. 1.8. A B C D

1.3. 1.4. 1.5. 1.6.

Date of commencement of Commercial Production: Authorised Capital : Issued Subscribed Paid-up Calls in arrear (If changes proposed, please furnish details)

1.9. 1.10.

Particulars of top TEN shareholders of the company : Financial Assistance required : Nature of Facility : (a) (b) (c) Grant of Term Loan. Guarantee for Deferred Payment arranged from machinery suppliers. Underwriting of Shares or Debebtures

154

(d) 1.11. 1.12.

Working Capital Assistance

If Term Loan is required please indicate amount of loan, how it is proposed to be drawn. If Deferred Payment Guarantee is required, please describe in detail the arrangements for deferred payment, including inter alia, the following : (a) (b) (c) (d) Name of beneficiary Goods covered by Deferred Payment Initial payment to be made by the applicant to the suppliers. Amount to be covered by Deferred Payment Guarantees. Principal and interest figures to be separately indicated together with rate of interest. Period of the guarantee

(e)

(A copy of the agreement with the suppliers and a copy of Government approval of Deferred Payment Agreement to be furnished, where applicable) 1.13. If the request is for underwriting, the following particulars are to be furnished : (a) (b) (c) (d) (e) 1.14. 1.15. Details regarding Share/Debenture Issue. Other underwriting arrangement Listing arrangements made/proposed to be made with Stock Exchange Copy of sanction from the Controlling of Capital Issue. Copy of the Draft Prospectus.

If any other assistance is required, details thereof may please be given. Particulars of applications made to other Financial Institutions/Banks for the project and the latest position in respect of the same. Borrowing powers of the company : (a) Reference to the relevant Clause/Article of the Memorandum and Articles of Association or bye-law which enables borrowing, may please be given. If the applicant is a company, please mention if necessary resolution has been passed in terms of section 293 (1)(d) of the Companies Act if the total borrowings of the company exceed its paid-up capital and free reserves.

1.16.

(b)

2.

Management : 2.1. Names and addresses of the promoters along with their educational/professional background, business and industrial experiences.

155

2.2. 2.3.

Existing/proposed shareholdings of Promoters/Director ; List of concerns with which promoters are connected as proprietors/partners directors and also particulars of associate/allied concerns and their principal bankers. If the company belongs to a group of affiliated companies, please give brief particulars of the group and the relationship of the company with it. Particulars of credit limit enjoyed by the affiliated firms/companies with our Bank.

2.4.

2.5. 3.

Past Performance of the Company : 3.1. Please furnish a statement for the last 3 years showing production in quantity and sales in quantity and value (for individual units located within India). Licenced/Registered Installed Capacity Capacity Production (Quantity) Sales (Quantity) Sales (Value)

3.2. 3.3.

Estimated production and sales after implementation of scheme. Please furnish three copies of the Audited Balance Sheet and Profit & Loss account for the last three/five years.

4.

The Project : General : 4.1 Please state whether financial assistance relates to new project, expansion modernisation or diversification. (Please enclose a project report/techno-economic feasibility report prepared by a reputed consultancy bureau experts, if available). Please enclose a certified copy of the Certificate of Registration/Lincence under the Industries (Dev. & Regulation) Act, 1951, for undertaking the project/substantial expansion of the existing unit. Technical : 4.3 Please furnish the present installed capacity (mentioning shift basis) for each of the products and installed capacity after the project is completed. Please furnish the planned production capacity and the basis on which it has been arrived at.

4.2

4.4

156

4.5

Please indicate the progress already made regarding planning, design, construction, order placement etc Mention other arrangements made/to be made as regards acquisition of land, land development, construction of buildings, shed, purchase of plant & machinery, import licence formalities for implementation of the project. A detailed list of plant & machinery, cost, sources of supply, manufacturers, specifications etc to be enclosed.) Do you have technical collaboration/consultancy arrangement? If so, give details. Please enclose Plant lay-out. Describe briefly the Technical Process involved (submit process flow chart). Indicate approximate time schedule for implementation of scheme. Describe briefly proposed site/location along with the infrastructural facilities available. If the unit is proposed to be located in a declared Backward Area, please state incentives to be available from Central/State Government(s). What is the estimate of indigenous/imported raw materials requirement and arrangements made for ensuring regular supply of the same. What is the estimated power requirement (in KWH) showing peak demand and sources of supply and whether the necessary sanction has been obtained from the appropriate authority, if so, a copy to be enclosed. What is the estimate of water and fuel requirement and arrangements made for. Please furnish requirement of skilled, unskilled labour and availability. Please furnish qualifications and experience of Senior Technical Accounts and Administrative Personnel along with an organisation chart

4.6

4.7 4.8 4.9 4.10 4.11

4.12

4.13

4.14 4.15 4.16

5.

Cost of Project : Means of Finance : 5.1 Please furnish details of Capital Cost of the Project and Means of Financing as mentioned in the application. Details of financial arrangement proposed to be made with other Banks/Financial Institutions.

5.2

6.

Profitability of the Project (as per annexures) : 6.1 6.2 Please furnish Projected Profitability Statement. Based on the indicated sources of finance and profit forecast, please submit projected Funds Flow Statement. (This should indicate availability of adequate funds at various stages during the full term of the loan.)

157

6.3 6.4

Based on the cost of production and sales estimates please furnish Break-Even Chart. From the foregoing forecasts, please submit projected Balance Sheets for each year of the currency of the loan.

NOTE : The projected Cost of Production & Profitability Statement, projected Fund Flow statement and Projected Balance Sheet should be submitted both for the Project and the company as a whole if there are other divisions also. 7. Working Capital Requirement of the Project : 7.1 Please furnish assessment of Working Capital requirement in different phases stating clearly the basis of estimation and stocking policy.

Marketing : 8.1 8.2 Please enclose a copy of Market Survey Report, if available. Sales/Marketing Network arrangements to be indicated.

9 9.1 9.2

Security : Indicate the nature of security to be offered to the Bank against various facilities asked for. Names and addresses of Guarantors and their estimated worth (as per wealth tax return, if applicable). Repayment : 10.1 Repayment schedule of Term Loan/Deferred Payment as proposed by the company. Declaration We hereby declare that the information given herein and the statements and other papers enclosed are to the best of our knowledge and belief, true and correct in all particulars. .. (Signature)

10

Additional Enclosures : Besides the forms and statements cited above, three copies each of the following to be enclosed wherever applicable. Governments & other Clearances/Approvals It should be ascertained whether the borrower has obtained consents/approvals as below (wherever applicable) in connection with the unit to be financed. (a) Industrial licence/letter of intent/registration with DGTD.

158

(b) (c) (d) (e) (f) (g) (h) (i) (j)

SEBI clearance for issue of Capital. Consent for technical collaboration arrangements. Clearance for capital goods. Import licence for plant and machinery Allocation of raw materials, imported/indigenous. Approval from State Pollution Control Board. Environmental clearance from Ministry of Environment & Forests. Commitment for supply of water and power. Any other approvals and consents, e.g., mining lease, foreign exchange permission etc.

159

ANNEXURE - II Example on Break Even Analysis Break-even point measures the operating strength of the business. To /measure break-even sales, fixed cost, variable cost and contribution are to be calculated (example of Chapter-III). Variable Cost Account Head Raw materials consumed Wages & Bonus Carriage Inward Stores & Spares Power, Fuel & Water Excise Duty Fixed Cost Total Cost Sales Variable cost Contribution Fixed Cost : : : : : : 51,685 43,741 7,944 7,158 Amount (Rs) 35,115 1,247 29 358 1,886 5,106 43,741 7,158 50,899

Total Fixed Cost 7158 Break-even Point = x 100 = x 100 Total Contribution 7944 = 90.11% Break-even sales = 51685 x 90.11% = 46573 Total Sales - Break-even sales Margin of safety = x 100 Sales 51685 - 46573 = x 100 = 9.89% 51685 This means that if the volume of sales falls by 9.89 per cent, the company will be just at the breakeven point.

160

United Bank of India Pre-Sanction Inspection Report Date of Inspection : Branch _________________ 1. Applicants/Borrowers name in full with name of Unit (a) (b) (c) (d) (e) 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Registered Address Office Address Units address Details of Telephone Nos. Age of the borrower/applicant

Fathers name of the applicant/borrower Residential address of the applicant/borrower Date of establishment of the unit Whether rented/owned/under lease agreement Terms of agreement Line of business : Trade License/Textile license/Driving license etc. as the case may be obtained? Accessibility from the Road/Railway Station by vehicles Provision for electricity, water supply etc. Security aspect; distance from Police Station, boundary wall etc. Availability of floor space. Whether the space is adequate to achieve the projected business ? Possibility of Insurance Coverage. Identical business in and around the unit : (a) (b) (c) (d) Nos. Their condition Whether any of them is our borrower If so, what is his present position

161

(e) (f) (g) 15.

Whether a feed back for the market obtained. Population of the locality. Others

Whether the location of the unit is conducive to growth?

Signature of the Inspector

162

FINANCING WORKING CAPITAL TOPIC 14.1 14.2 14.3 14.4 14.5 14.6 14.7 14.8 14.9 Assessment of working capital Operating Cycle Methods of Lending Projected Turn Over Method Assessment of Working Capital-under First and Second Method of lending Data-base required for Assessment of Working Capital Norms for Inventory & Receivables Classification of Current Assets & Current Liabilities First Method of Lending PAGE NO.

14.10 Second Method of Lending 14.11 Computation of MPBF for working capital 14.12 Excess Borrowing Defined 14.13 Exemptions from second Method of Lending 14.14 Relaxation 14.15 Treatment of Term Loan Instalments for assessment of working capital requirement 14.16 Facility-wise sharing of working capital finance 14.17 Adhoc Credit Limit 14.18 Sharing of Working Capital Finance 14.19 Rate of Interest 14.20 Commercial Paper 14.21 Reporting of credit sanctions to large borrowers to RBI 14.22 Financing working capital under consortium arrangement 14.23 Syndication of Credit 14.24 Discount value of Bills ANNEXURE I : Overall level of Inventory & receivables for various industries

163

CHAPTER XI

BANK FINANCE: WORKING CAPITAL 14.1 ASSESSMENT OF WORKING CAPITAL General 14.1.1 Besides long term fund to take care of the infrastructure (land & building, plant & machinery etc.), a business organization needs short term fund to acquire different inputs (raw materials, packing materials, labour, fuel, power, consumable stores & spares and other miscellaneous expenses) which are absorbed in the process of production. The produce is then sold and the sale proceeds come back to the pool at different time intervals as and when paid up by the buyers, sale proceeds thus received are then again invested in the business for the same purpose i.e., to support and sustain the activities relating to production and sale. 14.1.2 The process is repetitive or cyclic for an ongoing business unit manufacturing/trading or servicing etc. The cycle, however, takes definite time to complete, though it is different for different business units. But what is common is that certain amount of fund is always necessary to support such activities and the fund always remains blocked at each stage of the cycle. 14.1.3 But on what factors, the quantum of such blocked fund depends? The answer is : i) scale of production or level of activity , ii) requirement of different kinds of inputs, services depending on scale of production, iii) availability of required inputs, iv) length of the manufacturing process, v) companys policy regarding maintenance of safety level of final products, vi) terms and conditions of credit granted to the buyers. 14.1.4 This is so, because certain level of inputs like raw materials will always be there in the store, certain quantity of semi-finished goods will always be there in the production pipeline, certain volume of final output will always be there in the godown, certain amount of accounts receivables will always remain unrealized. 14.1.5 The working fund so blocked generates a class of asset called Current Assets. In other words, Current Assets are held by the unit to support activities relating to production and sales. Its quantum depends on scale of production which in turn depends on market demand of the products. 14.1.6 By definition, Current Assets are those which are expected to be converted into cash within a period of one year from the date of balance sheet.

164

The Current Assets have, therefore, time dimension for their liquidation. 14.1.7 Total Current Assets held by the company does not reveal how much of it has been financed by way of profit retention or by way of long term funds. Bankers need to know this aspect and hence the concept of Net Working Capital is important to them. Net Working Capital (NWC) is the difference between Current Assets and Current Liabilities including Bank Borrowings. 14.1.8 The net working capital is the extent of deployment of money from long term sources in building up total current assets of the business. It is the cushion or buffer that provides a certainly that current liabilities might be met up even if there is a fall in the market value of current assets. Gross Working Capital Net Working Capital : Gross Current Assets : Current Assets Current Liabilities (inclusive of Bank Borrowings)

It is always undesirable that Net Working Capital is zero or negative. 14.1.9 A firm must have arrangements for working fund which is just sufficient to meet the level of production and selling. If the working capital is insufficient, production suffers. If it is excess, there is misutilisation, which is unwholesome for the business. 14.2.1 A lending banker would need to work out the just requirement of working capital of a given level of activities, on the basis of the assumption that it would make best and productive use of the fund : Bankers calculation of working capital requirement is based on operating cycle model. 14.2 OPERATING CYCLE/HOLDING LEVEL 14.2.1 Operating cycle/Holding levels of a firm begins with acquisition of raw materials and end with collection of receivables. The stages of the cycle are : Purchasing of raw materials-for cash or credit. Processing them in the factory Converting stock-in-progress into finished goods Arranging the sale of this finished goods either for cash/credit, Finally collection of credit extended for sale.

14.2.2 While the cycle and its stages have got definite time dimension, the cycle would involve blocking of funds. The duration of the operating cycle/holding level is the sum of the duration of the stages and the quantum of fund blocked is the sum of the fund blocked in each of the stages. The stages are :

165

a)

Time period to procure raw materials & stores and the average period for which they are in store. The process time required for converting raw materials into finished products. Average period for which finished goods are held in stores Average collection period for receivables.

Depends on regularity of supply, transportation time, economy in bulk purchase etc. Depends on technology and the duration of the manufacturing cycle. Depends on production pattern, and market demand and sales policy. Depends on the credit policy of the business unit and efficiency of its credit collection machinery.

b)

c)

d)

The length of the operating cycle equals to (a) + (b) + (c) + (d). 14.2.3. How to calculate the individual components of the operating cycle/holding level : a) Time period to procure raw materials etc. and their holding in store i.e. months consumption : Level of raw materials at the end of a year = Consumption of raw materials per month b) Time period for which raw materials etc. remain in process i.e. work-in-process Level of work in progress as at the end of the year = Cost of production per month * (COP) c) Time period for which the finished goods are held in store Level of finished goods at the end of the year = Cost of sales per month ** d) Time period for collection of receivables Amount of book debt/receivables as at the end of a year = Gross sales per month

166

* for cost of production, please refer Annexure - V of Chapter III ** for cost of sales, please refer Annexure- V of Chapter III Note :1. The above computation shall have a relevance with the past trend and may also be decided following the above principle in discussion with the borrower with reference to actual level of holding required. 2. Stock of spares is generally taken at 5% of inventory level or with reference to the past trend. 14.3. METHODS OF LENDING : General : 14.3.1 While the above gives an idea about what is an operating cycle in the matter of procedure for computation of individual components of the cycle and in the process for computation of the working capital funds blocked in an operating cycle, RBI has from time to time, based on recommendations of the various Working Groups/Committees, issued instructions/guidelines to banks about methods of computation of Maximum Permissible Bank Finance to borrowal units depending on the size of their credit requirements. 14.3.2 The concept of Maximum Permissible Bank Finance (MPBF) was introduced in November, 1975, as part of implementation of the recommendation of the Study Group to frame guidelines for follow-up of Bank Credit (Tandon Working Group). Over the years various improvements have been brought about in the system on the basis of experience gained and suggestions received from Banks and the borrowers. Consistent with the policy for liberalisation, greater operational freedom has been provided to the Banks in dispensation of credit. 14.3.3 Reserve Bank of India decided in April, 1997, to withdraw the prescription in regard to assessment of working capital needs on the concept of MPBF enunciated by the Tandons Study Group and advised the Banks that proper system may be evolved by the banks for assessing the working capital needs of the borrowers. 14.3.4 It may be clarified that though the Banks have been given freedom to adopt suitable methods of assessment for working capital requirements, Banks are, in general, still following broadly the Reserve Bank of India guidelines based on the concept of MPBF. As per the said guidelines, for proper assessment, steps to be followed are outlined in Para 14.11 covering First and Second Methods of Lending based on the norms for inventories and receivables and classification of current assets and current liabilities as directed in the lending policy of the banks issued from time to time. 14.4. Projected Turn-over Method (PTOM) :

167

14.4.1 With the object of simplifying the procedure for assessment of working capital requirements of all the units, the instructions relating to the First and Second Methods of Lending based on norms for inventories and receivables and classification of current assets and current liabilities have been replaced by simplified assessment christened as Projected Turn-over Method/Nayak Committee. This method is applicable for assessment of the credit requirements of all Units (new as well as existing) whose fund-based working capital limits are upto Rs.5 crore from the banking system and in case of IT/Soft-ware sector Rs. 2 crore. As per the above guidelines issued by the Reserve Bank of India, such units may be provided working capital limits by Banks on the basis of a minimum 20 percent of their projected annual turn-over. The borrowers would be required to bring a minimum margin of 5% of the projected annual turn-over. In other words, 25% of the projected annual turnover should be computed as the total working capital requirements of which 4/5th (80%) should be provided by the Banks and the balance 1/5th i.e. 20% should be provided as margin by the borrower. The projected turnover/output value may be interpreted as projected Gross Sales which will include excise duty also. Additionally, the assessment of Working Capital requirement of such unit should be done as per first method of lending and if the requirement so computed is different than the one assessed on projected turn-over method basis, the need based working capital finance should be considered by the Bank judiciously. For Working Capital Assessment of MSME, reference may be made to Vol-II of Manual of Instructions(MSME Chapter) 14.4.2 The above guidelines under projected turn over method have been framed assuming an average working capital cycle (expressed in sales value) of 3 months i.e. the working capital provided would be rolled over 4 times in a year. It is possible that in certain industries/trade, the working capital cycle may be less than or equal to 3 months and in all such cases the borrower will receive working capital finance from Bank based on need base requirement.Where the cycle is longer than 3 months, then automatically the assessment as per first method will be higher and the bank finance will be fixed accordingly. 14.4.3 Actual drawings under the working capital limits may be allowed on the basis of drawing power to be determined after excluding unpaid stocks. EXAMPLE 1 M/s. X & Co.have submitted their projected turn-over/other financial figures for the next financial year as under : Projected Gross Turnover : Raw materials consumption : Cost of Production : Rs.100 lac Rs. 65 lac Rs. 75 lac

168

Cost of Sales Other Current Assets Creditors for goods Other Current Liabilities

: : : :

Rs. 80 lac Rs. 10 lac Rs. 6 lac Rs. 2 lac

Assumptions: 1. 2. The projected Turnover appears reasonable and hence acceptable. Projected level of holdings are as under : Raw materials Work-in-process Finished goods Receivables Creditors for goods A. : : : : : 1 months consumption months cost production 1 months cost of sales 2 months sales 1 months purchases

Working Capital Requirement as per Projected Turnover basis Projected Turnover The Total Working Capital Requirement = Rs.100 lac = Rs.25% of Rs.100 lac = Rs. 25 lac Minimum Margin to be provided by the Borrower (5%) Margin available (say) MPBF

= Rs.5 lac = Rs.6 lac = Rs.25 lac Rs.6 lac = Rs.19 lac

In this case, if margin available is less than 5 lac, the borrower is required to bring the shortfall portion. In other words, if margin is more than 5 lac, excess would reduce MPBF whereas if it is less than the required margin (here 5 lac), the borrower would have to meet up the shortfall. B. Computation under First Method of Lending : Raw Materials for 1 months consumption Work-in-process for months cost of production = Rs. 5.40 lac = Rs. 3.12 lac

169

Finished goods for 1 months cost of sales Receivables for 2 months sales Other Current Assets Total Current Asset Less : Sundry Creditors : Rs. 6 lac Other Current Liabilities: Rs. 2 lac The Total Working Capital Gap/Requirement

= Rs. 6.66 lac = Rs.16.66 lac = Rs.10.00 lac Rs.41.84 lac

= Rs. 8.00 lac = Rs. 33.84 lac

It will be evident from the above two methods of assessment, the Working Capital Requirement as arrived at by first method of lending the actual working capital cycle is more than 3 months. Minimum Margin to be provided by = 25% of Rs.33.84 lac = Rs.8.46 lac Margin Available (say) MPBF = Rs.6.00 lac = Rs.33.84 (-)Rs. 8.46 = Rs.25.38 Here, the borrower should be given a limit of Rs. 25.38 lac since it is the need based requirement of the borrower. EXAMPLE 2 1. 2. The Projected sales of Rs.100 lac appear reasonable. The Projected level of holdings are acceptable as under : Raw materials Work-in-process Finished goods Receivables Creditors for goods Other Current Liabilities : : : : : : months consumption 1/4 months cost production months cost of sales 1 months sales Rs. 6 lac Rs. 2 lac

170

A.

Computation of bank finance requirement under projected turnover method remains the same as in the Example 1A i.e. Rs.19 lac.

B.

Computation under First Method of Lending Method: Raw materials ( months consumption) Work-in-process (1/4 months COP) Finished goods ( months COS) Receivables ( months sales) Other Current Assets : : : : : Rs. 2.70 lac Rs. 1.56 lac Rs. 3.33 lac Rs. 12.50 lac Rs. 10.00 lac Rs. 30.09 lac Less : Sundry Creditors : Rs. 6 lac Other Current Liabilities: Rs.2 lac Working Capital Requirement Minimum Margin to be provided by the borrower (25% of Rs.22.09) Margin available (Say) MPBF = Rs. 8.00 lac = Rs. 22.09 lac

= Rs. 5.52 lac = Rs. 6.00 lac = Rs.22.09 Rs.6.00 lac = Rs.16.09 lac

It is evident from the above, the actual working capital cycle being less than 3 months, the working capital requirements as arrived at under first method of lending is lower at Rs.16.09 lac compared to Rs.19.00 lac under PTO and a limit of Rs.16.09 lac may be considered for sanction from the Bank. Actual drawals may be regulated on the basis of drawing power to be determined by the branch after excluding unpaid stocks. In the case Selective of Credit Control Commodities, the margin should conform to RBI directives. 14.5. Assessment of Working Capital Under First and Second Method of Lending: As stated earlier, Reserve Bank of India has given freedom to the Banks to adopt suitable methods of assessment of Working Capital requirements. The Banks in general, are still following broadly the Reserve Bank of India guidelines based on the concept of Maximum Permissible Bank Finance (MPBF) which have brought in an element of certain degree of discipline in inventory and receivable holdings and proper use of banks funds. For all other borrowers ( except certain seasonal industries as specified below) enjoying fund based working capital limit over Rs. 5 crores, the Bank would continue to follow MPBF method

171

under 2nd method of lending with a minimum projected margin of 25% of total build up of current asset which results in the desired level of current ratio of 1.33. In case of certain seasonal industries like tea, sugar mill, cold storage , brick fileld etc and certain specified sector like advances to borrowers engaged in construction business and IT and soft ware sector Bank follows cash budget system for working capital assessment.

14.6

Data-base required for Assessment of Working Capital:

14.6.1 In assessing the requirement of Working Capital for production needs, it is necessary to obtain requisite information from borrowers and RBI have prescribed forms under its Scheme of Credit Monitoring Arrangement(CMA). Separate set of forms has been prescribed for general purpose , for traders and merchant exporters, for Hire Purchase and/or Leasing Companies and diamond exporters. The revised set of forms has been brought into use from April 1, 1991 which formed the data-base for appraisal by the Banks. Information/particulars in case of manufacturer borrowers have to be obtained in the following forms. Form I Form II Form III Form IV Form V Form VI
14.6.2

: Particulars of existing/proposed limits from banking system : Operating Statement : Analysis of the balance sheet : Comparative statement of current assets and current liabilities : Computation of maximum permissible bank finance : Funds Flow Statement

Apart from the above, the borrower will submit Form VII which is relevant in the case of Term Loan. The said Form-VII data relates to total cost of the project and sources of finance and the contents have been taken care of in the Chapter- XIII (Bank Finance-Term Loan). Banks should verify not only the arithmetical accuracy of the data furnished by the borrowers but also rationale behind various assessments based on which the projections have been made. For this purpose wherever necessary the Bank officials should hold discussions with the borrowers on projected sales, level of operations, level of inventory and receivable etc. The data furnished should be recast wherever necessary so that the projections on which the working capital assessment is being made are realistic and acceptable to the Bank. The levels of holding for inventory and receivable as enumerated in para 11.4.1 Vol I of the Lending Policy need to be considered

14.7

Norms for Inventory & Receivables : Working capital is defined as the funds required to carry the required level of current assetto enable the industry to carry on its operation at the expected level uninterruptably. These level of current assets

172

again hing on the activity level and type of activity. Working capital is thus the amount invested or blocked by the unit in various current asset which takes the form of raw material , consumable goods, WIP , finished goods and receivables.Banks have been given freedom to decide on the reasonable levels of holding of each item of inventory and receivable.

14.8

Classification of Current Assets and Current Liabilities : 14.8.1 After estimating the acceptable level of Current Assets (inventory and Receivables) required for smooth operation of a unit, the sources of financing the same are to be decided. Current Assets will comprise of cash and other assets or resources commonly identified as those which are reasonably expected to be realised in cash or sold or consumed or turned over during the operating cycle of the business usually not exceeding one year. The Current Liabilities include items payable or expected to be turned over within one year from the date of the balance sheet and the term is used principally to designate obligations whose liquidation is reasonably expected to require the use of existing resources properly classified as Current Assets or the creation of other liabilities. 14.8.2 It is, therefore, extremely important to have proper classification of various items of Current Assets and Current Liabilities with a view to calculate the projected net working capital, the working capital gap and the Maximum Permissible Bank Finance (MPBF). Reserve Bank of India from time to time has advised the Banks about treatment of these items and an illustrative list of Current Assets and Current Liabilities is enclosed as Annexure-II of Chapter III. The expected level of Current Assets (CA) are to be financed by : a) b) c) d) Credit on purchase/Sundry Creditors (Short Term Sources) Other Current Liabilities (Short Term Sources) Bank Borrowings (Short Term Sources) Net Working Capital (Long Term sources) Net Working Capital (NWC) i.e. margin = Current Assets (CA) Current Liabilities (CL) Working Capital Gap (WCG) = Current Assets (CA) Current Liabilities (excluding Bank Borrowings). In the context of the above approach, the Tandon Study Group has suggested computation of the Maximum Permissible Bank finance as under : = Current Liabilities (CL)

14.9

First Method of Lending :

173

Under this method, the Maximum Permissible Bank Finance (MPBF) will be 75% of the Working Capital Gap. The balance should come out of long-term funds i.e. Net Working Capital (NWC) subject to, however, the fact that in case NWC is in excess of 25% of WCG, the MPBF will get reduced by the excess amount. Under this method, the current ratio will be less than 1.33:1 but above 1.00:1. It is also clarified that first method of lending is generally applied for assessment of Working Capital requirement for sick/weak units under rehabilitation and for other units requiring working capital up to 5 crores ( for IT and software industries upto 2 crore) from the banking system is discussed under para 14.4.3

14.10

Second Method of Lending : Under Second Method of Lending, the borrower should provide for a minimum of 25% of the total Current Assets out of long-term funds i.e. the Net Working Capital (NWC). Sundry creditors for purchase of goods and other Current Liabilities will be available to finance the part of the remaining amount and the bank will provide the balance. The computation of Maximum Permissible Bank Finance (MPBF) under the above two methods would be as under.

14.11 COMPUTATION OF MPBF FOR WORKING CAPITAL Under 1st Method of Lending (A) Same (B) Same (C) Same (D) 25% of C Under 2nd Method of Lending (A) Estimated/Accepted Level of Current Assets (B) Less : Estimated/Accepted level of Current Liabilities (other than Bank borrowing) (C) Working Capital Gap (WCG) (A-B) (D) Minimum Margin Contribution (i.e. Matching Contribution) from Long Term Sources equivalent to 25% of the estimated Current Assets (A) (E) Estimated NWC (which is equivalent to Total Current Assets less Current Liabilities ) (F) Item (C) Item (D) (G) Item ( C ) Item ( E ) (H) MPBF : Item (F) or Item (G) whichever is lower

(E) Same (F) Same (G) Same (H) Same

Excess Borrowing : This will arise when item (G) is less than Item (F).

174

The above two methods of lending may be illustrated by taking the following example of a borrowers financial position estimated/projected as at the end of the Current/Next year :

Illustration : (Rs.in lac) Current Liabilities a) Creditors for purchases b) Other Current Liabilities c) Current Liabilities (Other than Bank borrowings)(a+b) d) Bank borrowings including bills discounted with banks 660 Finished goods Receivables including bills 880 discounted with Bank Other Current Assets TOTAL 1540 TOTAL Current Ratio : 1.05:1 A. Total Current Assets Less : B. Current Liabilities other than Bank borrowing C. Working Capital Gap E. Estimated Net Working Capital First Method of Lending C. Working Capital gap D.Minimum 25% of working Capital gap from long term sources E. Estimated Net Working Capital 242 88 660 968 88 968 407 1628 396 242 66 1628 Current Assets 440 Raw materials 220 Stock in process 836 88

Second Method of Lending 968 C) Working Capital Gap D) Minimum Margin contribution from long term sources equivalent to 25% of the estimated current assets

175

F. C - D G. C E H. MPBF(Lower of F or G) I. Excess borrowing (G-F)

726 E) Estimated Net Working Capital 880 F) Item (C) (D) G) Item (C) (E) 726 MPBF (Lower of F or G) 154 Excess borrowing

88 561 880 561 319

It may also be observed from the above that in the First Method, the borrower has to provide a minimum of 25% of the working capital gap from long-term funds (own funds and term borrowings). In the Second Method, the borrower has to provide a minimum of 25% of the total Current Assets from long-term funds (own funds and term borrowings).

While estimating the requirement of long term funds for new projects, Banks and Financial Institutions should calculate margin for Working Capital on the basis of norms prescribed for inventory and receivables and by applying the Second Method of lending. A project may suffer if sufficient margin for Working Capital is not provided as per the Second Method of Lending while funding new projects. 14.12 EXCESS BORROWING DEFINED : The example cited above gives rise to a situation of excess borrowing as the Current Ratio is lower than the minimum requisite level i.e. 1.33:1 as per Second Method of Lending. Such excess borrowing can be taken care of as under : Type (a) : The borrower may bring in additional long term funds by way of capital/future cash accruals/long term borrowings etc. so that adequate long term surplus fund is available to augment the projected NWC at least to a minimum requisite level and the element of Excess Borrowing is extinguished. Type (b) : Excess Borrowing projected can be adjusted by way of liquidation of the excess current assets estimated, if any, taking into consideration the production/processing cycle of the industry. In the aforesaid context, it is to be clearly understood that while determining the ways of taking care of the projected Excess Borrowing, a banker must ensure that the Bank does not unwillingly become an instrument to finance an undue accumulation of inventory/receivables etc. It is also to be ensured that there is no incident of diversion of the bank finance granted for working capital purposes for other activities (e.g. inter-corporate deposits/investments, investments in finance companies). 14.12 (A) Cash Budget In case of seasonal industries like Tea, sugar mill, cold storage, brick field and other specified activities like construction and IT, Bank follows cash budget system for

176

assessing working capital requirement.While following cash budget system para 11.4.1 of Vol I of the lending policy to be referred. 14.13 Exemptions from Second Method of Lending : (a) Borrowing units engaged in export activities need not bring in 25% contribution from long term funds in respect of export receivables. 25% contribution from long term funds in respect of receivables arising out of domestic/inland sales by drawings bills of exchange under usance Letter of Credit (whether revocable or irrevocable) and negotiated strictly in accordance with the terms of Letter of Credit. NOTE :(1) In case the receivables in the form of sale bills (Inland/export) drawn under L/Cs are included in the build up of current assets for the purpose of assessment of MPBF, then borrowings in the form of Inland/Export Bills purchased/ Discounted/Negotiated under L/C are included in the projected/assessed MPBF. However, in case such receivables arising out of BP/BD under LC do not form part of build up of current assets, bank finance against such receivables will not form part of the assessed MPBF as per the Banks extant guidelines. (2)Since minimum contribution by way of NWC from long term sources of funds is not contemplated in respect of export receivables as also inland receivables arising out of domestic sales made by way of bills drawn under usance L/C (as discussed here-in-before), adherence to the prescribed minimum current ratio of 1.33:1 as per Second Method of Lending may be ensured after excluding the above items from the Current Assets and corresponding Short-term Bank Borrowings form the Current Liabilities in the balance sheet of the borrowing company. For the purpose the bank may apply the above relaxation on case to case basis, only after ensuring that projections made in regard to the aforesaid two items are not only realistic but also in conformity with the overall level of Current Assets estimated. (c) Sick/Weak units under rehabilitation will be exempted from the application of Second Method of Lending.

(b)

14.15 Treatment of Term Loan Instalments for Assessment of Working Capital Requirement:

177

14.15.1. While assessing the MPBF, the entire amount of term loan instalments payable within the next twelve months need not be treated as an item of current liabilities for the following purposes : a) b) for computation of MPBF for computation of NWC

14.15.2. For the aforesaid purpose, the overdue term loan instalments should be treated as current liabilities unless the loan is re-scheduled by the term lending bank/financial institution. 14.15.3. The entire amount of term loan instalments payable within the next 12 months need not be considered as an item of current liabilities for computation of MPBF and NWC.

14.16 FACILITY-WISE SHARING OF WORKING CAPITAL FINANCE (MPBF) 14.16.1 Once the Maximum Permissible Bank Finance (MPBF), which represents working capital requirement of the borrower from Banks, is arrived at, the nature of facilities such as cash credit, working capital demand loan. Bills purchase/discounting, preshipment export, packing credit, post-shipment Foreign Bills Purchase/Negotiation etc. and the limits for each of them have to be determined and allocated. The allocation should be based on the nature of business, business cycle, holding levels of inventory and receivables, export finance requirement depending upon the business needs of the borrower. Seasonal factors and other factors like bulk purchase of raw materials particularly by imports, bunching of sales etc. should also be looked into and flexibility by way of interchangeability between the limits to the extent genuinely needed without jeopardizing security and safety aspects of the particular facility may be permitted, Similarly sub-limits within the limit, restriction in drawing power, margin for each facility have to be decided. Limit against book debt should not normally exceed 75% of the requirement of fund for financing credit sales. 14.16.2 In case of multi-division company, Data have to be obtained division-wise, and also for the company as a whole. While the level of Current assets build-up as per inventory/receivables norms, Working Capital Gap etc. are also to be worked out division-wise and the company as a whole, the MPBF is assessed for the company as a whole. The MPBF thus assessed is then allocated/shared to/between various divisions on the basis of ratio of the division-wise Current Assets or Working Capital Gap to that of the company as a whole, as may be considered more appropriate, depending upon nature and working capital needs of various divisions, security available etc.

178

14.17 Adhoc Credit limit As at present, adhoc/additional credit for meeting temporary requirement can be considered by the financing bank only after the borrower has fully utilized/exhausted the existing limit. 14.18 Sharing of working capital finance The ground rules for sharing of cash credit may be laid down by the consortium, wherever formed. The level of individual banks share shall continue to be governed by the norm for single borrower/group exposure.

14.19 Rate of interest The rate of interest shall apply as may be decided by the bank from time to time.

14.20 Commercial Paper (CP) 14.20.1 Highly rated borrower, Primary Dealers (PD/Satellite Dealers(SD) and All India Financial Institutions (AIFI) are eligible for issuing CP to raise resources. A corporate shall be eligible to issue CP provided (a) tangible net worth of the company as per last audited Balance Sheet is not less than Rs. 4.00 crore, (b) the company has been sanctioned working capital limits by banks/AIFIs and the borrowers account is classified as Standard by banks/AIFIs. 14.20.2 Further all participants are also required to obtain credit ratings for issuance of CP from either Credit Rating Information Services of India Ltd (CRISIL) or the Investment Information & Credit Rating Agency of India Ltd (ICRA) or Credit Analysis & Research Ltd (CARE) or Fitech Ratings India Pvt. Ltd or such other credit rating agency (CRA) as may be specified by RBI from time to time. The minimum rating requirement shall be P(2) (pronounced as P minus 2 ) or such equivalent rating by other agencies. The rating has to be current. CP can be issued in lot minimum of Rs. 5.00 lac or multiples thereof. 14.20.3 Maturity : CP may be issued for maturities between a minimum of 15 days upto a maximum of one year. However, maturity of the CP should not go beyond the date upto which the credit rating of the issuer is valid. 14.20.4 Mode of Issuance : CP is to be issued in a dematerialised form through any of the depositories approved by and registered with SEBI. 14.20.5 Limits and Amount of CP Issue :

179

14.20.5.1The aggregate amount of CP from an issuer shall be within the limit as approved by the Board of Directors or the quantum indicated by the CRA for the specified rating whichever is lower. 14.20.5.2Where CP is issued as a stand alone product, bank will have the flexibility to fix working capital limits duly taking into account the resources pattern of issuers financing including CPs. 14.20.5.3The bank may, however, have the flexibility to provide for a CP Issue, credit enhancement by way of stand-by assistance/credit back-stop facility on merit where necessary within the prudential norms as applicable. 14.20.5.4Non-banking entities including corporate can now provide guarantee for credit enhancement under stand-by/ back-stop arrangements for issue of CP provided (a) the issuer fulfils all eligibility criteria prescribed for issue of CP, and (b) the guarantor has a credit rating of at least one notch higher than the issuer from any approved CRA and the offer document of CP discloses the net worth of the guarantor, names of other companies to which similar guarantees have been issued, the extent of guarantee now being offered and the conditions under which the guarantee will be invoked. 14.21 REPORTING OF CREDIT SANCTIONS TO LARGE BORROWERS (in lieu of CMA) TO RESERVE BANK OF INDIA 14.21.1 In the context of major developments in the Banking Sector such as (a) discretion given to banks to decide on the levels of holding of inventory as also of receivables by the borrower (b) withdrawal of mandatory formation of consortium and freedom given to banks to frame the ground rules even where consortium is formed on voluntary basis, (c) operational freedom given to banks in the assessment of working capital, reporting under CMA was no longer considered necessary and the same has since been discontinued with effect from January, 1998. However, in order to have data base in relation to the flow of Bank credit to borrowers in various segments of industries, Banks are required to report to Reserve Bank of India in respect of borrowers availing working capital credit or term loan including deferred payment guarantee limit of Rs.10 crore or above from the banking system on quarterly basis as or the last Friday of every quarter. Branches should submit the above returns to their controlling offices promptly at the end of quarter as applicable so that consolidated return could be submitted by Head Office to RBI within the prescribed time limit.

14.21.2

14.21.3

14.22 FINANCING WORKING CAPITAL UNDER CONSORTIUM/MULTIPLE ARRANGEMENT :

180

14.22.1

Under the consortium arrangement a number of Banks join hands to meet the financial requirements of large borrowers and share the risks involved in it. The benefit of each others skill and expertise could be pooled together under the consortium arrangement. Normally, the Bank providing largest quantum of working capital assistance to the borrower is designated as the Leader Bank. It is also to be ensured that such arrangement does not put the borrowers to inconvenience causing delays in dealings with several Banks. Reserve Bank of India Guidelines (April 1997) : Reserve Bank of India advised the Banks in April, 1997, regarding withdrawal of the hitherto existing mandatory requirement of formation of consortium for working capital finance for corporate borrowers enjoying working capital facility of Rs.50 crore and above. Banks have been advised that they may evolve appropriate mechanism for adoption of sole bank/Multiple Banks/Consortium or Syndication approach by framing necessary ground rules on operational aspects. It may be noted that the level of individual Bank shall continue to be governed by the prudential exposure norms for single borrower/group. Banks in their own interest should endeavour and ensure to have an effective system of appraisal, flow of information on borrower among participating Banks, commonality in approach and sharing of lendable resources under the single window concept. As syndication is an internationally practiced model for financing credit requirements, Banks are free to adopt syndication route, irrespective of the quantum of credit involved, if the arrangement suits the borrower and the lending Banks.

14.22.2

Consortium Advance/Multiple Banking Arrangement i) The Bank prefers consortium arrangement to share the inherent risks involved in credit exposure. However, credit requirement of Bank's existing customers having fund-based limit up to Rs.10.00 crore and under Bank's Credit Risk Rating UBICR2 or better, sole banking arrangement will be preferred. In case of existing borrowers of the Bank having working capital limit of Rs10.00 crores and above from the banking system under consortium arrangement, the same will continue provided the borrower does not opt for sole or multiple banking. Bank's own appraisal method of lending as mentioned above will be followed in case of consortium arrangement where Bank is leader of the consortium. However, in cases where Bank is not the consortium leader, the appraisal done by Consortium Leader will be given due importance, but the Bank will also have to carry out its own assessment and if it shows major variation from that assessed by the leader, necessary clarification should be obtained from the leader and needs to be critically examined with justification. Bank will prefer to have, subject to prudential norm, minimum 5% share or Rs.10.00 crore as a member of consortium for a meaningful participation in the consortium. It will be the sole discretion of the Bank to take up enhanced share on pro rata basis irrespective of its status in the consortium. Bank will take its own credit decision on the borrower.

ii)

iii)

181

Bank may consider opting out of the consortium in case it is not satisfied with the performance/financial operations of the borrower. iv) Pending execution of consortium documents, Bank's own documents should be executed supported by exchange of No Objection Certificate (NOC) ceding pari-passu charge. Bank will file its individual hypothecation charge based on such note. The Bank will follow other operational formalities as agreed in the meeting of consortium members, subject to approval from the sanctioning authority. Bank will always prefer to have pro-rata share of the non-fund business of the borrowers under consortium finance. In case of multiple division borrowers, division wise multiple banking arrangement may be accepted provided the financial parameters of the division as well as the company as a whole commensurate with the benchmark parameters as per prevailing lending policy of the bank. However, compliance in respect of Credit Risk Rating (both internal and external) may be considered in respect of company as a whole. In order to avoid delay in release of credit facility and creation of security, both in case of Consortium Advance and Multiple Banking the required No Objection Certificates (NOC) for ceding / creating charge on the securities, when asked for, by the Banks is to be issued expeditiously. In case of new sanction / enhancement / modification of terms of sanction execution of joint documentation (wherever required) needs to be ensured at the earliest but preferably not later than six months. viii) Lenders / consortium meeting needs to be held at least once in a quarter. Immediately on receiving the notice for consortium meeting the concerned branch will forward a copy of agenda to the respective sanctioning authority and will ensure obtaining his views / stand before attending such meeting. In case of HO / RO controlled account, wherever required officials from such offices should also attend the meeting. Regular exchange of information within lender banks to be ensured at least on quarterly basis in RBI prescribed format (enclosed in Appendix-II under Annexure VI) as per HO Circular No: CPPMI/ADV/180/OM-0620/08-09 dated 17.02.2009. A declaration from the existing borrowers enjoying credit facility from the Bank for Rs.5.00 crore & above who are not under consortium / multiple banking arrangement may be obtained mentioning whether they are enjoying any credit facility from any other bank. If on the basis of such declaration any borrower is found to be enjoying banking facility from other bank(s), exchange of information following above mentioned HO circular is to be ensured. The Bank should incorporate suitable clause in the loan agreement at the time of sanction / renewal regarding exchange of credit information so as to address confidentiality issues. In case of multiple/consortium arrangement the Bank should obtain regular certification, on half-yearly basis, by a professional, preferably a Company Secretary, Chartered Accountant or Cost Accountant, regarding compliance of various statutory prescriptions that are in vogue, as per RBI format given in Appendix-III under Annexure VI.

v) vi)

vii)

182

14.23 SYNDICATION OF CREDIT 14.23.1 Syndication of loan/credit has become an internationally accepted model for financing credit requirements of the borrower. Banks are free to adopt syndication of credit limits irrespective of quantum of credit involved, if the arrangement suits the borrower and the financing banks. It is easier to arrange syndication of credit limits for those borrowers whose financial position is sound and credit rating is high. It may be clarified that a syndicated credit is an agreement between two or more lending institutions/banks to provide a borrower credit facility using a common loan documentation. A prospective borrower intending to raise resources through this mode may award a mandate to a bank/Institution (commonly referred to as lead manager) to arrange credit on its behalf. The mandate should give details regarding terms and conditions of the proposed credit. On receipt of the mandate the lead manager prepares an information memorandum about the borrower and distributes the same amongst the prospective lending banks inviting their participation in the credit to be extended to the borrower. The information memorandum may provide necessary and adequate information to each prospective lending bank for making its own independent evaluation of the borrower, if necessary, by seeking additional supporting information. The information memorandum should also contain the evaluation made by the lead manager. On receipt of the offers from the intending participating banks, a meeting of the prospective lenders is convened by the lead manager to finalise the deal-timing, charges towards management expenses, cost of credit, share of each participating banks in the syndicated credit etc. A loan agreement is prepared and signed by the participating banks. The borrower is required to give prior notice to the lead manager or his agent for drawing the loan amount to enable the latter to tie up disbursement with the other lending banks. While a syndication is quite similar to the system of consortium lending in terms of disposal of risk, a fixed repayment period is kept under syndicated credit which is absent in the present system of lending through consortium arrangement. Therefore, syndication of credit has already become a convenient mode of raising long term funds by highly rated borrowers in the international market. It is also likely that gradually this model would become a practiced model in our country.

14.23.2

14.23.3

14.24 DISCOUNTED VALUE OF BILLS CORRESPONDING TO AN EFFECTIVE RATE OF INTEREST : 14.24.1 Branches have reported operational problems in working out the rate of discount to be applied at the commencement of the usance period in such a manner as

183

to ensure that the effective interest rate remains the rate of interest specified in the terms of sanction. 14.24.2Considering the operational difficulties, we indicate hereunder the formula prescribed by the Reserve Bank of India for arriving at the discounted value of bills for varying usance period. By applying this formula the branches should be able to work out the discounted value of bills for the various unexpired usance period. The bank should scrupulously observe the procedure set out hereunder. Branches should carefully note that when discounting a bill the amount of discount has to be deducted at the time the bill is discounted. Hence, recovering of interest by the branches at the end of the usance period would not be in order. In addition to recovery of the discount on bills the branches should recover the bill collection charges/commissions on bills discounted as per extant guidelines of the bank.

14.24.3

Formula for Deriving the Discounted Value of Bills corresponding to an Effective Rate of Interest D F I N : Discounted Value of the bills (Rs.) : Face value of the bill (Rs.) : Effective interest rate per cent per annum : Usance period i.e. number of days

Formula : F D = [IxN 1+ [ ] [ 100 x 365 ] Illustration For a face value of a bill of Rs.100 and effective rate of interest of 15.5 percent per annum, the discounted value of bills of usance periods of 30, 60, and 90 days would be as under : Usance (days) Discounted value (Rs.) ]

184

30

100 1+[15.5x30/100x365] = 98.7421

60

100 1+[15.5x60/100x365] = 97.5154

90

100 1+[15.5x90/100x365] = 96.3188

APPENDIX-I Minimum Information to be Declared by Borrowing Entities to Banks while Approaching for Finance under Multiple Banking Arrangement a. Details of borrowing arrangements from other banks (institution-wise and facility-wise)

I. II. A

B. C.

Name and address of bank/ institution Facilities availed Fund-based credit facilities (Indicate the nature of facilities e.g. working capital / demand loan / term loan / short term loan) / foreign currency loan, corporate loan / line of credit / Channel financing, bill discounting etc. amount and the purpose) Non-fund-based facilities other than derivatives (Indicate the nature of facilities e.g. L/C, BG, DPG (I&F) etc. amount and the purpose) Derivatives contracts entered into with the bank (Indicate the nature of the contract, maturity, amount and the purpose) Date of sanction Present outstanding (In the case of derivatives contracts, negative MTM i.e. which is not due for settlement may be indicated) Overdues position, if any (In the case of derivatives contracts, the negative MTM i.e. amount payable to the bank under the contract but not yet paid may be indicated) Repayment terms (for demand loans, term loans, corporate loans, project wise finance) Security offered

III. IV.

V.

VI.

VII.

185

(complete details of security both primary and collateral including specific cash flows assigned to project wise finance / loan raised & personal / corporate guarantee, to be furnished] VIII. Requests for facilities which are under process (The information to be given for domestic and overseas borrowings from commercial banks, Financial Institutions and NBFCs)

b. I. II. III (i) (a) (b) (c) (ii) (a) (b) (c) (iii) (iv) III. IV. V.

Miscellaneous Details (Rs. in crore)

VI. VII. VIII. IX.

CPs raised during the year and current outstanding Details of financing outside banking system e.g. L/C Bills discounting Amount of un-hedged foreign currency exposures (please give currency-wise position in the format given below) Short term exposures (less than one year) Long positions Short positions Net Short term exposures (a-b) Long term exposures (one year and beyond) Long positions Short positions Net Long term exposure (a-b) Overall Net Position (i-ii) for each currency Overall Net Position across all currencies Main and allied activities with locations Territory of sales and market share Details of financial aspects incl. DSCR Projections wherever applicable as per requirement of bank-Imp. Financial covenants, if any, agreed to/accepted with other lenders. C.D A/cs. within / outside financing Banks, being operated, if any Demands by statutory authorities/current status thereof Pending litigations A declaration authorizing the bank to share information with other financing banks

186

APPENDIX II Revised Format under Multiple Banking Arrangement Credit Information Exchange Part I Bio Data of the Company I. II. III. IV. Borrowing partys name and address Constitution Names of Directors/Partners Business activity * Main * Allied Names of other financing Banks Net worth of Directors / Partners Group affiliation, if any Date on associate concerns, if ban king with the same bank Changes in shareholding and management from the previous report, if any Part II Major credit quality indicators I. II. III. IV. IRAC Classification Internal Credit rating with narration External Credit rating, if any Latest available Annual Report of the borrower

V. VI. VII. VIII. IX.

As on __________

Part III Exposure Details other than Derivatives (Rs. in crore) I. Type of credit facilities, e.g. working capital loan/demand loan/term loan/short term loan/foreign currency loan, corporate loan/line of credit/Channel financing, contingent facilities like LC, BG & DPG (I&F) etc. Also, state L/C bills discounting/project wise finance availed). Purpose of loan Date of loan facilities (including temporary facilities) Amount sanctioned (facility wise) Balance outstanding (facility wise) Repayment terms Security offered * Primary * Collateral * Personal/Corporate Guarantees * Extent of control over cash flow Defaults in term commitments/lease rentals/Others Any other special information like court cases, statutory dues, major defaults, adverse internal/external audit observations

II. III. IV. V. VI. VII.

VIII. IX.

187

Part IV Exposure Details Derivation Transactions (Rs. in crore) Sr. No Nature of the derivations Transactions Notional Amount of contracts Weightedaverage maturity of contracts Amount of Amount of positive MTM contracts for the bank classified (Not due for as NPA settlement) Notional Major Amount of reasons outstanding for contracts restructur which have ing (in been brief) restructured

A. 1. 2. 3. 4. B.

1. 2. 3.

Plain Vanilla Contracts) Forex Forward contracts Interest rate Swaps Foreign Currency Options Any other contracts (Please specify) Complex derivatives including various types of option combinations designed as cost reduction/zero cost structures Contracts involving only Interest rate derivatives Other contracts including those involving foreign currency derivatives. Any other contracts (Please specity)

188

Part V Un-hedged foreign currency exposures of the borrower with currency-wise details (Rs. in crore) I (a) (b) (c) II (a) (b) (c) III IV Short term exposures (less than one year) Long positions Short positions Net short term exposure (a-b) Long term exposures (one year and beyond) Long positions Short positions Net long term exposure (a-b) Overall Net Position (I-II) for each currency (Please give Overall Net position in this format for each currency) Overall Net Position across all currencies Part-VI Experience with the borrower Conduct of funded facilities (based on cash management/tendency to overdraw) II. Conduct of contingent facilities (based on payment history) III. Compliance with financial covenants IV. Companys internal systems & procedures V. Quality of management VI. Overall Assessment (The above to be rated as good, satisfactory or below par only) (*) Broad guidelines for incorporating comments under this head is furnished in the next page I.

189

Broad Guidelines for Incorporating Comments under Part VI (Experience) of the Credit Information Report
Good 1. Conduct of funded facilities * * Over-drawings (No. of times) Average period of adjustment Upto 4 times Within 1 month 5 to 6 times Within 2 months 10 to 20% 3 to 4 times Within 2 weeks Above 6 times Beyond 2 months Above 20% Above 4 times Beyond 2 weeks Satisfactory Below Par

* Extent of overdrawings (% of limit) Upto 10% II. Conduct of contingent facilities (Other than Derivatives) * No. of Defaults Upto 2 times * Average period of adjustment Within 1 week III. Conduct of Derivatives Transactions * No. of contracts where the positive MTM value due to the bank remained overdue for more than 30 days * No. of contracts where the positive MTM value due to the bank remained overdue for more than 90 days and the account had to be classified as NPA (but later on regularized and is not NPA as on the date of exchange of information) Note: All cases where any of the contracts has been classified as NPA and continues to be NPA as on the date of the exchange of information should be shown as Below Par) * No. of contracts restructured during the relevant period Compliance with financial covenants * Stock statement/Financial data * Creation of charge Companys internal systems and procedures * Inventory Management * Receivables Management * Resource Allocation * Control over Information Quality of management * Integrity * * Expertise Competence /Commitments Tract Record

<25% of total number of contracts

25-50% of total number of contracts

>50% of total number of contracts >5% of total number of contracts

<1% of total number of 1-5% of total number contracts of contracts

<25% of total number of contracts Timely Prompt Adequate systems are in place -do-do-doReliable Professional & visionary Timely

25-50% of total number of contracts Delay upto 15 days Delay upto 2 months Adequate systems are in place but not adhered -do-do-doNothing adverse Have necessary experience Executions

>50% of total number of contracts Delay over 15 days Delay over 2 months Adequate systems are not in place -do-do-doCannot be categorized in previous columns -do-do

IV.

V.

VI.

190

Appendix III Part: I DILIGENCE REPORT To, The Manager, ___________________ (Name of the Bank) I/We have examined the registers, records, books and papers of ____________ Limited having its registered office at as required to be maintained under the Companies Act, 1956 (the Act) and the rules made thereunder, the provisions contained in the Memorandum and Articles of Association of the Company, the provisions of various statutes, wherever applicable, as well as the provisions contained in the Listing Agreement/s, if any, entered into by the Company with the recognized stock exchange/s for the half year ended on . In my/our opinion and to the best of my/our information and according to the examination carried out by me/us and explanations furnished to me/us by the Company, its officers and agents. I/We report that in respect of the aforesaid period: 1. The management of the Company is carried out by the Board of Directors comprising of as listed in Annexure ., and the Board was duly constituted. During the period under review the following changes that took place in the Board of Directors of the Company are listed in the Annexure ., and such changes were carried out in due compliance with the provisions of the Companies Act, 1956. 2. The shareholding pattern of the company as on ------- was as detailed in Annexure : During the period under review the changes that took place in the shareholding pattern of the Company are detailed in Annexure.: 3. The company has altered the following provisions of (i) The Memorandum of Association during the period under review and has complied with the provisions of the Companies Act, 1956 for this purpose. (ii) The Articles of Association during the period under review and has complied with the provisions of the Companies Act, 1956 for this purpose. 4. The company has entered into transactions with business entities in which directors of the company were interested as detailed in Annexure.. . 5. The company has advanced loans, given guarantees and provided securities amounting to Rs. ____________ to its directors and/or persons or firms or companies in which directors were interested, and has complied with Section 295 of the Companies Act , 1956. 6. The Company has made loans and investments; or given guarantees or provided securities to other business entities as detailed in Annexure .and has complied with the provisions of the Companies Act, 1956. 7. The amount borrowed by the Company from its directors, members, financial institutions, banks and others were within the borrowing limits of the Company. Such borrowings were made by the Company in compliance with applicable laws. The break up of the Company's domestic borrowings were as detailed in Annexure .. : 8. The Company has not defaulted in the repayment of public deposits, unsecured loans, debentures, facilities granted by banks, financial institutions and nonbanking financial companies. 9. The Company has created, modified or satisfied charges on the assets of the company as detailed in Annexure. Investments in wholly owned Subsidiaries and/or Joint Ventures abroad made by the company are as detailed in Annexure 10. Principal value of the forex exposure and Overseas Borrowings of the company as on are as detailed in the Annexure under"

191

11. The Company has issued and allotted the securities to the persons-entitled thereto and has also issued letters, coupons, warrants and certificates thereof as applicable to the concerned persons and also redeemed its preference shares/debentures and bought back its shares within the stipulated time in compliance with the provisions of the Companies Act,1956 and other relevant statutes. 12. The Company has insured all its secured assets. 13. The Company has complied with the terms and conditions, set forth by the lending bank/financial institution at the time of availing any facility and also during the currency of the facility 14. The Company has declared and paid dividends to its shareholders as per the provisions of the Companies Act, 1956. 15. The Company has insured fully all its assets. 16. The name of the Company and or any of its Directors does not appear in the defaulters' list of Reserve Bank of India. 17. The name of the Company and or any of its Directors does not appear in the Specific Approval List of Export Credit Guarantee Corporation. 18. The Company has paid all its Statutory dues and satisfactory arrangements had been made for arrears of any such dues. 19. The funds borrowed from banks/financial institutions have been used by the company for the purpose for which they were borrowed. 20. The Company has complied with the provisions stipulated in Section 372 A of the Companies Act in respect of its Inter Corporate loans and investments. 21. It has been observed from the Reports of the Directors and the Auditors that the Company has complied with the applicable Accounting Standards issued by the Institute of Chartered Accountants in India. 22. The Company has credited and paid to the Investor Education and Protection Fund within the stipulated time, all the unpaid dividends and other amounts required to be so credited. 23. Prosecutions initiated against or show cause notices received by the Company for alleged defaults/offences under various statutory provisions and also fines and penalties imposed on the Company and or any other action initiated against the Company and /or its directors in such cases are detailed in Annexure.. . 24. The Company has (being a listed entity) complied with the provisions of the Listing Agreement. 25. The Company has deposited within the stipulated time both Employees' and Employer's contribution to Provident Fund with the prescribed authorities. Note : The qualification, reservation or adverse remarks, if any, are explicitly stated may be stated at the relevant paragraphs above place(s).

Place: Date:

Signature: Name of Company Secretary/Firm: C.P. No.:

192

Part II CERTIFICATIONS OF BORROWAL COMPANIES BY CHARTERED ACCOUNTANTS / COMPANY SECRETARIES / COST ACCOUNTANTS i) ii) iii) Terms of reference for stock audit are to be spelt out clearly by the Banks, so that the Chartered Accountants can give focused attention to such areas. End-use verification of funds lent, if certified by Statutory Auditors, will be a good comfort to the Banks. As Banks quite often deal with unlisted companies, disclosure requirements for such companies above a specific turnover may be made akin to those for listed companies, viz. consolidated balance sheet, segmental reporting etc. Information on large shareholding also will be useful. Further, the following additional certification either from Chartered Accountant or Company Secretary or Cost Accountants may also be thought of :a) Company Directors not figuring in defaulters list (RBI/ECGC)/willful defaulters list etc. b) Details of litigation above a specified cut off limit. c) A specific certificate, probably from the Company Secretary, regarding compliance with Sec. 372 (a) of the Companies Act. d) Details of creation/ modification/satisfaction of charges on the assets of the company, position regarding insurance, show cause notices received, finds and penalties awarded. As regards rotation of Auditors, for the sake of operational convenience, it is suggested they may be changed once every 5 years instead of every 3 years.

iv)

v)

In order to avoid concentration, group companies may have different Statutory / Internal Auditors in case group turnover exceeds Rs.100 crores.

193

Chapter - XII

194

Different types of charges

TOPIC 16.1 General 16.2 Assignment 16.3 Lien 16.4 Bankers Lien 16.5 Negative Lien 16.6 Set Off 16.7 Pledge 16.8 Hypothecation 16.9 Mortgage 16.10Various forms of Mortgage

PAGE NO.

195

CHAPTER XII

DIFFERENT TYPES OF CHARGES 16.1 GENERAL Bankers secure their advances by various securities. To make these securities available to cover our advance, the assets/properties are to be charged to the bank. Such securities are source of strength for the banks as the same would be crystallised for recovery of debt, if necessary. When a charge is created on asset/property to cover a debt, the bank does not become the absolute owner but has certain rights over the asset/property charged until the debt is repaid. The common ways of charging a security are explained in the under noted paragraphs. 16.2 ASSIGNMENT 16.2.1 An assignment is a transfer by one person of a right in property or debt existing or future to another person. The person assigning the right is called the assignor and the person in whose favour the assignment is made is called the assignee. The most common types of assignment are those in respect of book debts, supply bills on Government/Semi Government bodies and life policies. To be accepted as a security for an advance the assignment of a book debt must be in writing signed by the assignor and irrevocable notice in writing must be given to the debtor of the assignor (usually the customer). At the same time the bank should ask the debtor to acknowledge receipt of the notice and enquire whether he has any right of set off against the assignor and whether the debtor has received notice of any prior assignment. 16.2.2 In banking, the usual subject of assignment is actionable claim. Section 3 of the Transfer of Property Act, 1882 defines actionable claim as a claim to any debt other than a debt secured by mortgage of immovable property, or to any beneficial interest in movable property not in the possession, either actual or constructive, of the claimant, which the Civil Courts recognise as grounds for relief, whether such debt is beneficial or contingent. It is permissible under Section 130 and 136 of the Transfer of Property Act, 1882, to assign Actionable Claim to anyone except to a judge, a legal practioner or an officer of the Court of Justice. An assignment is valid, whether or not accompanied by a separate agreement that the assignee would, on repayment of the debt, reassign the subject matter of assignment to the assignor. 16.2.3 The value of the assignment of an actionable claim, say, a right or a debt as a banking security depends not only upon the integrity of the borrower who offers the security but

196

also on the credit worthiness and integrity of the borrowers debtor whose debt is assigned; ultimately the payment has to come from the latter source. 16.3 LIEN 16.3.1. A lien is the right of a creditor to retain in his possession goods or securities belonging to a debtor until the debt is repaid. The ownership remains with the borrower, the lender has the possession. A lien may be either particular or general. A particular lien arises when the right of retention of property is limited to a particular debt only. A general lien, however, confers the right to retain the property not only in respect of the debt in connection with the property but also in respect of general balances due arising out of other transactions by the owner of the property. 16.4 BANKERS LIEN 16.4.1 A Bankers lien is more than a general lien-it is implied pledge. An ordinary lien does not carry with it creditors right to sell a property. But a pledge does. The banker has the power to realise securities such as bills, promissory notes, cheques, securities against a loan left with the bank even after the payment without filing a suit, subject, of course, to reasonable notice to the customer. N.B. : From a strictly legal point of view there is no necessity to obtain a written agreement for lien vide Section 171 of the Indian Contract Act, 1872. In practice, however, the Bank usually obtains a stamped letter of lien from the customer. 16.4.2. It is to be considered as to what securities may be subject of a bankers lien. The lien extends only to such securities as a banker ordinarily deals with for his customer. The securities should also be owned by the customer in his own right. In deciding whether a particular security is subject to a bankers lien, the test is how the said security came into the hands of the bankers. If the security was handed over to him in the ordinary course of business & not for a special purpose inconsistent with the lien, the banker can exercise his right of general lien over the security. 16.5. NEGATIVE LIEN : Under this, the bank does not get any right to retain any asset of the borrower. The borrower here gives a declaration to the banker that his assets mentioned therein are free from any charge or encumbrance and also that he shall not create any charge over such assets or dispose of without the consent of the bank. 16.6. SET-OFF 16.6.1. Set-off is the statutory right under which in the absence of any agreement to the contrary, the creditor is entitled to take into account any balance to the credit of a debtor for adjustment of the debt of the latter either wholly or partially. For example, if a

197

person has a debit balance of Rs. 2,000/- in his overdraft account and a credit balance of Rs. 1,000/- in his Savings Account, the Bank shall have the right to apply the credit balance for adjustment of the overdraft account unless there is express or implied agreement to the contrary. In order that this right of set-off may be exercised, the debt must be a sum certain, due by and to the same parties and in the same right. A debt accruing due cannot be set-off against a debt already due. In case of a loan repayable on demand or on a specified date, is not due for payment until demand notice is served on the arrival of the due date. This loan cannot be set-off until it is due by application of the amount of a fixed deposit in the borrowers name which has matured and is already due. 16.6.2. The various ingredients of a set-off are as under : (a) Mutual debts must be for sums certain : one person must be a creditor of another person and vice-versa, for known amounts. All the branches of a bank are considered as one for the purpose of the right of set-off. If X has a borrowal account with Calcutta branch and a current deposit account with Mumbai branch showing a credit balance, the bank has a right of set-off and can transfer the credit balance at Mumbai wholly or in part to Calcutta branch for the adjustment of the borrowal account. Debts to be due immediately. Only those debts can be the subject of set-off which are due and recoverable on the date of set-off. Debts in same right : The parties must be mutually indebted in the same right. If the customer has one account for his own money and another for trust money, the bank cannot set-off a credit balance in his personal account. No agreement to the contrary : The creditor has a right of set-off under law provided the conditions in (a), (b) and (c) are satisfied and further there is no express or implied agreement to the contrary.

(b)

(c)

(d)

16.7. PLEDGE 16.7.1. Pledge, as defined in the Indian Contract Act, 1872, is the bailment of goods as security for payment of a debt or performance of a promise. Bailment is the delivery of goods by one person to another for some purpose under a contract that the goods shall be returned or otherwise disposed of according to the direction of the bailor when the purpose is accomplished. The person depositing the goods or securities is termed as the pledgor and the party with whom they are left is called the pledgee. 16.7.2. In a pledge the pledgee is entitled to the exclusive possession of the property (without ownership which remains with the pledgor) until the debt is discharged. Legal delivery of the goods to the pledgee is an essential part of the contract. But it is not essential

198

that there should be an actual physical delivery. Constructive delivery, such as delivery of the keys of the godown in which goods are stored or delivery of warehouse receipts will be sufficient. Securities subject to pledge are goods (or the documents of titles thereto such as bill of lading, railway receipt) and fully negotiable securities such as stocks, shares etc. 16.7.3 In the event of failure by the pledger to repay the loan amount as per terms of sanction Bank has the authority to sell the pledged goods after issuing a notice to the defaulting borrower in this respect. 16.8. HYPOTHECATION 16.8.1. Hypothecation is a legal transaction whereby goods are made available as security for debt without transferring ownership or possession to the creditor. Under the arrangement the goods remain in the possession of the borrower under an equitable charge to the Bank. As a security value it has got a low rating. As the lender does not obtain actual or constructive possession of the goods, his measure of control over them is often very limited, with the result that the borrower may have ample opportunity of dealing with them for misuse. Limited Companies of good standing are generally considered good for advances against hypothecation of goods as the registration of the charge with the Registrar of Companies tantamount to a public notice. Advance against hypothecation is also made to first class parties as well, especially in case of industrial advances and advance to small borrowers, when it may be impossible for the borrowers to give actual or constructive possession of the goods to the banker, which may result in bottleneck in production or sale, hypothecation, is the only convenient method of charge. The securities covered under hypothecation are generally goods too bulky for storage in a godown or requiring frequent handling, transport vehicles, plant and machinery, work-in-progress, raw materials, finished goods, book debts, standing or future crop etc. Only moveable goods and book debts can be hypothecated. 16.8.2. STATEMENT OF STOCK In case of hypothecation advances, statements of stocks are taken periodically, say, once in a month or a fortnight, from the borrowers, with a declaration regarding their clear title to the goods and the correctness of the quality, quantity and valuation thereof. 16.9. MORTGAGE 16.9.1. A mortgage is a transfer of a legal interest in specific immovable property as security for the payment of an existing or a future debt or performance of an engagement which may give rise to pecuniary liability. 16.9.2 The transferor is called the mortgagor, the transferee, the mortgagee and the money of which repayment is secured by the mortgage, the mortgage money while the instrument

199

by which the transfer is effected is called the mortgage deed. The immovable properties which can be mortgaged are land and buildings, machinery fixed to the earth etc. N.B. : The word Interest denotes a real right. Whatever may be the form of a mortgage, a mortgagor does not part with the whole interest-only an interest is transferred subject to the right of redemption. Only in case of sale the whole interest is transferred to the buyer. 16.10. VARIOUS FORMS OF MORTGAGE The various forms of mortgage as described in Section 58 of the Transfer of 1882 are given below : (a) Simple mortgage Where without delivering possession of the mortgaged property the mortgagor binds himself personally to pay the mortgage money and agrees, expressly or impliedly, that in the event of his failing to pay according to his contract, the mortgagee shall have a right to cause the mortgaged property to be sold and the proceeds of sale to be applied, so far as may be necessary, in payment of the mortgage money, the transaction is called a simple mortgage and the mortgagee a simple mortgagee. (b) English Mortgage Where the mortgagor binds himself to repay the mortgage money on a certain date, and transfers the mortgaged property absolutely to the mortgagee, but subject to the proviso that he will retransfer it to the mortgagor upon payment of the mortgage money as agreed, is called an English Mortgage. An essential characteristic of an English Mortgage is the personal liability of the mortgagor notwithstanding the absolute transfer of the property to the mortgagee. (c) Mortgage by conditional sale Where the mortgagor ostensibly sells the mortgaged property on the condition that in default of payment of mortgage money on a certain date the sale shall become absolute or on the condition that such payment being made the sale shall be void, or on the condition that such payment being made the buyer shall transfer the property to the seller, the transaction is known as mortgage by conditional sale. (d) Usufructuary Mortgage Where the mortgagor delivers the possession or binds himself expressly or impliedly to deliver possession of the mortgaged property to the mortgagee and authorises him to retain the possession until repayment of the mortgage money and to receive rents and Property Act,

200

profits accruing from the property or any part of such rents and profits and to appropriate the same in lieu of interest or in payment of the mortgage money, or party of both, then the transaction is known as usufructuary mortgage.

(c)

Mortgage by deposit of title deeds Where a person in any town, the Provincial Government concerned may, by notification in the Official Gazette, specify on this behalf, delivers to a creditor or his agent documents of title to immovable property, with intent to create a security thereon is called a mortgage by deposit of the title deeds and is commonly known as Equitable Mortgage. Notified towns for the purpose of clause (f) of Section 58 of the Transfer of Property Act, 1882, are declared from time to time by the Provincial Governments. This form of mortgage, which is valid only if made in notified towns, is not required to be registered and though an unregistered transfer of property, it stands on the same footing as a registered simple or English Mortgage. The requisites of a valid equitable mortgage are : (i) (ii) (iii) (iv) A debt (actual or contingent) Deposit of the original title deeds to a creditor or his agent Intention to create a security thereon In the notified towns to which the provision is extended by the Provincial Govt.

There must be a deposit of title deeds with an intention that they shall serve as a security for the debt. Mere delivery of the deeds is not enough when there is no existing debt unless there is an intent to create a mortgage for a future debt. A mortgage by deposit of title deeds is created by the deposit and it is not necessary that the terms on which the deposit is made should be in writing. The transaction being an oral one there is no question of registration. But as a measure of precaution it is usual for the deposit to be accompanied by a letter of admission wherein the borrower confirms having deposited the title deeds with intent to create mortgage. If, however, the mortgage is created through the instrument of a suitably drafted memorandum of deposit it comes under the operation of the Registration Act, and the memorandum requires ad valorem stamp duty and has to be registered with the Registrar of Assurances. If there is a deposit of title deeds independently of the writing, it is the deposit that creates the mortgage and the letter of admission is as mere confirmation and is not required to be stamped or registered. (f) Anomalous Mortgage

201

A mortgage which is not a simple mortgage, a mortgage by a conditional sale, an usufructuary mortgage, an English Mortgage or a mortgage by deposit of title deeds within the meaning of Sec. 58 of the Transfer of Property Act 1882 is called an anomalous mortgage. An anomalous mortgage is usually a combination of two or more types of mortgages. For instance, if personal liability to repay is incorporated in a deed for usufructuary mortgage, it results in anomalous mortgage. Of the various forms of mortgages described above, simple mortgage and equitable mortgage or mortgage by deposit of title deeds are more commonly acceptable to the Bank. For the purpose of creation of mortgage charge, searching and valuation etc are to be done as per HO directives issued from time to time.

202

CHAPTER XIII

WORKING CAPITAL FINANCE TO INFORMATION TECHNOLOGY (IT) AND SOFTWARE INDUSTRY TOPIC 17.1 17.2 17.3 17.4 17.5 17.6 17.7 17.8 17.9 Introduction Classification Eligibility Methodology for assessment of working capital Papers to be submitted for credit appraisal Nature of credit facilities Security Margin Rate of interest PAGE NO.

17.10 Monitoring & Follow-up system 17.11 Administrative Arrangement & Sanctioning Authority 17.12 Definitions Form A Form B Form C Form D

203

Chapter XIII

WORKING CAPITAL FINANCE TO INFORMATION TECHNOLOGY (IT) AND SOFTWARE INDUSTRY 17.1. Introduction : Information Technology (IT) and Software Industry has gained considerable importance in view of its high potentiality for contribution to rapid and all-round national development. Bank credit is an essential input for the growth and progress of IT and Software Industry. 17.2. Classification : Various segments of the Information Technology and Software Industry are broadly classified into four categories. 17.2.1. Software services Staffing services and programming services These services, which are also known as manpower exports, involve deputation of professionals for delivering programming services at customers locations within the country, as well as abroad, under different contracts. The working capital requirements for these services would be in the form of initial travel costs for order canvassing and mobilisation expenses, as also travel costs and living expenses of the personnel deputed for executing orders. The party may, in a few cases, receive some amount by way of advance payment from the clients which would be mentioned in the contract; the contract would also indicate the mode of payment, i.e., whether by way of monthly/periodical payments or payment in lumpsum after execution of the contract. Thus, the working capital requirements of the party would, inter alia, depend upon the gap in cash flows. 17.2.2. Project Services : i) Customised software development These services comprise providing solution to specific problems of the customer which would be utilised by corporate main frame and mini computer users. These services could be rendered either at customers location or delivered on physical magnetic media (like floppies and diskettes) or through satellite communication networks. This service is normally offered under special contracts which provide for mile-stone payments. In these cases also, working capital requirements would be for meeting the gaps as disclosed by the cash flow statements. ii) Systems solution and integration This involves providing a complete business solution using information technology. In this, integrator addresses a business problem of the client and

204

offers an IT based business solution. The work involves programming, testing, documenting customised software solution for clients and integration of this programme with the clients existing IT system as well as with the systems of the clients parties/associates. Working capital requirements would arise mainly on account of expenditure on professionals, products, purchase of software packages/tools. iii) Maintenance of software In this category, the party takes up an assignment for maintenance of clients software. Typically, it takes on the complete responsibility for maintaining a suit of software of the client. These contracts cover trouble shooting operations and at times even updation of the software. Working Capital for this activity would be needed mainly for meeting expenditure on professionals. 17.2.3. Software products and packages : (a) These comprise of (i) systems software viz. Operating system software, conversion of programmes and utilities which enhance the computers capabilities and (ii) application software which lets the computer perform specific functions; packages like word processing, graphic design, financial analysis etc. come under this category. These products are prepared to meet standard requirements of end-users and are sold as packaged units comprising software manual and other user aids (tutorials). The development of these products involves fairly large scale investment, the return on which can be realised only after the product is fully developed and sufficient demand is generated. By and large, no payment by the buyers would be involved at any stage of development and the developer would be receiving payments only when the products are purchased by interested buyers. In such cases, working capital requirements would be mainly for meeting expenditure such as salaries and expenses of the professionals associated with the development of the products. The period required for development would vary and, in some cases, may extend up to 24 months. As regards the financing of this category, it would have to be funded as a venture at considerable risk.

(b)

(c)

17.2.4. Information technology related services (IT service) IT Services such as call centres, mentoring, teleconferencing, tele medicine etc. result from the use of any IT software over a system of IT Products for realising value

205

additions. Working capital requirements may also arise for meeting the expenditure incurred in providing these services. However, these may not be of a significant scale.

17.3. Eligibility : Application for credit facility should be considered on the basis of track record of the promoters/their group affiliation, quality and competenence of the management team with reference to academic/professional qualifications and work experience in software programming/development/marketing besides infrastructural facilities available with the unit. This would be based on business age of the borrower and the quantum of turnover achieved in the previous year. An unit should have successfully run for a minimum period of one year and its projected annual turnover should be Rs.100 lacs or above (Rs. 50 lacs and above where it is operating as ancillary to established Indian Software Co.) backed by past performance before it could be considered as eligible for working capital finance. 17.4. Methodology for assessment of working capital : The working capital requirement of the IT and Software Industry would arise mainly on account of expenditure on professionals (i.e. travel costs, salaries and other incidental expenses) for utilising their intellectual proprieties and expertise in delivering programming service, providing solution to specific problems or complete business solution for the customers or for maintenance of clientssoftware or for development of software packages to meet standard requirements of the end users. In the case of development of software package, the return can be realised only after the product is fully developed and sufficient demand is generated for the same. Thus, there would be no generation of any tangible goods and the value of the end product depends upon its acceptability to client users. Only when specified mile-stones are reached, assets in the form of receivables from buyers are generated and can be valued. In view of above, the Cash Budget System would be convenient for arriving at the permissible bank finance (PBF) where peak deficit in the Cash Budget would determine the PBF but credit would be disbursed on the basis of deficit at relevant point of time. The Cash Budget would be subjected to revision/modification in the event of change in the basic presumptions and the credit limit would be modified accordingly. While Cash Budget System would be followed in general for assessing the PBF, in case of borrowers requiring working capital limit up to Rs.2.00 crores, such working capital finance may be assessed on the basis of 20% of projected turnover. In other cases, assessment of MBPF should be done on the basis of the monthly cash budget system. Borrowers enjoying working capital limit of 10 crore and above from banking system, the guidelines regarding the loan system for delivery of banks credit would be applicable.

206

However, in order to ensure proper end-use of funds even when limit is sanctioned on the basis of turnover, release of limits should be based on cash flow statement and taking into account quarterly cash gaps.

17.5. Papers to be submitted for credit appraisal The borrower/applicant is required to submit the following papers in connection with appraisal of the credit proposal : a) Operating statement showing the actual /projected annual income and expenditure (as per Format A). Actual/projected Balance Sheet (as per format B) Cash Budget showing the monthly projection of receipts and payments under different heads for 12 months (as per Format C). Statement of economics showing contract-wise value, manpower requirement, contractspecific expenses, additional investment in hardware, equipment, software tools/packages etc. (as per Format D). Detailed project report and business plan specifying the short-term and long term goals of the unit, strategies proposed to develop and market software, stage-wise financial outlay and revenue/cost projection, and the basis on which the proposed limit is sought.

b) c)

d)

e)

17.6. Nature of credit facilities The credit facilities would be in form of Cash Credit/Overdraft and Bill Purchase/Discounted. 17.7. Security : As already narrated in item 17.4 above, the process of development of software product and service does not generate any tangible goods and value of the end project depends upon its acceptability to the client/user. Thus, the book value of the end product may be different from its real value in future. In view of above, the entire credit line to the borrower should be fully secured by collateral securities in form of mortgage of property and/or charge on moveable assets and debts besides personal guarantee of promoters/corporate guarantee from affiliate concerns of the promoters. 17.8. Margin : In view of uncertainty in the value of end product and its volatile nature, the margin should be minimum of 50% in the form of promoters contribution. However, margin may be reduced up to 25% on case to case basis when credit facility is allowed against purchase/discounting of bills backed by L/C or otherwise. In deserving cases relaxation

207

of margin may, however, be considered on their merits having regards to the nature and value of additional securities offered, market reputation of the applicant/borrower and its group.

17.9. Rate of interest : The rate of interest would be governed by the guidelines on lending rate of the bank issued from time to time. 17.10. Monitoring & Follow-up system : Monitoring of the credit facilities should be done by obtaining from the borrower monthly cash flow statement and comparing the same with the relative monthly cash budget so that correction, if any necessary, can be made in the cash budget, before future fund release. In case of software export business the relevant guidelines issued by RBI for the purpose of exchange control should be adhered to. 17.11. Administrative Arrangement & Sanctioning Authority : Keeping in view the unconventional nature of activities carried out and products dealt with in IT & Software industry, financing of such activities/products and the aspect of monitoring of the relative bank credit assumes special importance. In view of the above, it is proposed that all proposals relating to IT and Software Industry emanating from any of our Regional Offices are to be sanctioned by H.O. from the level of General Manager and onwards under their respective overall Discretionary Power. The Regional Offices will identify the centres under their area of control where IT Software & Services Units are sufficiently large in number and identify the branches to approach prospective borrowers. The proposals received by the branches will be sent to concerned credit departments at H.O. through the Regional Offices with their recommendation/views for final disposal. 17.12. Definitions : (a) Information Technology (IT) Product : This means computer, digital/data communication and digital data broadcasting products. (b) IT Software : It means any representation of instruction, data, sound or image (including source code and object code), recorded in a machine readable form, and capable of being

208

manipulated or providing interactivity to a user, by means of an automatic data processing machine falling under the heading IT Products. (c) IT Service : It is defined as any service which results from the use of any IT Software over a system of Products, for realising value addition. (d) IT Industry : It will cover development, production and services related to IT Products.

209

FORM A OPERATING STATEMENT (Consolidated) Last 2 years (Actuals) 1. Income : (i) from software services - Export - Domestic (ii) from other activities/products - Exports - Domestic (iii) Total - Export - Domestic 2. Contract/Specific Expenses i) Salaries of software professionals ii) Travelling expenses of software professionals iii) Cost of softwares acquired iv) Data Transmission charges v) Other contract/project related overheads 3. Administrative, Marketing & General Expenses i) Salaries of office staff ii) Travelling expenses (not included in 2(ii) above) iii) Telecommunication Expenses iv) Other overheads 4. Depreciation 5. Interest 6. Change in work in progress 7. Operating Profit i.e. 1-(2+3+4+5+6) 8. Other Income 9. Other Expenses (Rupees in lac) Current Year Next Year (Estimated) (Projections)

210

10. Profit before tax i.e. (7+89) 11. Income Tax, if any 12. Net Profit i.e. 11-12

Note : For items 1 & 2 above, separate annexures giving information relating to each of the activities (Staffing and Programming services, Project Services etc. ) should be given.

211

FORM B ANALYSIS OF BALANCE SHEET (FOR THE UNIT AS A WHOLE) Liabilities Last 2 years (Actuals) I. Current Liabilities Bank Borrowings (including Bills discounted) Other Current Liabilities i) Advances Received ii) iii) Sub-Total I II. Term Liabilities Term Loans Suppliers Credit Debentures/FDs (Not maturing within 1 year) Preference shares (Maturity of more than 1 year but not exceeding 12 year) Sub-total II iii. Total outside liabilities (I+II) iv. Net Worth Equity Share Capital Share Premium Preference Shares (maturity exceeding 12 years) Free Reserves & Surplus Sub-total IV Total III & IV

(Rupees in lac)

Current Year Next Year (Estimated) (Projections)

212

FORM B Assets Last 2 years (Actuals) V. Current Assets Cash & Bank Balances Fixed Deposits (including margin money) Receivables (including Bill Discounted) Work in Progress Other Current Assets i) Advance payments ii) iii) Sub total V VI. Fixed Assets Less : Depreciation Net Fixed Assets Sub total VI VII. Other Non-Current Assets Licenced Software packages Investment in Associates/ Subsidiaries Miscellaneous Assets Sub-total VII VIII. Intangible Assets Sub-total VIII Total V to VIII i) TNW [sub-total (IV) (VIII)] ii) BB/TNW iii) TOL (item III) iv) TOL/TNW Current Year Next Year (Estimated) (Projections)

213

FORM C PROJECTED CASH BUDGET FOR A PERIOD OF 12 MONTHS (Rs in lac) Months Receipts-Section I 1. Cash inflows from contracts I. Receipts from contracts executed (including Bills Discounted with Bank) II. Advance Receipts towards order Sub-Total (A) 2. Other Cash inflows i) Miscellaneous income ii) Other short term inflows (to be specified) Sub-Total (B) 3. Cash inflows relating to working capital (A+B) Payments- Section I 4. Cash outflows for Contract Expenses i. Expenses for contracts under execution ii) Expenses towards fresh contract (Execution not yet started) Sub-total (C) 1 2 3 4 5 6 7 8 9 10 11

214

5. Other cash outflows i. Administrative, Marketing and general expenses ii. Travelling expenses (other than those included in contract expenses) iii. Other overheads/ miscellaneous expenses Months iv. Other short term outflows Sub-total (D) 6. Cash outflows relating to working capital (C+D) Receipts Section II 7. Cash Inflows from Long Term sources (a) Capital loans : i. Share Capital & Premium ii. Preference share capital/quasi-equity iii. Term Loans iv. Fixed Deposits/ Debentures (b) Other long term sources (to be specified) Long term Cash inflows Sub-total (E) Payments Section - II

10

11

215

8. Cash outflows towards Long Term uses i. Acquisition of Fixed Assets ii. Repayment of TL/ Supplier Credit/FDs/ Pref.shares iii. Others (to be specified) Long Term Cash outflows Sub-total (F) 9. Cash deficit relating to working capital(6-3) 10. Cash surplus from long term source (7-8) 11. Overall cash deficit/ surplus(9-10) 12. Opening WC outstandings (excluding bills discounted) 13. Closing WC outstandings (excluding bills discounted)

216

FORM D CONTRACT ECONOMICS PROGRAMMING SERVICES/SOFTWARE PROJECTS ETC. (Rupees in lac) Contract No. Contract No. Contract No. Contract No. Client Country Type of work Duration of contract Milestones & timeframes for completion Terms of payment including advance payments, if any Manpower requirement Additional investments required Hardware, other equipment, Premises, infrastructure, Software tools/package, Personnel Value of the contract Contract specific expenses Other overheads appropriated for the contract Estimated surplus

217

Annexure-III United Bank of India Pre-Sanction Inspection Report Date of Inspection : 1. Applicants/Borrowers name in full with name of Unit (a) (b) (c) (d) (e) 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Registered Address Office Address Units address Details of Telephone Nos. Age of the borrower/applicant Branch _________________

Fathers name of the applicant/borrower Residential address of the applicant/borrower Date of establishment of the unit Whether rented/owned/under lease agreement Terms of agreement Line of business : Trade License/Textile license/Driving license etc. as the case may be obtained? Accessibility from the Road/Railway Station by vehicles Provision for electricity, water supply etc. Security aspect; distance from Police Station, boundary wall etc. Availability of floor space. Whether the space is adequate to achieve the projected business ? Possibility of Insurance Coverage. Identical business in and around the unit : (a) (b) (c) (d) Nos. Their condition Whether any of them is our borrower If so, what is his present position

218

(e) (f) (g) 15.

Whether a feed back for the market obtained. Population of the locality. Others

Whether the location of the unit is conducive to growth?

Signature of the Inspector

219