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Q1. Discuss the principles of lending in detail. Ans.1.

Principles of sound lendingThere are three cardinal principles of bank lending that have been followed by the commercial banks since long. These are the principles of safety, liquidity and profitability. The traditional principles of bank lending have, therefore, been followed with certain modifications. The concept of security has undergone a radical change and profitability has been subordinated to social purpose in respect of certain types of lending.

1. Safety. As the bank lends the funds entrusted to it by the depositors, the first and foremost principle of lending is to ensure the safety of the funds lent. By safety is meant that the borrower is in a position to repay the loan, along with interest, according to the terms of the loan contract. The repayment of the loan depends upon the borrowers (a) capacity to pay, and (2) willingness to pay. The former depends upon his tangible assets and the success of his business; if he is successful in his efforts, he earns profits and can repay the loan promptly. Otherwise, the loan is recovered out of the sale proceeds of his tangible assets. The willingness to pay depends upon the honesty and character of the borrower. 2. Liquidity. Banks are essentially intermediaries for short term funds. Therefore, they lend funds for short periods and mainly for working capital purposes. The loans are, therefore, largely payable on demand. The banker must ensure that the borrower is able to repay the loan on demand or within a short period. This depends upon the nature of assets owned by the borrower and pledged to the banker. 3. Profitability. Commercial banks are profit-earning institutions; the nationalized banks are no exception to this. They must employ their funds profitably so as to earn sufficient income out of which to pay interest to the depositors, salaries to the staff and to meet various other establishment expenses and distribute dividends to the shareholders (the Government in case of nationalized banks). 4. The Purpose of the Loan. While lending his funds, the banker enquires from the borrower the purpose for which he seeks the loan. Banks do not grant loans for each and every purpose they ensure the safety and liquidity of their funds by granting loans for productive purposes only, viz., for meeting working capital needs of a business enterprise. Loans are not advanced for

speculative and unproductive purposes like social functions and ceremonies or for pleasure trips or for the repayment of a prior loan. Loans for capital expenditure for establishing business are of long-term nature and the banks grant such term loans also. After the nationalization of major banks loans for initial expenditure to start small trades, businesses, industries, etc., are also given by the banks. 5. The Principle of Diversification of Risks. This is also a cardinal principle of sound lending. A prudent banker always tries to select the borrower very carefully and takes tangible assets as securities to safeguard his interests. Tangible assets are no doubt valuable and the banker feels safe while granting advances on the security of such assets, yet some risk is always involved therein. An industry or trade may face depressionary conditions and the price of the goods and commodities may sharply fall. Natural calamities like floods and earthquakes, and political disturbances in certain parts of the country may ruin even a prosperous business. To safeguard his interest against such unforeseen contingencies, the banker follows the principle of diversification of risks based on the famous maxim "do not keep all the eggs in one basket." It means that the banker should not grant advances to a few big firms only or to concentrate them in a few industries or in a few cities or regions of the country only. The advances, on the other hand, should be over a reasonably wide area, distributed amongst a good number of customers belonging to different trades and industries. The banker, thus, diversifies the risk involved in lending. If a big customer meets misfortune, or certain trades or industries are affected adversely, the overall position of the bank will not be in jeopardy. Q2. What are the key features of a good security? Ans.2. The basic objective of obtaining security is to recover the loan dues, in case of need, from their sale. It is very important that such securities can be realized in case of need without any problem. Hence, the securities should meet the following criteria to be considered as a good security. 1. Marketability: The security should have a ready market where regular transactions of sale and purchase take place. The market should preferably be available locally so that it does not pose the problem of transportation etc. 2. Ascertainability: The security should be ascertainable both in terms of physical form & value. In other words, the bank should be in a position to identity the security without any problem. Similarly, it should not be difficult to verify the value of the security.

3. Stability: This is another basic feature of a good security as the high fluctuations in the price of a security can leave the bank with lower margins of safety available. Those securities are certainly preferable whose market price continues to be stable over a period of time. 4. Transferablity: The title of the security should be easily transferable, so that it does not pose any problem in transferring the title in favour of the buyer thereof.

Q3. How is CVP analysis relevant to a lending banker? Ans.3 CVP is the technique to study the relationship between Cost, Volume and Profits. These elements are inter-related and are dependent on one another. While profits depend on sales, the selling price is largely determined among others, by the cost, which in turn depends in Volume of Production. CVP helps to determine: The Volume of sales to avoid losses. The Volume of sales to achieve a desired profit level. The effect of changes in price, costs & Volume on profits. Product or Product-mix that is profitable or whether the business should manufacture or buy etc. P.V. Ratio expresses the relationship of contribution to sales & is expressed as: P.V Ratio = Contribution / Sales P.V Ratio = ((Sales Variable Cost)/ Sales) P.V Ratio = (Fixed cost + Profit)/ Sales or or or

P.V Ratio = Change in Profit or contribution/ Change in sales.

*Higher the P.V. Ratio, the more profitable it would be and vice-versa. *If a firm realizes book debt in cash- No change in current assets, Quick Ratio, Current Ratio or Net Working Capital. *If a Firm realizes old assets or non-current assets in cash or sell fixed assets in cash-Current assets, Quick Ratio, Current Ratio or Net Working capital will improve.

*If a firm issues bonus share. There is no change in any ratio. *If a firm issues Right shares. Quick Ratio, Current Ratio Net Working capital, Debt Equity Ratio, Net worth will improve. *If breakeven Point of a firm goes up, It is an indicator of decline in profits. *If debtor turnover ratio increases, It will show efficiency in recovery. *if stock turnover ratio increases, it indicates better use of stock. * If breakeven Point of a firm goes down, it is an indication of increase in profits. Q4. What are the techniques commonly used to ascertain the financial viability of the project? Ans.4. There are several alternative criteria for financial evaluation. They are:

Net Present Worth (NPW) (or Net Present value) Annual Equivalent Worth (AE) Financial Internal Rate of Return (FIRR) Benefit-Cost Ratio (B/C ratio) Payback Period (a simple but not sound basis)

Financial ratios used to assess financial viability The following financial ratios may be useful to provide insight into a tenderers profitability, liquidity and financial stability. These are a subset of the large range of potential ratios that an experienced practitioner could consider in any given procurement situation. The most appropriate financial ratios will vary with the industry, the economic conditions, and the risk of the procurement associated with the project. 1. Net Present Worth (NPW): It is the difference between the present value of cash inflows (revenues) and the present value of cash outflows (costs) at the minimum attractive rate of return of the project owner. NPV = (P.V. of benefits) (P.V. of costs) . 2. Debt-equity ratio: This ratio indicates the extent to which the promoters funds are leveraged to procure loans. The formula of DER is:

DER = Total Long-term Debt / Total Promoters Fund 3. Break-even point (BEP): This is another important tool. The break-even point is the level of activity where the total contribution is equal to the total fixed cost. Contribution is the excess of sales over variable cost, i.e.; Contribution = Sales- Variable Cost Contribution is a type of surplus that the business generates after paying fully the variable cost from the sales revenue. The break-even point is the point of activity where all costs (variable as well as fixed) are recovered from the sales values. Ratio Net profit margin ratio (%) Gross profit margin (%) Return on assets (%) Definition Net profit divided by total revenue Gross profit divided by total revenue Net profit divided by total assets

Issues relating to financial stability that should be considered for high risk procurements include:

whether there is adequate capital to support the proposed procurement; the maturity breakdown of the borrowings of the tenderer; how non-current assets are valued in the financial statements and whether an independent valuation used or whether it was the Directors valuation; whether there are any disclosures in the notes on commitments and contingent liabilities that could impact on the successful delivery; and whether there are any post balance date event disclosures that could affect successful delivery.

Q5. Write an essay on the structure and functioning of CDR. Ans.5. The Corporate Debt Restructuring (CDR) Mechanism is a voluntary non-statutory system based on Debtor-Creditor Agreement (DCA) and Inter-Creditor Agreement (ICA) and the principle of approvals by super-majority of 75% creditors (by value) which makes it binding on the remaining 25% to fall in line with the majority decision. The CDR Mechanism covers only multiple banking accounts, syndication/consortium accounts, where all banks and institutions together have an outstanding aggregate exposure of Rs.100 million and above. It covers all categories of assets in the books of member-creditors classified in terms of RBI's prudential asset classification standards. Structure of CDR System: The edifice of the CDR Mechanism in India stands on the strength of a three-tier structure: CDR Standing Forum CDR Empowered Group

CDR Cell

Corporate Debt Restructuring may seem like a daunting and embarrassing task, but your lenders will be most appreciative if you start your corporate debt restructuring program early. Corporate Corporate Debt Restructuring, done properly, will bring immediate financial relief to your company and an effective corporate debt restructuring program will be viewed as actions of capable and responsible management. Corporate restructuring is the process of redesigning one or more aspects of a company. The process of reorganizing a company may be implemented due to a number of different factors, such as positioning the company to be more competitive, survive a currently adverse economic climate, or poise the corporation to move in an entirely new direction. Here are some examples of why corporate restructuring may take place and what it can mean for the company. Restructuring a corporate entity is often a necessity when the company has grown to the point that the original structure can no longer efficiently manage the output and general interests of the company. For example, a corporate restructuring may call for spinning off some departments into subsidiaries as a means of creating a more effective management model as well as taking advantage of tax breaks that would allow the corporation to divert more revenue to the production process. In this scenario, the restructuring is seen as a positive sign of growth of the company and is often welcome by those who wish to see the corporation gain a larger market share. However, financial restructuring may take place in response to a drop in sales, due to a sluggish economy or temporary concerns about the economy in general. When this happens, the corporation may need to reorder finances as a means of keeping the company operational through this rough time. Costs may be cut by combining divisions or departments, reassigning responsibilities and eliminating personnel, or scaling back production at various facilities owned by the company. With this type of corporate restructuring, the focus is on survival in a difficult market rather than on expanding the company to meet growing consumer demand. Q6. Write a note on the various tools available for credit risk management in banks. Ans.6. Credit Risk Management for banking can be customized to the needs of each client, providing them with tools for: 1. Profitability analysis. Ambit enables banking executives to make decisions for improved profitability by identifying important relationships and trends in profitability and by monitoring and analyzing the institutions risk-adjusted performance. 2. Credit risk assessment . Ambit provides a standardized method for analyzing credit quality, enabling banks to make better lending decisions, facilitate loan approvals, ensure ongoing credit compliance and have more meaningful interactions with customers.

3. Capital management. Ambit gives banking risk and compliance officers an integrated view of regulatory and economic capital, in order to make more effective decisions concerning the banks risks and capital management.

4. Credit portfolio monitoring. Ambit helps banking officers better understand the impact of economic events and business decisions on their portfolio through tools for advanced risk analysis, stress testing, risk appetite and limit setting, and more 5. Exposure Ceilings: Prudential Limit is linked to Capital Funds say 15% for individual borrower entity, 40% for a group with additional 10% for infra-structure projects undertaken by the group, Threshold limit is fixed at a level lower than Prudential Exposure; Substantial Exposure, which is the sum total of the exposures beyond threshold limit should not exceed 600% to 800% of the Capital Funds of the bank (i.e. six to eight times). 6. Review/Renewal: Multi-tier Credit Approving Authority, constitution wise delegation of powers, 7. Higher delegated powers for better-rated customers; discriminatory time schedule for review/renewal, Hurdle rates and Bench marks for fresh exposures and periodicity for renewal based on risk rating, etc are formulated. 8. Risk Rating Model: Set up comprehensive risk scoring system on a six to nine point scale. Clearly define rating thresholds and review the ratings periodically preferably at half yearly intervals. Rating migration is to be mapped to estimate the expected loss. 9. Risk based scientific pricing: Link loan pricing to expected loss. High-risk category borrowers are to be priced high. Build historical data on default losses. Allocate capital to absorb the unexpected loss. Adopt the RAROC framework. 10. Portfolio Management : The need for credit portfolio management emanates from the necessity to optimize the benefits associated with diversification and to reduce the potential adverse impact of concentration of exposures to a particular borrower, sector or industry.