SVKMs NMIMS

Mukesh Patel School of Technology

Management and Engineering
Final Report
On

Credit Risk in Project Finance

By
Surbhi Sejra
Roll Number: J075
SAP Number: 71208110030

Faculty Mentor
Abhay Kumar
Industry Mentor
Lakshman Kumar

A REPORT
On
CREDIT RISK IN PROJECT FINANCE

By
Surbhi Sejra
Roll Number: J075
SAP Number: 71208110030

A report submitted in partial fulfillment of the requirements of 5 years Integrated

MBA (Tech.) Program of Mukesh Patel School of Technology Management &
Engineering, Narsee Monjee Institute of Management Studies (NMIMS) (Deemed
to be University), Mumbai

Acknowledgement
I take this opportunity to express my profound gratitude and deep regards to my
guide Mr.Lakshman Kumar, Chief Manager, Corporation Bank & Mr. Abhay Kumar,
Head of Department Finance, MPSTME for his exemplary guidance, monitoring and
2

constant encouragement throughout the course of this Project. The blessing, help
and guidance given by him time to time shall carry me a long way in the journey of
life on which I am about to embark.
I also take this opportunity to express a deep sense of gratitude to Mr.Prince Arora,
Senior Officer of Credit Department, and Mrs.Sandhya Behl, Corporation Bank Zonal
Office, for his/her cordial support, valuable information and guidance, which helped
me in completing this task through various stages.
I am obliged to staff members of Corporation Bank Zonal Office, for the valuable
information provided by them in their respective fields. I am grateful for their
cooperation during the period of my project.
Lastly, I thank almighty, my parents, brother, sisters and friends for their constant
encouragement without which this Project would not be possible.

Table of Contents
Acknowledgement......................................................................... 3
Table of Contents..........................................................................4
List of Tables.................................................................................6
List of Figures................................................................................ 6
3

Abstract........................................................................................ 7
Corporation Bank..........................................................................8
Early Mover............................................................................................................. 8
History..................................................................................................................... 8
Corporate Mission.................................................................................................... 9

Credit Risk in Project Finance......................................................10

1. Introduction....................................................................................................... 10
Sources of data..................................................................................................... 10
Limitations............................................................................................................. 10
Literature Study.................................................................................................... 10

OBJECTIVES OF THE STUDY.........................................................11

Main Text..................................................................................... 11
Non-recourse or Limited recourse financing................................12
Difference between a non-recourse loan and a recourse loan...............................12

Corporate Finance v/s Project Finance.........................................12

Project Finance Structure............................................................13
Project Finance By Corporation Bank...........................................16
Term Finance by Corporation Bank..............................................17
Working Capital Finance by Corporation Bank.............................17
Main Challenges.......................................................................... 18
Credit Risk................................................................................... 18
Segmentation of Credit Approval Processes:.........................................................19

Accounting for Risk Aspects........................................................20

Probability of Default............................................................................................. 20
Loss Given Default................................................................................................ 20
Exposure at Default............................................................................................... 20

Segmentation of Credit Approval Process....................................21

Type of Borrower................................................................................................... 22
Source of Cash Flows............................................................................................. 22
Value and Type of Collateral Value........................................................................22
Level of Exposure.................................................................................................. 23
Individual processes.............................................................................................. 23
4

Overview of the Credit Approval Process.....................................24

Work Flow Model of Credit Division by Corporation Bank.............24
Process Steps Leading up to the Credit Review.....................................................24
Data Collection...................................................................................................... 25
Check List.............................................................................................................. 25
Plausibility Check and Preliminary Review............................................................27
Exposure Assessment............................................................................................ 28
Credit Rating......................................................................................................... 28
Individual Decision................................................................................................ 29
Preparation of Offers............................................................................................. 31
Single and Double Vote Requirement....................................................................31
Delineation of the Levels of Authority...................................................................32
Bypassing Hierarchical Layers...............................................................................32
Internal Documentation and Credit Agreements...................................................33
Credit Disbursement Check...................................................................................34
Periodic Reviews.................................................................................................... 34

Intensive Servicing and Handling of Troubled Loans....................35

Risk Assessment Module of Corporation Bank.............................36
Bibliography................................................................................ 53
Search Engine.............................................................................53

List of Tables
Table
Table
Table
Table
Table
Table
Table
Table

1:
2:
3:
4:
5:
6:
7:
8:

Difference between Corporate Finance and Project Finance.............13

Check List.........................................................................................25
Nature of Proposal............................................................................36
Present Proposal...............................................................................36
Banking Arrangements.....................................................................37
Term Borrowings...............................................................................38
Borrower Details...............................................................................38
Financials..........................................................................................43

List of Figures
Figure
Figure
Figure
Figure
Figure

1: Project Finance Structure................................................................15

2:Possible Risk Mitigation Measures....................................................19
3: Standard and Individual Process.....................................................21
4: Four Steps in Rating Process...........................................................29
5: Bypassing Hierarchical Layers May Lead to Risk Mitigation............33

Abstract

In project finance, credit risk tends to be relatively high at project inception

and to diminish over the life of the project. Hence, longer-maturity loans
would be cheaper than shorter-term credits.
In project finance, raising sufficient funds via the debt channel is a key task
for all project companies and sponsors. Before furnishing a loan, lenders
typically need to ascertain the ability of the project company to service
principal payment plus interest. This report aims to establish a quantitative
model to analyze default risks and loan losses in projects. Acting as an
assessment system, the risk assessment module will help lenders evaluate
their exposure to default risk by monitoring the change in credit quality of
the project company. The model uses a credit rating transition to predict the
probability of default and the net present value technique to estimate the
maximum default loss.
The whole process of credit risk in project finance is very extensive and
requires rigorous training to effectively analyze and evaluate a loan
proposal.

Corporation Bank
Corporation Bank is a public sector banking company headquartered
in Mangalore, India. The bank has pan-India presence with 8,000 functional units
comprising 3200 branches, 3200+ ATMs and 4,000 branchless banking units as of
30 January 2015.
Every institution has its start in modest initiatives but what makes it great is the
passion of the people behind it. Carrying the legacy forward with an undaunted
commitment to its vision, the journey of Corporation Bank truly epitomizes this.
Started about 109 years ago in 1906, with an initial capital of just Rs.5000/-,
Corporation Bank has recorded Rs. 3,44,412 Crore mark in business and even far
more, with over 9916 service outlets across the nation, served by committed and
dedicated 18,000 plus Corp Bankers. Proof of which is seen in its enviable track
record in financial performance. We have many reasons to cheer, predominant of
them is, being able to participate in nation building by empowering the rural and
urban population alike. Today, we are proud that we are significant contributors to
the growth of the country's economy.

Early Mover
Nationalized in 1980, Corporation Bank was the forerunner when it came to evolving
and adapting to the financial sector reforms. In 1997, it became the Second Public
Sector Bank in the country to enter capital market, the IPO of which was oversubscribed by 13 times. the Bank has many " firsts " to its credit - Cash
Management Services, Gold Banking, m-Commerce, " Online " approvals for
Educational loans, 100% CBS Compliance and more recently, its pioneering efforts
to take the technology to the rural masses in remotest villages through low-cost
branchless banking - Business Correspondent model. All of which symbolize Bank's
unswerved commitment to its customers to provide convenience banking.

At Corporation Bank, what motivates us is the passion to excel in banking by

maintaining highest standards of service to our customers, backed by innovative
products and services which makes us one of the leading Public Sector Banks in the
country, catering to a wide range of customers - from individuals to corporate
clients.

History
Corporation Bank came into being as Canara Banking Corporation (Udipi) Limited,
on 12th March, 1906, in the temple town of Udupi, by the pioneering efforts of a
group of visionaries. The Bank started functioning with just Rs.5000/- as its capital
and at the end of the first day, the resources stood at 38 Rupees-13 Annas-2 Pies.
The Founder President Khan Bahadur Haji Abdullah Haji KasimSahebBahadur,
committed to fulfill the long felt banking needs of the people and also to inculcate
the habit of savings, provided the much-needed impetus to founding a financial
institutionthat would bring about prosperity to the society.
The content of the first Appeal to the public dated 19th February, 1906 speaks
volume about the lofty ideals and ethos behind the foundation. The Founder
PresidentHaji Abdullah declared that:
"The Primary object in forming Corporation is not only to cultivate habits of thrift
amongst all classes of people, without distinction of caste or creed, but also habits
of co-operation amongst all classes.
This is Swadeshism pure and simple and every lover of the country is expected to
come forward and co-operate in achieving this end in view .

Corporate Vision
"The Most Preferred Bank with Global Standards"

Corporate Mission

To become a provider of World - Class Financial Services

To meet Customer expectations through Innovation and Technological
Initiatives
To maintain leadership in inclusive banking
To enhance stakeholders' value
To fulfill national and social obligations
9

To create an environment, intellectually satisfying and professionally

rewarding to the employees
To emerge as a role model for ethical values and Good Corporate Governance

Credit Risk in Project Finance

1. Introduction
During the last decades, a new financing approach of major projects, called Project
Finance, characterized by high investment costs and high risks, is more and more
applied. This approach aims the long-term financing of infrastructure and industrial
projects based upon the projected cash flows of the project rather than the balance
sheets of its sponsors. Usually, a project financing structure involves a group of
equity investors, called 'sponsors', and a 'syndicate' of banks or other lending
institutions that provide loans to the operation. They are mostly non- recourse
loans, secured by the project assets and fully paid from project cash flows, rather
than from the general assets or creditworthiness of the project sponsors. The
financing is typically secured by all of the project assets.
Generally, a special purpose entity is created for each project, and so the project
company has no assets other than the project. In this context, risk identification and
allocation are a key component of project finance. A large project is often exposed

10

to a number of technical, environmental, economic and political risks, particularly in

developing countries.
Project financing is mainly characterized by a high debt level. The debt/equity ratio
of the projects company is generally around 70% and 82% of the loan part take the
form of syndicated banks loans. Facing this specific financing approach, the banks
will usually adopt a different strategy than the one commonly applied for the more
conventional loans. In fact, the bank will not evaluate the solvency and the
creditworthiness of the sponsors but only the project and its potential to generate
the necessary cash flows for loans repayment.

Sources of data
The various sources of data at different stages include company financials, data
from external agencies such as rating agencies, valuation reports, audit reports thus
data is collection of primary and secondary data.

Limitations

The actual financials could not be revealed due to confidentiality reasons and
hence failing to give the real picture of the final outcome.

The duration of internship is less to learn all aspects of banking sector .

Literature Study
Project finance is mainly a non-recourse financing, based on projections especially
the cash flow of the project, whereas corporate financing is extended on the basis of
creditworthiness of the company which is the ultimate obligor for repayment of the
financing facility.
A corporate finance is generally extended to an established company with a track
record and the financing is provided for general business purposes, mostly working
capital purposes. Cash flow generated by the corporate cannot be generally be
generally segregated and practically controlled for the benefit of the financiers
except in very limited cases whereby a strongly structured assignment of
receivables is worked out.
Project Finance is generally extended to a special purpose entity that has been
created exclusively for implementing a specific new project (green- field project).
Cash flow generated by the project company can be legally and practically

11

identified and controlled for the benefit of the financiers through relevant project
financing agreement.
Project financing has evolved through the centuries into primarily a vehicle for
assembling a consortium of investors, lenders and other participants to undertake
infrastructure projects that would be too large for individual investors to underwrite.

OBJECTIVES OF THE STUDY

1. To make study of Lending and Recovery Management in Corporation
Bank
2. To know the eff ective utilization of credit facilities provided by the
bank.
3.
To study the various
corporation loan facilities
are available
to
customer.
4. To study the establishment, growth and progress of customer service
provided by the Bank

Main Text
Project Finance
Project financing is a loan structure that relies primarily on the project's cash flow
for repayment, with the project's assets, rights, and interests held as secondary
security
or
collateral.
Not every project financing transaction will have every characteristic, but the
following provides a preliminary list of common features of project finance
transactions.

Capital-intensive. Project financings tend to be large-scale projects that

require a great deal of debt and equity capital, from hundreds of millions to
billions of Rupees. Infrastructure projects tend to fill this category.

Highly leveraged. These transactions tend to be highly leveraged with

debt accounting for usually 65% to 80% of capital in relatively normal cases.

Long term. The tenor for project financings can easily reach 15 to 20 years.

Independent entity with a finite life. Similar to the ancient voyage-tovoyage financings, contemporary project financings frequently rely on a
newly established legal entity, known as the project company, which has the
sole purpose of executing the project and which has a finite life.

12

Non-recourse or Limited recourse financing

The project company is the borrower. Since these newly formed entities do not have
their own credit or operating histories, it is necessary for lenders to focus on the
specific projects cash flows. That is, the financing is not primarily dependent on
the credit support of the sponsors or the value of the physical assets involved.
Thus, it takes an entirely different credit evaluation or investment decision process
to determine the potential risks and rewards of a project financing as opposed to a
corporate financing. In the former, Bank place a substantial degree of reliance on
the performance of the project itself. As a result, they will concern themselves
closely with the feasibility of the project and its sensitivity to the impact of
potentially adverse factors. From the project sponsors perspective, the advantage
of project finance is that it represents a source of off-balance sheet financing.

Difference between a non-recourse loan and a

recourse loan
The essential difference between a recourse and non-recourse loan has to do with
which assets a lender can go after if a borrower fails to repay a loan. As a matter of
principle, borrowers almost always favor non-recourse loans, while lenders almost
always favor recourse loans.
In both types of loans, the lender is allowed to seize any assets that were used
as collateral to secure the loan. In most cases, the collateral is the asset that was
purchased by the loan. For example, in both recourse and non-recourse mortgages,
the lender would be able to seize and sell the house to pay off the loan if the
borrower defaults.
The difference comes if money is still owed after the collateral is seized and sold. In
a recourse mortgage, the lender can go after the borrower's other assets or sue to
have his or her wages garnished. In a non-recourse mortgage, however, the lender
is out of luck. If the asset does not sell for at least what the borrower owes, the
lender must absorb the difference and walk away.
While potential borrowers might find it attractive to hold out for non-recourse loans,
it is important to remember that they come with higher interest rates and are
reserved for individuals and businesses with the best credit. Additionally, failure to
pay off a non-recourse debt may leave other assets unharmed, but the
borrower's credit score will be affected in the same way as a failure to repay
recourse debt.

13

Corporate Finance v/s Project Finance

Venture Capital or Corporate Finance different sharply from Project Finance in
several important ways. A key difference between the two approaches lies in how
debt (borrowing money, via one or more loans) is structured. Both project and
venture capital often include a debt component (to leverage or preserve owner
equity, among other reasons) alongside the equity owned by the principals,
sponsors, and other shareholders.
But, in project finance, the project owners borrow against the cash flow generated
by the project alone (additionally secured by available assets and loan guarantees),
while venture finance leverages the company balance sheet, not the cash flows.
The key on project finance: the cash flows from the project must be sufficient to
service the debt (repay the loan). Thus, careful financial modeling that shows
adequate cash flows coming from the project on its own is critically important. This
must be done properly. How much cash flow is deemed adequate depends a bit
on the lender, and other risks, but generally a metric called debt service coverage
ratio must be in the range of at least 1.0 to 1.25 to qualify.
Table 1: Difference between Corporate Finance and Project Finance

Dimension
Financing vehicle
Type of capital

Corporate finance
Multi-purpose organization
Permanent - an indefinite

Project finance
Single-purpose entity
Finite - time horizon

time horizon for equity

matches life of project

Dividend policy and

Corporate management

Fixed dividend policy -

reinvestment decisions

makes decisions

immediate payout; no

autonomous from investors

reinvestment allowed

and creditors
Capital investment
decisions
Financial structures

Size of financings

Opaque to creditors

Highly transparent to

Easily duplicated; common

creditors
Highly-tailored structures

forms

which cannot generally be

Flexible

re-used
Might require critical mass
to cover high transaction
costs
14

Basis for credit evaluation

Cost of capital
Investor/lender base

Overall financial health of

Technical and economic

corporate entity; focus on

feasibility; focus on projects

balance sheet and cash

assets, cash flow and

flow
Relatively lower
Typically broader

contractual arrangements
Relatively higher
Typically smaller group;

participation; deep

limited secondary markets

secondary markets

Project Finance Structure

This section describes the roles of these major participants.

Government.
Though local governments generally participate only
indirectly in projects, their role is often most influential.
The local
governments influence might include: approval of the project, control of the
state company that sponsors the project, responsibility for operating and
environmental licenses, tax holidays, supply guarantees, and industry
regulations or policies, providing operating concessions.

Project sponsors or owners. The sponsors are the generally the project
owners with an equity stake in the project. It is possible for a single company
or for a consortium to sponsor a project. Typical sponsors include foreign
multinationals, local companies, contractors, operators, suppliers or other
participants. The Bank estimates that the equity stake of sponsors is
typically about 30 percent of project costs.
Because project financings use the project company as the financing vehicle
and raise non- recourse debt, the project sponsors do not put their corporate
balance sheets directly at risk in these often high-risk projects. However,
some project sponsors incur indirect risk by financing their equity or debt
contributions through their corporate balance sheets. To further buffer
corporate liability, many of the multinational sponsors establish local
subsidiaries as the projects investment vehicle.

Project Company. The project company is a single-purpose entity created

solely for the purpose of executing the project. Controlled by project
sponsors, it is the center of the project through its contractual arrangements
with operators, contractors, suppliers and customers. Typically, the only
source of income for the project company is the tariff or throughput charge
from the project. The amount of the tariff or charge is generally extensively
detailed in the off-take agreement. Thus, this agreement is the project
companys sole means of servicing its debt. Often the project company is the
15

project sponsors financing vehicle for the project, i.e., it is the borrower for
the project. The creation of the project company and its role as borrower
represent the limited recourse characteristic of project finance. It is possible
for the project sponsors to borrow funds independently based on their own
balance sheets or rights to the project.

Contractor. The contractor is responsible for constructing the project to the

technical specifications outlined in the contract with the project company.
These primary contractors will then sub-contract with local firms for
components of the construction. Contractors also own stakes in projects.

Operator. Operators are responsible for maintaining the quality of the

projects assets and operating the power plant, pipeline, etc. at maximum
efficiency. It is not uncommon for operators to also hold an equity stake in a
project. Depending on the technological sophistication required to run the
project, the operator might be a multinational, a local company or a jointventure.

Supplier. The supplier provides the critical input to the project. For a power
plant, the supplier would be the fuel supplier. But the supplier does not
necessarily have to supply a tangible commodity. In the case of a mine, the
supplier might be the government through a mining concession. For toll
roads or pipeline, the critical input is the right-of-way for construction which is
granted by the local or federal government.

Customer. The customer is the party who is willing to purchase the projects
output, whether the output be a product (electrical power, extracted
minerals, etc.) or a service (electrical power transmission or pipeline
distribution). The goal for the project company is to engage customers who
are willing to sign long-term, off take agreements.

Commercial banks. Commercial banks represent a primary source of funds

for project financings. In arranging these large loans, the banks often form
syndicates to sell-down their interests. The syndicate is important not only
for raising the large amounts of capital required, but also for de facto political
insurance.
Even though commercial banks are not generally very comfortable with
taking long term project finance risk in emerging markets, they are very
comfortable with financing projects through the construction period. In
addition, a project might be better served by having commercial banks
finance the construction phase because banks have expertise in loan
monitoring on a month-to-month basis, and because the bank group has the
flexibility to renegotiate the construction loan.

16

Figure 1: Project Finance Structure

Project Finance By Corporation Bank

The proposals for project finance would be considered by the bank on a selective
basis in view of the larger outlay of funds an longer duration of credit which may
have an adverse impact on bank's Asset-Liability Management system and strain on
its liquidity. Usually such projects would be operationalized through consortium
arrangement along with the Term Lending Financial Institutions and other public/
private sector Banks.
The project would be appraised by the Lead Bank of the consortium and all other
banks would accept the appraisal made by the lead bank. If required, the assistance
of the professionals in the line/ project appraisal groups of FIS/ Commercial Banks
would be obtained for the appraisal.
Before extending finance for Projects, the economic feasibility an financial viability
of the project in relation to the macro economic conditions prevailing at the time of
conceptualization of the project and also the likely scenario that may prevail during
the normal life span of the project should be established. The project should be able
17

to withstand reasonable levels of variation in crucial parameters which should be

established by sensitivity analysis of the cash flows.
The means of finance for the project along with provisions to meet contingencies
such as cost/ time overrun should be established. The entire source of funds for the
project from sources other than that by the promoters shall be fully tied-up before
sanction/ disbursement of the limits.
Wherever the project is one of unusually longer duration such as infrastructure
development, the involvement of agencies such as Financial Institutions and ways of
reducing the blockage of bank's fund that are sourced mainly out of short term
lending institutions, take-out financing, securitization, Inter-Bank participation
Certificates, etc. would be resorted to.
The disbursements under project Finance would be made strictly in tune with the
sanction terms, only after ensuring the end use of funds already disbursed by the
consortium, meeting the required margin at each stage of project implementation
and certification by the competent consultants/ specialists as per the procedure in
vogue from time to time and as decided by the consortium.
The rate of interest on such credit facilities would be determined based on the
borrower gradation and the interest rate policy of the bank from time to time.
The credit facilities shall be secured by tangible assets and collaterals as may be
required based on the nature of project, quantum and duration of the credit,
anticipated return on investment and risk perception.
In addition to the above, Bank's usual normal lending norms and policy guidelines in
force from time to time would be equally applicable to project finance cases also.

Term Finance by Corporation Bank

The Bank extends Term Loans for capital investments being made by the clients on
account of expansion of existing enterprise or for establishment of a new enterprise.
Term Loans are also extended to clients for project implementation purposes, to
meet non-recurring expenditure of long term nature, etc.. The Term Loans are also
considered for investments in personal segment such as housing, vehicle
purchases, etc.
The aggregate outstanding quantum of Term Loans at any point of time is
determined by the Asset-Liability Management Committee of the Bank in tune with
the Asset Liability Matrix to avoid mismatch in the same.
18

The rate of interest on Term Loans depends upon the quantum of loan, its purpose,
Type of borrower, the gradation applicable and the nature of loan.
Adequate security for the Term Loans by way of hypothecation/ mortgage/ charge
over the assets created out of the loan proceeds and such other collaterals
depending upon the borrower, duration of credit, type of activity and the risk
perception, as stipulated by the sanctioning authority shall be provided by the
applicants. In addition, personal guarantee of promoter directors/ partners of Firm/
proprietors etc. and additional third party guarantee of a person/s of adequate net
worth acceptable to the bank shall be given for such loans.
The repayment of the term loans would be in periodic Instalments with initial
moratorium, if needed, during the period of project implementation. The periodicity
and the nature & quantum of Instalments shall be based on the time and quantum
of cash generation, operating costs and the surplus available at the disposal of the
borrower.

Working Capital Finance by Corporation Bank

The working capital limits would be considered only after the project nearing
completion and after ensuring full tie-up of the term loan requirements of the
borrower. These limits would be either in the form of fixed loans or running accounts
and / or bill financing facility. The finance extended under this category would be for
meeting the funds requirements for day to day operations of the units i.e, to meet
recurring expenses such as acquisition of raw material, the various expenses
connected with products, conversion of raw materials into finished products,
marketing and administrative expenses, etc..
In tune with the Reserve Bank of India guidelines on Loan System for delivery of
bank Credit for working capital purposes to larger borrowers, the same would be
extended in the form of fixed loan (working capital Demand loan) and cash credit
(running account) in the ratio of 60:40 in respect of borrowers enjoying aggregate
working capital limits of Rs.10 crore and above from the Banking system. The
working capital demand loan facility shall be for a minimum fixed term of 7 days
subject to roll over at the option of the borrower concerned.
Eligible Working Capital Limits would be assessed by adopting various methods
such as Projected Turnover Method, Permissible Bank Finance Method, Cash Budget
Method and Net Owned Funds Method, depending upon the type of borrower, the
aggregate working capital facility enjoyed from the banking system, the scale of
operation, nature of activity/enterprise and the duration/ length of the production
cycle, etc..

19

The working capital limits would require such security and personal/ third party
guarantees as applicable to general lending norms of the bank and risk perception
in respect of individual borrowal account.

Main Challenges
Big Project under one company or new company require large amount of
investment.
First, they require large indivisible investments in a single-purpose
asset. In most industrial sectors where project finance is used, such as
oil and gas and petrochemicals, over 50% of the total value of projects
consists of investments exceeding $1 billion.

Second, projects usually undergo two main phases (construction and

operation) characterised by quite different risks and cash flow
patterns.
Construction
primarily
involves
technological
and
environmental risks, whereas operation is exposed to market risk
(fluctuations in the prices of inputs or outputs) and political risk,
among other factors.
Most of the capital expenditures are concentrated in the initial
construction phase, with revenues instead starting to accrue only after
the project has begun operation.

Third, the success of large projects depends on the joint effort of

several related parties so that coordination failures, conflicts of interest
and free-riding of any project participant can have significant costs.
Moreover, managers have substantial discretion in allocating the
usually large free cash flows generated by the project operation, which
can potentially lead to opportunistic behaviour and inefficient
investments.

Credit Risk
Risk is inherent part of banks business. Effective risk management is critical to any
bank for achieving financial soundness. In view of this, aligning risk management to
banks organizational structure and business strategy has become integral in
banking business. Credit risk is the banks risk of loss arising from a borrower who
does not make payments as promised. Such as event is called as default. Another
term for credit risk is default risk. The risk of loss of principal or loss of a financial
reward stemming from a borrowers failure to repay a loan or otherwise to meet a
contractual obligation is termed as credit risk. Credit risk arises whenever a
borrower is expecting to use future cash flows to pay a current debt. Banks are
compensated for assuming credit risk by way of interest payments from the
borrower or issuer of a debt obligation.
Credit risk (or counterparty risk) is increasingly faced by banks in their product
assortment (not only lending) and can be considered as the oldest and largest risk
20

in banking. Important in a bank relationship is the know your client principle, by

becoming familiar with the borrower and/or credit basel. It is important that banks
deal with customers with sound reputation and creditworthiness. Therefore banks
need not only manage the credit risk in their credit portfolio but also that in any
individual credit or transaction. The relationship between credit risk and other risks
should also be considered by banks. The effective management of credit risk is a
critical component of a comprehensive approach to risk management and important
to the long-term success of any banking organization. Effective credit risk
management process is a way to manage portfolio of credit facilities. Credit risk
management encompasses identification, measurement, monitoring and control of
the credit risk exposures. The effective management of credit risk is a critical
component of comprehensive risk management and essential for the long term
success of a banking organization.

Figure 2: Possible Risk Mitigation Measures

Segmentation of Credit Approval Processes:

In order to assess the credit risk, it is necessary to take a close look at the
borrowers economic and legal situation as well as the relevant environment (e.g.
21

industry, economic growth). The quality of credit approval processes depends on

two factors, i.e. a transparent and comprehensive presentation of the risks when
granting the loan on the one hand, and an adequate assessment of these risks on
the other. Furthermore, the level of efficiency of the credit approval processes is an
important rating element. Due to the considerable differences in the nature of
various borrowers (e.g. private persons, listed companies, sovereigns, etc.) and the
assets to be financed (e.g. residential real estate, production plants, machinery,
etc.) as well the large number of products and their complexity, there cannot be a
uniform process to assess credit risks.

Accounting for Risk Aspects

The quality of the credit approval process from a risk perspective is determined by
the best possible identification and evaluation of the credit risk resulting from a
possible exposure.

Probability of default
Loss given default
Exposure at default
Maturity

Probability of Default
Reviewing a borrowers probability of default is basically done by evaluating the
borrowers current and future ability to fulfill its interest and principal repayment
obligation. This evaluation has to take into account various characteristics of the
borrower (natural or legal person), which should lead to a differentiation of the
credit approval processes in accordance with the borrowers served by the bank.
Furthermore, it has to be taken into account that for certain finance transactions
interest and principal repayments should be financed exclusively from the cash flow
of the object to be financed without the possibility for recourse to further assets of
the borrower. In this case, the credit review must address the viability of the
underlying business model, which means that the source of the cash flows required
to meet interest and principal repayment obligations has to be included in the
review processes in accordance with the borrowers served by the bank.
Furthermore, it has to be taken into account that for certain finance transactions
interest and principal repayments should be financed exclusively from the cash flow
of the object to be financed without the possibility for recourse to further assets of
the borrower. In this case, the credit review must address the viability of the
underlying business model, which means that the source of the cash flows required
to meet interest and principal repayment obligations has to be included in the
review.

22

Loss Given Default

The loss given default is affected by the collateralized portion as well as the cost of
selling the collateral. Therefore, the calculated value and type of collateral also have
to be taken into account in designing the credit approval processes.

Exposure at Default
In the vast majority of the cases described here, the exposure at default
correspondsto the amount owed to the bank. Thus, besides the type of claim, the
amount of the claim is another important element in the credit approval process.

Figure 3: Standard and Individual Process

23

Segmentation of Credit Approval Process

Four factors should be taken into account in the segmentation of credit approval
processes:

Type of borrower

Source of cash flows

Value and type of collateral

Amount and type of claim

The lending business in which banks engage is highly heterogeneous in terms of

volume and complexity; this makes it impossible to define an optimal model, and
therefore we will not show a model segmentation. After the description of possible
segmentations, two principles are dealt with that have to be included in the
differentiation of the credit approval processes along the four risk components to
ensure an efficient structure of the credit approval processes.

Type of Borrower
It is used as the highest layer in credit approval processes. This is due to the higher
priority of reviewing legal and economic conditions within the substantive credit
review process. The way in which the economic situation is assessed greatly
depends on the available data. The following segments can be distinguished:

Sovereigns
Other public authorities (e.g. regional governments, local authorities)
Financial services providers (incl. credit institutions)
Corporates
Retail

Usually, at least the segments of corporate and retail customers are differentiated
further (e.g. by product category).

Source of Cash Flows

The distinction of so-called specialized lending from other forms of corporate
finance is based on the fact that the primary, if not the only source of reducing the
exposure is the income from the asset being financed, and not so much the
unrelated solvency of the company behind it, which operates on a broader basis.
Therefore, the credit review has to focus on the asset to be financed and the
expected cash flow.
In order to account for this situation, the segmentation of the credit approval
processes should distinguish between credits to corporations, partnerships, or sole
24

proprietors; and specialized lending Credit institutions have to distinguish between

the following forms of specialized lending in the calculation of regulatory capital.

Project Finance
Object Finance
Commodities Finance
Finance of income-producing commercial real estate

This subdivision of Basel II primarily serves to determine the required capital

correctly, but it can also prove useful from a procedural point of view.

Value and Type of Collateral Value

Type of collateral have a significant impact on the risk involved in lending. Two
forms of finance are particularly relevant in practice:

Mortgage finance
Leasing finance

Mortgage finance and leasing are those forms of finance which often give the lender
a substantial degree of control over the asset being financed. The strong legal
position resulting from such collateral may warrant special treatment of the relevant
forms of finance.
Security may be classified as primary security and collateral security.
Primary Security
The security deposited by the borrower himself as cover for the loan is called
the primary security. In the banking sector, it refers to the asset which has been
bought with the help of bank finance. For instance, machinery has been bought with
the help of Bank finance. That machinery constitutes the primary security to the
banker. All other securities deposited to cover advance are called collateral
securities.
Collateral Security
The term collateral security is used in two senses. In a narrow sense it refers to the
securities deposited by the third party to secure advance for the borrower.
In a wider sense it denotes any type of security on which the creditor has
a personal right of action on the debtor in respect of the advance.

Level of Exposure
The level of exposure has an immediate impact on the exposure at default (EAD).
Therefore, any increase in the level of exposure should trigger a more detailed
credit review of the respective borrower. This aspect and the risk minimization that
can be achieved by standardization and automation are the rationale behind the
separation of low-volume and high-volume lending business that can often be found
in the way in which credit approval processes are designed.

25

Individual processes
They are characterized by an adaptive design which makes it possible to deal with a
variety of products, collateral, and conditions. Typically, this will be required
especially for high-volume corporate customer business, as both the borrowers
characteristics to be taken into account in the credit review and the specifics of the
products wanted are very heterogeneous. The higher risk involved with loans
examined in an individual process should be addressed by using a double vote (one
vote by the front office, and one vote by the back office).
Object of Review and Exposure Management Credit approval processes are started
on behalf of a credit applicant. Especially in the context of lending to corporate
customers, it is often necessary to include several (natural or legal) persons in the
credit rating process. This will be required if these (natural and legal) persons are to
be considered one economic unit and would thus probably have a mutual impact on
each others credit standing. In practice, granting an individual loan often involves a
large number of (natural and legal) persons. This has to be borne in mind
throughout the entire credit approval process, but particularly in the course of the
credit review. Credit approval for groups of companies should be designed in a
manner which is specific to the risk involved and efficient and should aim to focus
the review on the actual risk-bearer, that (natural or legal) person whose legal and
economic situation ultimately determines the ability to fulfill the obligations under
the credit agreement.
From a risk perspective, the overall risk of the risk-bearer should always be
aggregated over the bank as a whole and then presented to the decision makers;
the internal guidelines should contain provisions which clearly define the riskbearer. This classification is usually based on loss-sharing arrangements or legal
interdependences. Also, it should be stipulated whether aggregation should be
effected by one person in charge (at group level) in processing or risk analysis, or in
a decentralized fashion by each unit itself.

Overview of the Credit Approval Process

The order of the following subsections reflects the sequence of steps in the credit
approval process, with the credit approval process for new customers serving as the
general framework.
Credit approval processes for existing customers will be addressed explicitly if they
contain process steps that are not found in the credit approval process for new
customers at least in a similar form.

26

The segmentation of the credit approval processes is a central component of risk

mitigation. While the risk mitigation measures should be designed in accordance
with the specifics of each segment, there is a uniform basic structure of these
measures.

Work Flow Model of Credit Division by

Corporation Bank
CREDIT PROPOSAL
FROM THE
BORROWER
PROPOSAL SENT
TO THE
SENCTIONING
AUTHORITY
KNOW YOUR
CUSTOMER (KYC)
GENERAL
DISCUSSION
TERMS AND
CONDITIONS
COMMUNITACTED
DATABASE
CREATED

APPRISAL OF
THE PROPOSAL
RISK MEETING
FINAL
DISCUSSION

Process Steps Leading up to the Credit Review

The execution of the credit review is based on external and internal data on the
credit applicant. Especially for extensive exposures, considerable resources may be
tied up in the process of collecting the data, checking the data for completeness
and plausibility, and passing on the data to people in charge of handling, analyzing,
and processing the exposure within the bank. These steps can also lead to a large
number of procedural errors. As the data included form the basis for the credit
review, errors in collecting, aggregating, and passing them on are especially
relevant also from a risk perspective.

27

Data Collection
The assessment of a credit applicants credit standing is based on different data
sources and data types in accordance with the type of borrower. In any case, a bank
must always be interested in having comprehensive and current data on the
economic and personal situation of the borrower. In order to ensure consistent
customer service, the respective account manager will typically coordinate the
gathering of information. The credit review incorporates not only economic data but
also qualitative information concerning the borrower. The account manager should
thus include a complete and critical picture of the borrower. In order to ensure that
all the information gathered by the account manager is passed on to the person in
charge of the credit review, it would be advisable to prepare standardized and
structured reports on customer visits. In practice, this has proven effective in
directing conversations with customers as desired. This procedure ensures that
information is gathered in its entirety and in an efficient manner.
To make sure that the data collected is complete, mandatory lists showing what
data are required should be used. These lists then have to be adapted to the
requirements of the credit review process conforming to the type of borrower in
each case. In addition to individual borrower data, many cases will require general
information on the economic situation of a region or an industry to allow a
comprehensive assessment of credit application, The bank can make use of external
sources. If a banks credit portfolio shows a focus on certain industries or regions,
banks are advised to conduct their own analyses of the economic situation in these
fields, this is particularly true if the available external information lacks the
necessary detail.
With regard to the credit review, it is particularly important to constantly update
customer data, and the bank should include according procedures and timeframes.
In terms of individual processes, it should be ensured that periods should be
compared at regular intervals in assessing the exposure. Therefore, the relevant
data should be available for at least the previous two, but preferably the last three
years.

Check List
Checklist to be submitted along with the proposals to CCPCs
Table 2: Check List

Sl. No.

Data / Information

Enclosed
[Yes/No/N.A]

1.
2.

Application form duly filled and signed by the Borrower

Latest statement of Assets and Liabilities of all the
Directors / Partners / Properties / Guarantor as the case
28

3.
4.

5.
6.
7.
8.

9.

10.

11.

12.

13.

14.

15.

may be duly filled and certified by Chartered Accountant

Confidential report from Bankers of Associate / Sister
Concerns.
Copy of MOA and AOA / Partnership deed as the case
may be. Copy of Certificate of Incorporation and
Commencement of Business in case of Company. . In
case of partnership concerns, firm registration certificate
issued by registrar of firms. In case of proprietorship
concerns, certificate issued by sales tax / shop &
establishment authorities showing the date of
establishment.
In case of reconstitution of Partnership, reconstituted
Partnership Deed should be submitted.
In case of Companies, copy of Board Resolution for
availing the credit facilities with us.
Audited Financial Statements along with annexure/
schedules and Auditors report for the last three years.
Projected financial statement along with annexures /
schedules for the current year along with assumptions of
the projected figures.
CMA data incorporating audited financials for the last
two years, current year along estimates and next year
projections.
Unaudited financial results for the latest quarter end, if
not available, month wise sales details up to a recent
date from the beginning of the current financial year.
Copies of Income Tax Return along with Tax Audit Report
(Form 3CB, 3CD) filed by the firm / Company / Individual
of the last 3 years
Copies of Income Tax Return along with computation
statement filed by the proprietor / partners / directors
and guarantors for the last 3 years
Term Loan Proposals:
a. Detail Project report covering information on the
project, project cost, source of finance, technical
feasibility & economic viability report, implementation
schedule, current status of the project.
b. Projected profitability statement, projected cash flow
statement and projected Balance Sheet covering the
tenor of the term loan sought. The assumption
underlying the profitability estimates and DSCR
calculations.
In case of new borrower accounts / projects, Chartered
Accountant's Certificate for the capital so far invested by
the promoters in the business and sources of meeting
margin requirements.
Details of the associate concerns of the Borrower in
29

terms of their principal activity, directors, Financial

details i.e., turnover tangible networth and net profit for
the last two years along with the details of credit limits
enjoyed by the associate / group concerns of the firm
along with financial statement for the last two years.
16.
Details of primary security and collateral security
available / offered for the credit limits.
17.
CSI Compliance for the limits sanctioned / renewed/
reviewed vide latest CSI.
18.
Details of credit limits enjoyed with other Banks /
Financial Institutions.
19.
Point wise reply to the irregularities pointed out in the
recent inspection report / legal audit report / statutory
audit report / concurrent audit report / RBI inspection
etc.
20.
Resume of existing limits enjoyed by the borrower from
our Bank for last financial year and for the broken period
of current financial year.
21.
Site / Unit Visit report.
22.
Due Diligence report, Credit investigation report and KYC
confirmation by the Branch Manager.
23.
Gradation Chart based on the latest financial
statements.
24.
Value of the account indicating ancillary business
received / expected from the client.
25.
Specific recommendation from the Branch Covering the
following aspects:
a. Brief Profile of the Borrower.
b. Details of dealing of the Borrower with our Bank with
other Banks.
c. Value of the account. Details of Existing limits and
existing security.
d. Details of limits applied and security offered.
e. Comment on due diligence and site visit conducted by
branch.
f. Names of Associate / sister concerns of the borrower.
g.Details address of the security offered along with
ownership details, basis of valuation.
h. Guarantor Details.
i. Terms and condition of sanction of the limits applied.
NOTE: 1. All the documents submitted should be signed and have
stamp / seal of the Borrower.
2. The documents should be arranged and forwarded in the same order
as mentioned above.

30

Plausibility Check and Preliminary Review

Before a credit exposure is subjected to a comprehensive credit review, the
employee initially in charge should conduct a plausibility check and preliminary
review. This check should look at the completeness and consistency of the
documents filed by the borrower to minimize any process loops and the need for
further inquiries with the customer. In addition, sales should carry out an initial
substantive check based on a select few relevant criteria. The objectives include the
creation of awareness and active assumption of responsibility for credit risk on the
part of the sales department. The preliminary check is especially significant in
segments with high rejection rates, as a comprehensive credit review ties up
considerable resources in these segments. The preliminary check should prevent
exposures which will most likely be rejected from tying up capacities in risk analysis.
The resulting reduction in number of cases dealt with by risk analysis allows a more
detailed scrutiny of promising exposures and is thus desirable it terms of risk as well
as efficiency
Passing on Data making sure that information is passed on in its entirety is relevant
from a risk perspective and concerns those processes in which the credit approval
process is not concluded by the account manager himself, if the credit review is
conducted by two or more people, it is necessary to ensure that the complete set of
relevant documents is handed over. It would be advisable to prepare handover
reports for this purpose. Handover reports should fully reflect changes in
responsibility in the course of the credit approval process as well as any interface
occurring in the process. In practice, a modular structure has proven particularly
effective for such forms.
Furthermore, appropriate modules should be included for all other interfaces
between sales and risk analysis, or between different persons in processing. To
facilitate a consistent application of the handover reports, it would be advisable to
prepare detailed interface plans, which should, in particular, show the interfaces
between sales and risk analysis. This can help avoid errors in the credit approval
process that could result from unclear responsibilities.

Exposure Assessment
Credit Review and Valuation of Collateral Exposure assessment involves the credit
review and a valuation of the collateral based on the data provided by the credit
applicant. These steps aim at making the risks resulting from the exposure
transparent and allowing a final assessment of the exposure.
The credit review basically consists of two process components:
1. Standardized models of data evaluation
2. Documentation and evaluation of other credit assessment factors

31

Credit reviews are increasingly marked by standardized procedures. These

procedures support and sometimes even replace the subjective decision making
process in assessing credit standing. In practice, we can also find credit review
processes that are completely based on standardized and automated models and
thus do not provide for any manual documentation and assessment of other credit
assessment factors beyond that. After establishing and assessing the risk involved
in lending, the collateral offered by the applicant is examined and evaluated, and its
impact on assessing the exposure thus has to be dealt with independently of the
credit review.

Credit Rating
Credit ratings for borrowers are based on substantial due diligence conducted by
the rating agencies. While a borrower will strive to have the highest possible credit
rating since it has a major impact on interest rates charged by lenders, the rating
agencies must take a balanced and objective view of the borrowers financial
situation and capacity to service/repay the debt.
A credit rating not only determines whether or not a borrower will be approved for a
loan, but also the interest rate at which the loan will need to be repaid. Since
companies depend on loans for many start-up and other expenses, being denied a
loan could spell disaster, and a high interest rate is much more difficult to pay back.
Credit ratings also play a large role in a potential buyer's determining whether or
not to purchase bonds. A poor credit rating is a risky investment; it indicates a
larger probability that the company will not pay off its bonds.
It is important for a borrower to remain diligent in maintaining a high credit rating.
Credit ratings are never static, in fact, they change all the time based on the newest
data, and one negative debt will bring down even the best score. Credit also takes
time to build up. If an entity has good credit but a short credit history, that isn't
seen as positively as the same quality of credit but with a long history. Debtors want
to know a borrower can maintain good credit consistently over time.

32

Figure 4: Four Steps in Rating Process

Individual Decision
In an individual decision, the standardized data evaluation is complemented by
further process steps to assess the credit standing. After the credit review, the
collateral is evaluated. An integrated look at the detailed results leads to an
individual credit decision which is not directly contingent on the results of the
individual process components.
If analyses that were drawn up by employees other than those primarily responsible
for the credit approval process, it is essential to make sure that the administrative
process involved is as efficient as possible. There should be a general guideline
stipulating that the analysis is confirmed by the person in charge of the
organizational unit supplying the module for the credit analysis when this module is
handed over to the credit officer managing the exposure. The common practice of
having the people in charge of every single organizational unit involved in the credit
approval process also confirm the completed credit application is rejected as
33

inefficient and does not seem necessary in terms of risk, either. In contrast to
financial rating, which requires specific technical know-how, qualitative rating
requires comprehensive knowledge of the borrower to be successful. In the course
of the rating, the qualitative factors are also evaluated in a standardized fashion by
means of one of the models described above. Accordingly, this is typically done by
the sales employee it is possible to provide for the integration of additional
organizational units within the bank. This could, for example, be units specializing in
the evaluation of product markets. What was said above also applies to the
inclusion of these modules. Using a weighting function, financial and qualitative
ratings are combined, with the result usually referred to as base rating. In
companies are affiliated, it is necessary to look at possible loss-sharing
arrangements in the rating process. The inclusion of a loss- sharing arrangement
can affect the assessment of the probability of default of the company on which the
rating is based positively and negatively.
The final borrower rating should be awarded and confirmed together by the sales
and risk analysis employees primarily in charge of the exposure. In addition to the
factors evaluated by means of the standardized credit rating process, the
employees handling the exposure could include further data/factors in the credit
review.
The need to offer at least the option to add a description and evaluation of the
exposure results from the fact that the standardization of the credit rating process
makes it necessary to limit the extent to which all existing credit assessment factors
are presented. Ideally, the processes should adequately reflect all factors necessary
to assess the credit standing, and the need for a separate description should arise
only as an exception. The description and assessment of these factors should be
carried out in accordance with clear rules in the internal guidelines. In practice, the
credit applications show fields that help document these factors. Five categories are
usually distinguished:

Legal situation
Market situation
Economic situation
Project evaluation

Debt service capacity

The documentation of the factors to be considered in these categories should

contain clear and unambiguous statements describing their potential impact on
credit standing.
Exposure Assessment after reviewing borrower rating, other credit assessment
factors, and the collateral, it is possible to assess the borrowers creditworthiness
34

with regard to the proposed exposure. The final assessment of the exposure risk can
only be made after a comprehensive evaluation of all sub-processes of credit
review. The results of the valuation of the collateral will also be included in this
assessment which has to be made by the employees handling the exposure. The
credit form should thus provide appropriate fields. Here, it is important to make sure
that the internal guidelines contain clear rules on the level of detail and the form in
which the explanation has to be presented. In practice, it has proven useful to
compare the positive and negative assessment criteria.
Preparation of Offers, Credit Decision, and Documentation After reviewing and
determining the applicants creditworthiness in the course of assessing the
exposure, the process leading up to disbursement of the credit can be initiated.

Preparation of Offers
When preparing a firm costing this offer plays a central role. From a procedural point
of view, special emphasis has to be placed on clearly defining the authority to set
conditions and the coordination process between sales and risk analysis.
Credit Decision Decision making Structure If a set-up of the specific credit exposure
was agreed upon in the course of preparing the offer, this is followed by a formal
internal approval of the individual exposure as part of the credit approval process.
The essential risk-related issue of this process step is the definition of credit
authority, particularly with regard to the coordination of sales and risk analysis.
Credit authority describes the authorization granted by the management to use
discretion in making credit decisions up to a certain amount. In order to comply with
the four-eye principle, this authority can as a rule only be exercised jointly by two or
more decision makers. Moreover, a credit decision should always involve people
that do not belong to the sales department (double vote). In addition, the level of
authority should be commensurate with the experience of the employees in charge
of assessing the credit exposure. Looking at decision-making authority, we will now
discuss an idealized decision-making structure. Special emphasis is placed on the
determining factors to allow an adaptation to different business models.

Single and Double Vote Requirement

Entrusting the credit decision to persons from two unlinked departments is a major
tool to prevent risks associated with granting loans. The hierarchical decision level
should be identical for the sales and risk analysis departments. Like the assignment
of different levels of decision authority, the introduction of double vote requirements
helps avoid or mitigate the occurrence of substantive and procedural errors in the
course of the credit approval process. Furthermore, double vote requirements are
35

especially suitable for imposing an immediate check on personally motivated

decisions of a single person. Their significance in the context of risk mitigation
should become apparent from the design of the credit approval processes. Thus, the
double vote should apply as the basic principle for decisions concerning credit
approval. For efficiency reasons, the effort involved in introducing double vote
requirements has to be weighed against the risk costs that are prevented as a
result. Typically, a single vote will only be applied to low-volume loans on the basis
of standardized products in the retail and corporate segment (small businesses and
independent professionals). Here, too, the four-eye principle should be used. Finally,
we would like to point out models showing a differentiated layout of the decisionmaking structure. These models can have a considerable positive impact on the
individuals responsibility concerning the assumption of the risk associated with the
credit approval (by preventing the responsibility being socialized) as well on the
time available to carry out appropriate credit analyses.

Delineation of the Levels of Authority

In contrast to assigning authority to employees ultimately based on trust and the
experience of the employee in the credit business, the definition of the levels of
authority can be effected on the basis of a system which can be derived in a
logically consistent manner. The constraining factor in this context is the employee
capacity available to make credit decisions. First of all, the pool of the most
experienced employees should be fully exhausted, being assigned the exposures
with the highest risk level. The same method has to be used as long as different
employee pools can be formed on the basis of their qualification to evaluate credit
decisions. In practice, the authority to make credit decisions is usually linked to the
hierarchical level in the organizational structure to simplify matters. Normally,
however, this procedure should be equivalent also in terms of employee
qualification. It has to be borne in mind, however, that such a procedure creates a
dependence between the decision-making structure with its underlying number of
credit decisions and the banks organizational structure. It is particularly important
to make sure that changes in the organizational structure do not lead to a backlog
of credit decisions at a hierarchical level if the originally available capacity there is
reduced as a result of such changes. It would, of course, also be possible to solve
this problem by adapting the decision-making structure. Individual employees, for
example, might be endowed with the decision-making authority of their respective
managers. From a risk perspective, it needs to be ensured that no backlog of credit
decisions occurs that would result in a limited capacity to examine the risk level of
the individual exposures.

36

Bypassing Hierarchical Layers

In order to ensure that the credit decision is made by the persons in charge under
the decision-making structure not only formally but also effectively, responsibilities
must be defined clearly and in a transparent manner. Besides a substantive check
of the suggested decision, this assessment also requires a check of the compliance
with procedural rules. In practice, however, it shows that the decisions of the
persons actually in charge have sometimes become mere formalities, especially if
an exposure has to be handed up several hierarchical layers. The idea behind
handing up an exposure one level at a time to the person actually in charge is to
detect substantive or formal errors already at an early stage and thus to reduce the
workload of the person in charge. This is not achieved if the exposure is simply
passed on. Moreover, simply passing on the exposure leads to another effect that
increases the risk. Involving a number of people inevitably leads to a socialization of
responsibility. This denotes the effect that the involvement of many persons reduces
the responsibility of each individual person. Under an extreme scenario, this may
cause the failure to carry out a diligent credit review on the part of the credit officer,
as that person erroneously assumes that his superior and, ultimately, the person in
charge have actually assessed the exposure. This effect can be avoided by
introducing the possibility of bypassing hierarchical layers. This possibility provides
for the credit file to be handed over from the credit officer dealing with the
application directly to the person in charge, even if that person is two or more
layers above him.

37

Figure 5: Bypassing Hierarchical Layers May Lead to Risk Mitigation

Internal Documentation and Credit Agreements

The credit file is the central instrument of documentation. It should include all
documents and decisions relevant for the credit approval so that it is possible to
review the credit approval process at any time. Some banks use systems that allow
the automated preparation of credit agreements based on the information in the
credit file. This is done with the help of programs that combine predefined text
modules in predefined patterns. At the same time, that data specific to the exposure
are included. The credit officer can then focus on reviewing the agreements, as
procedural errors are largely excluded. A distinction has to be made between the
internal coordination and review of contracts and the legally effective conclusion of
contracts between bank and borrower. Therefore, the internal guidelines also have
to stipulate the signing authority. Internationally, systems that allow the fully
electronic compilation of the data to be recorded in the course of the credit approval
process are becoming increasingly important. Such electronic files, which in their
most sophisticated form are embedded in a workflow management system covering
the entire process, make it possible to significantly increase efficiency, particularly
for standardized transactions. The continuous monitoring of the data entry and
analysis process also helps avoid procedural errors.
38

Credit Disbursement Check

Prior to disbursing the credit, the individual credit exposure should be subjected to a
final check. This check should cover at least the following points:

Compliance with internal guidelines;

Completeness of the credit application;
Receipt of confirmation that the credit applicant has complied with the
conditions imposed;
Signing of the credit and collateral agreements in accordance with the decision
making structure.

Checklists should be used to achieve a risk-mitigating standardization of the

process. In terms of efficiency, it may be useful to centralize the credit
disbursement check for segments with a large number of comparable credit
applications. In many cases, however, the credit disbursement check is carried out
by the immediate superiors of the employees responsible for the exposure. Risk
aspects require the specific design of the process to make sure that the employee
performing the check arrives at a decision independently of the employees
responsible for the exposure working in sales, risk analysis, or credit approval
processing.
Continuous Monitoring of Credit Exposures, Early Warning System, and Reminder
Procedures Throughout the contractual relationship between the credit institution
and its borrowers, economic developments may bring about changes that have an
impact on risk. Banks should monitor their credit exposures continuously to detect
such changes in time. In general, this is done by means of so-called periodic and
regular checks. Individual exposures are checked at fixed periodic intervals. Many
banks integrate these checks in the roll-over of credit exposures which becomes
due as periods expire. In order to detect risks already prior to the periodic check to
be carried out due to the expiry of a specified term, many banks use early warning
systems. Based on early warning indicators which have to be defined for each
segment, a differentiated review process is triggered. Among other things, these
early warning systems take into account defaults with regard to the contractual
relationship between bank and borrower. Of great importance here is the insufficient
performance of interest and principal repayment obligations. In order to react to
these situations, banks have set up reminder procedures to inform the debtor of the
default.

39

Periodic Reviews
Typically, a periodic reviewed is carried out at one-year intervals starting from the
date of credit approval. For companies preparing financial statements, the periodic
review should be carried out as shortly after the balance sheet date or the date of
submitting the balance sheet as possible. The review of credit exposures should
comprise four major activities:

Assessing the personal and economic situation of borrowers based on current

data

Adapting the rating, if applicable

Checking and evaluating the available collateral

Checking and modifying the conditions

The review should focus on the development since the most recent approval or
review. The decision-making structure should stipulate who is responsible for
periodic reviews. In most case, it will be that level of authority which would also be
in charge of approving new credit applications. In order to make the review as
efficient as possible, banks typically distinguish between three types of review.
The review of standardized credits usually comprises small-volume credit exposures
for which the rating process has determined a low probability of default. The
internal guidelines have to define the limits of automated review based on exposure
volume, credit standing, and type of credit. The additional review triggered by risk
signals from the early warning system makes up for the manual check which is not
carried out here.
Just like the review of standardized credits, the abbreviated review is a tool used for
reasons of efficiency. Here, too, a full and comprehensive review of the credit
exposure is not carried out. In general, the banks just update the review-related
documents and use a short, standardized questionnaire which has to be completed
by the employee from the credit analysis department responsible for the exposure.
This questionnaire confirms the receipt of their view-related documents and the
plausibility check of these documents. Typically, the questionnaires relating to the
abbreviated review process contain checklists to check the data received for validity
and plausibility. In any case, there should also be guidelines stipulating a full review
in case certain credit assessment changes occur. The decisive factor for the range
of application of the abbreviated review process as was already the case for the
review of standardized credits the existence of an early warning system. The
early warning system makes up for the comprehensive review which is not triggered
40

by risk signals and is not carried out here. A full review comprises a comprehensive
review of the borrowers economic and personal situation in analogy to a new credit
application. The division of tasks between sales and credit analysis/processing is
typically the same as that for the preparation of the credit proposal for new
transactions. In addition to the classification into three process types described
earlier, a differentiation in the documentation of the review can also simplify the
task of the credit officers.

Intensive Servicing and Handling of Troubled

Loans
If a borrowers credit standing deteriorates, the bank should interfere in the
standardized servicing process and try to control credit risks that are imminent or
have already taken effect. This should ensure that adequate measures to secure
claims can be taken in time. The objective is not only an improved collateral
position of the lender compared to other creditors (caused by the time gained by
taking early precautionary measures), but also an effective restructuring of the
borrowers debt, thus preventing the total loss of the credit exposure. It does not
make economic sense to continue the credit exposure, the workout of the exposure
and the resulting sale of the collateral should be initiated.

Risk Assessment Module of Corporation Bank

Annexure 1

Corporation Bank
Credit Division (Sanctions)

Memorandum to the Credit Approval Committee

FOR APPROVAL
Date:

Ref. No :
Date of NBG Approval (if applicable)
Date of receipt of proposal at Branch:
Date of receipt of the proposal at ZO/ HO
Date of receipt of the additional information at ZO/ Head Office:

41

Date of disposal by ZO/ Head Office

Branch
Circle Office/Zone
Borrower
Line of Activity
Industry

NATURE OF PROPOSAL
Table 3: Nature of Proposal

Fresh
Sanction

Review

Renewal

Enhance
ment

Addition
al

Restruct
uring

Others

1. Present Proposal
(Rs. in crore)

Table 4: Present Proposal

Sl.
No
.

Nature of
Facility

Existing
Limits
Bankin Our
Bank's
g
Syste Share
m

1 Working Capital
Fund Based
1. Cash credit/ Export
Credit
Sub Total (A)
Non Fund Based
1. BG
2. Inland/ Import LC
Sub Total (B)
Total (A+B)
2 Term Loan
1. Term Loan- Sanction
2. Term Loan - Review
3. CVehi
Total (2)
42

Balance
As on (
)

Overdu
e*

Proposed
Limits
Bankin Our
g
Bank's
Syste Share
m

3 Grand Total (1+2)

Forward Sale
Forward Purchase
Notes: (Brief back ground of proposal)
2. Banking Arrangements:
a. Working Capital:
Table 5: Banking Arrangements

Sole

Multiple

Consortium

Name of the lead bank in case of

Consortium

Sharing pattern under Multiple / Consortium arrangement for

Existing
Proposed
Name of the
bank

FB

NFB

Tot
al

FB

NFB

Total

1.
2.
3.
4.
Total

b. TERM BORROWINGS
Table 6: Term Borrowings

Name of the bank

Limit

Outstanding
as on ( ------)

1.
2.
3.
4.
100.0
0

Total

Dates for

Q1

Q2
43

Q3

Q4

Exchange of
Information
Consortium Meeting
Notes:

Other Details:
Asset Classification as at [31-__-____]

Standard/ A1/A2/ A3

Due date for renewal / review

Reasons for delay in renewal /review, if any
Since when dealing with our Bank
Method of Lending Applied
Priority / Non Priority
Date of Last reporting to the Sanctioning
Authority
BORROWER DETAILS:
Table 7: Borrower Details

1 Name of the Borrower

2 PAN No.
3 Group
4 Key Promoter
5 Flagship Company
6 PAN No of Flagship Company
7 Corporate office / Registered Office
address of the borrower

8 Location of Unit/ works

9 Constitution
10 Date of Incorporation /
Establishment

11 Sector
12 Size
13 BSR Activity Code

44

14 Board of Directors/Partners/Proprietor:
Sr.
No

Name

Designation

DIN No

PAN No

Date of
Birth

1. MANAGEMENT:
(Brief profile of management)

A. Whether name of the Borrower Company / Directors / Partners /

proprietor/ promoters are appearing in:
Particulars
1) RBI defaulters list as at ________
2) RBI Willful defaulters list as at __________
3) CIBIL report dated ___________ and
comments on adverse features if any
4) ECGC SA List

Yes/ No

If Yes details

B. Confirmation regarding details as to whether the applicant borrower/

directors/ partners is related to any of the Senior officers/executives /
directors of the Bank Yes/ No
C. Details of court cases pending against the borrower including those
initiated by other Banks/FIs, information on suit filed and actionable
claims, if any
2. Shareholding Pattern:
As on:
a. Paid up equity capital:
Shareholder Category

% holding

Total

100%

3. Stock Market Perception:

Whether listed company:
Stock

Face value of per

Current market
45

52 weeks (Price)

Exchange

share (Rs.)

price (as on
)

High

Low

Details of Pledge of Shares:

4. BACKGROUND OF THE BORROWER COMPANY
(Including brief on Production/ Infrastructure facility and Selling and Marketing
Arrangement)
5. Due diligence/ Unit Visit details: ( in respect of fresh sanctions)
6. DETAILS OF ASSOCIATE / GROUP COMPANIES
Particulars
Company1
Company 2
Name of the Associate/ Group
Company
Activity
Banking
arrangement
name of Bankers
FB Limit
NFB Limit
External Rating
Whether CIBIL report is
obtained and found
satisfactory
Financial Performance for the
1
2
3
1
2
year
Net sales
PAT
TNW
DE ratio
Current Ratio
TOL/ TNW
7. DETAILS OF THE CREDIT FACILITIES PROVIDED BY OTHER DIVISIONS OF THE
BANK:

8. GROUP EXPOSURE:
Name

Interna
l
Gradati
on

Exter
nal
rating

Limits

F
B

NF
B

1.
2.
46

Derivati
ves

Aggrega
te value
of
Security
Tot
al

Credit
Expos
ure

3.
Total
GUARANTEE/ SECURITY/ COMPLIANCE OF GCP
1. GUARANTOR:
Sl.
Name of the Guarantor
Capacity
Net worth
Basis of Net worth
No.
1
2
3
CIBIL report of Guarantors dated _________ and comments thereon:
2. SECURITY:
Facility

Security
Name

Owner

Total
Value

Share of
Security
Value
Available
to the
Bank

Basis

Date of
Valuation

Primary Security
WC
TL
Other
Collateral Security
WC
TL
Other
Total
Security excluding stock and
book debts

Basis of computation of security coverage:

Existing :
Overall Security coverage (excluding current
assets) on the limits proposed:
Comments on security coverage:
3. COMPLIANCE WITH GROUP CREDIT POLICY GUIDELINES:

47

Proposed
:

In case of fresh sanctions

Parameters

Bank's
norm

Actual
position

Entry level per borrower exposure for FB/ NFB

facilities
Maximum per borrower exposure
Maximum Group Exposure
Exposure to industry / sector
Position as at
Current Ratio
Current Ratio for export oriented units
Debt Equity Ratio
DSCR
TOL/TNW
Promoter Contribution
Minimum Credit rating prescribed if any

Minimum CB 5

Whether the industry / activity falls under

category where selective approach is to be
adopted

No

In case of existing borrowers:

Parameters

Bank's norm

Actual
position

Maximum per borrower exposure

Maximum Group Exposure
Exposure to industry / sector as on
Unsecured Exposure (In case of clean/
unsecured exposure):
Whether the industry / activity falls under
category where selective approach is to be
adopted

No

Any other deviations :

FINANCIALS:
Whether the Audited Balance sheet submitted by the company has been
verified with MCA website and found correct: Yes/ NO
Financials:
48

Table 8: Financials

Particulars

31-03- 31-03- 31-03- 31-03- 31-03Audited Audited Audited Estimat Project

ed
ed

Net Sales (including Operating

Income)
%age growth in net sales over
previous year
Raw materials consumed
Raw materials consumed as a %
of CoP
Cost of Sales
Cost of Sales as a % of net sales
Operating Profit (after interest)
Operating Profit Margin (%)
Other Income
Profit Before tax
PAT
Net Profit Margin (%)
Cash Profit
Dividend (%)
Dividend
Retained Profit
Paidup Equity
Capital/Partners/Proprietors
Capital
Tangible Net Worth
TOL/ TNW
Debt Equity Ratio
DSCR
Net working capital
Current Ratio *
Current Ratio as per Schedule VI
#
(* Current ratio with out reckoning TL installment under current liabilities
# Current ratio reckoning TL installment under current liabilities)
Un audited Financials:
Financial Observations:
7.2.1 Sales
49

A. Sales Turnover: (segment wise performance to be commented)

B. Capacity Utilisation: (Installed v/s achieved capacity to be commented)
7.2.2 Profitability:
7.2.3 Net Owned Funds vis-a-vis Total Funds Deployed:
The net owned funds position of the Company is summarised as under:
Particular

31-03-Audited

31-03-Audited

Net worth
(-) Intangible assets
Tangible Networth
(+) Unsecured loans (quasi equity)
(-)Utilizn of funds for purposes
unrelated to busn
Net Owned Funds (NOF)
Total Funds Deployed (TFD)
NOF as a % to TFD
7.2.4 Long Term Funds and its deployment:
The sources of long term funds and its deployment is furnished here
below:
(Rs. in crore)
Particular
31-03-Audited
31-03-Audited
Tangible Networth
Unsecured loans (Quasi Equity)
Term Liabilities
Total Sources
Fixed Assets (Gross Block)
Fixed Assets (Net Block) including
Capital WIP
Non-Current assets
Net Working Capital
Total Deployment

7.2.5 Fund Flow Statement:

The position of movement of funds is furnished here below:
(Rs. in
50

crore)
31-03-Audited 31-03-Audited

Particular
Long term sources
Long Term uses
Long term surplus/deficit
Short term borrowings other than
bank borrowings
Short term uses
Short term surplus / deficit
Net surplus / deficit
Increase / Decrease in bank
borrowings
7.2.6 Debt Equity Position:
7.2.7 Debt Servicing Obligations:

7.2.8 Liquidity Position:

The position of current assets, adequacy of NWC and current ratio is discussed here
under:
(Rs. in Crore)
Particulars
31-0331-0331-03Audited Audited Audited
A. Total Current Assets (excld export
receivables
B. Minimum required NWC (20% of A)
C. Actual NWC
D. Surplus / Deficit in NWC
E. Current Ratio

7.2.9 Contingent Liabilities:

(Rs.
31-03Audite
d

Particular

Arrears of cumulative dividends

Guarantees issued (relating to business)
Guarantees issued to group companies
Gratuity Liability not provided for

51

in Crore)
31-03Audite
d

Disputed Tax Liabilities

All other cont liabs (incl.Bills pur under
LC)
Total
7.2.10 Audit Qualifications:

7.2.11 Comments on overall performance / financial position:

APPRAISAL
A. REVIEW OF TERM LOAN:
Sr Natur Exten
. e of
t
No limit
.

Purpose

Repayment
term

(Rs. In crore)
Outsta Overdu Date Of Date of
nding
es, if Sanctio Disburs
as on
any
n
ement
(--)

1 Term
Loan
I
(Revie
w)
Total

--

Present Status of the Project:

B. SANCTION OF TERM LOAN
A. Details of the project:
B. Project Location and Land requirement:
C. Technical Feasibility
D. Financial Viability:
i.
Project cost
The components of project cost envisaged and expenses incurred so far are as
under:
(Rs crores)
Particulars
Cost
Expense
Balance
envisage
s
to be
d
incurre
incurred
d
Land and Site development
Factory Building
52

Plant and Machinery

Miscellaneous Fixed Assets
Contingencies
Pre-operative Expenses
Margin Money for working Capital Limit
Total Project cost
(Components are indicative only)
Land and Site development:
Factory Building:
Plant & Machinery:
Miscellaneous Fixed Assets
Pre-Operative Expenses:
Margin for Working Capital:
ii.
Means of Finance:
Means of finance envisaged by the company is as under:
(Rs. in crore)
Particular
Total
%
Amount
Infused
1

2
3

Promoters contribution
1.1 Equity
1.2 Internal accruals
1.3 Unsecured Loan
1.4 Others
Term loan from bank
Other sources
Total

Balance
to be
Infused

100.00
%

Promoters Contribution:
Term Loan:
Other Sources:
iii.

Proposed Repayment terms and justification thereof:

53

iv.
Business Projections and DSCR :
Based on the projected financials; DSCR for the company is arrived at as under:
Particulars
Capacity utilization
Net Sales.
PAT.
Cash Profit.
Add: Interest on TL.
Total (A).
Installment due under
TLs
- Existing TLs
Proposed TLs.
Interest on TLs.
Total (B).
DSCR (A/B).
Average DSCR

II

III

IV

VII

VIII

Major assumptions underlying the profitability statements:

v.

Sensitivity Analysis of DSCR:

Specific Recommendations:
vi.

Project implementation Schedule:

Activity Name

vii.

Target Time

Status of Statutory/ Regulatory Approval:

Details of Approval

Authority

Present Status

1. ASSESSMENT OF FB WC REQUIREMENTS:
Net sales for the current year projected by the
54

: Rs.

Date and
reference of
approval

borrower
Net sales Projection accepted by us

: Rs.

( Net sales estimated/ accepted shall be duly justified by installed/ utilised capacity,
Unit Price etc)
Holding Level
Holding Levels

31-0331-03- 31-03- 31-0331-03Audited Audite Audited Estimat Project

d
ed
ed

Raw Materials
(months consumption)
Stock in Process
(months cost of production)
Finished Goods
(months cost of sales)
Receivables Domestic
(months sales)
Receivable Export
(months sales)
Other Current Assets
Total current assets
Sundry Creditors
(months purchases)
Other current liabilities
Total current liabs other than bank
borrowings
Raw material:
Stock in Process:
Finished Goods:
Domestic receivables:
Sundry Creditors:
Other Current Assets
Other Current Liabilities:
Permissible Bank Finance
(Rs. in
55

Assessment

Crore)
31-03- 31-03- 31-03- 31-03- 31-03Audited Audited Audited Estimat Project
ed
ed

A. Working Capital Gap

B. Min required NWC (20% of CA excl
export recvs)
C. Estimated NWC
D. PBF = (A-B) or (A-C) whichever is
lower
E. Net Working Capital to Total Current
Assets [%]
F. Bank Finance to Total Current Assets
[%]
G. Sundry Creditors to Total Current
Assets [%]
H. Other Current Liabs to Total Current
Assets (%)
Comments on buildup of NWC:
Specific Recommendations
Margin on Stock and Book debts:

2. ASSESSMENT OF NON FUND BASED LIMITS:

a. Assessment of Letters of Credit cum Buyers Line of Credit Limit:

Sl. Particulars
No
.

31-0331-03Estimate Projected
d

Annual Raw material consumption

Annual raw material purchases

Raw material to be procured LC (60% of 2) (A)

Lead time for shipment (days) (B)

Usance period (days) (C)

LC Requirement (A*(B+C)/365)
b. Assessment of Bank Guarantee Limit
c. Assessment of Forward Cover Requirements:

3. RATING SUMMARY INFORMATION:

56

Internal Credit
Rating

Based on financials
of

Specific model
Grade

Single scale
rating

Latest
Previous
Justification for the following:
a. Slippage in Internal rating if any:
b. Difference of two or more notches in Mapping of Internal gradation and external
rating, if any:
External Borrower Rating:
Facility

Agency

Date of Rating

Current Rating

Long term
Short Term
Rating Rationale

PRICING
1. RATE OF INTEREST:
Facility

Applicable

Indicative ROI approved by

NBG/ In-principle (if
applicable)
Or
Existing

Proposed

2. WAVIER/MODIFICATION OF TERMS AND CONDITIONS/CONCESSIONAL

TERMS/ANY OTHER REQUESTS:
Concession:
Facility
Applicable
Indicative charges approved
Proposed
by NBG/ In-principle (if
applicable)
Or
Existing
Relaxations:
Facility

Applicable

Indicative terms approved

by NBG/ In-principle (if
applicable)
OR
Existing

57

Proposed

(Justification for Concession/ Relaxations shall be provided)

INDUSTRY ANALYSIS:

OPERATIONAL EXPERIENCE:
1. Conduct of the Account:
(Comment on dealings of the borrower)
Particulars

For previous
year

Current year up
to completed
month

Credit Summation in the account

No of TODs permitted
No of cheques returns
2 Income Earned Analysis:
Income Category

For previous year

Currentyear up to
completed month

Interest Income
Non Interest Income
Total
3. Details of periodic Unit Visit:
4. Audit Comments:
Audit done by

Report Date

Pending
Comments

Present position

Concurrent Auditor
Internal Auditor
Legal Audit
RBI Inspectors
Statutory Auditor
Stock Audit
Credit Audit
5. Compliance of Sanction terms (for existing limits)
Whether earlier/ last sanction terms complied and certificate in this regard
are held on record/ submitted to the sanctioning authority: Yes/ NO
58

6. Value of account:
a. Deposit held with branch with details of encumbered/ unencumbered deposits:
b. Other business support:
KEY RISK ISSUES
Risk

Mitigant

RECOMMENDATIONS:
CLEARANCE BY THE CREDIT APPROVAL GRID:
Grid Observations

Reply

Bibliography
Cahill, B. (n.d.). Key Credit Risks of Project Finance. Moody Special Release.
(2013,). Crisil Ratings. CRISIL rates Indias first NBFC Infrastructure Debt Fund,.
Ruster, J. (February 1996). Mitigating Commercial Risks in Project. The World Bank.
Sinha, S. (March 2014 ). Long Term Financing of Infrastructure . INDIAN INSTITUTE
OF MANAGEMENT.
Sorge, M. (December 2004). The Nature of Credit Risk. BIS Quaterly review.

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