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Asian Research Journal of Business Management Issue 1 (Vol.

2)2014

Issn:2321-9246
Research Article

Asian Research Journal of Business Management


Credit Appraisal Procedures and Disbursement of Loans to Micro, Small and
Medium Enterprises with Special Reference to Lakshmi Vilas Bank Ltd-Chennai
Dr. R. Akila1*, Mrs. N. Padmavathy 2

*1 Professor,

Department of Management Studies, Jeppiaar Engineering College, Rajiv Gandhi Salai, Chennai, India
Professor -Management Studies, Jeppiaar Engineering College, Rajiv Gandhi Salai, Chennai, India.

2Associate

Received: 27 June 2014; Revised: 11 July 2014; Accepted: 18 July 2014

Abstract: Credit appraisal is a holistic exercise which starts from the time a prospective
borrower walks into the branch and culminates in credit delivery and monitoring with the
objective of ensuring and maintaining the quality of lending and managing credit risk within
acceptable limits. The main objective of this study is to understand the procedure of lending
loans to Micro, Small and Medium Enterprises and to comprehend the complete procedure of
lending loans to MSME, terms and conditions adopted by Lakshmi Vilas Bank. The study
also aimed to identifying the reasons for delay in repayments and non-performing asset. The
analysis is done on the basis of secondary data and the period is limited to the past five years
starting from 2009 and ending with 2013. The statistical and financial tools used to evaluate
the credit appraisal procedure and disbursement of loans to MSME are regression, correlation
(financial performance analysis), trend analysis and risk analysis. The study is totally confined
to LVB, kodambakkam branch and to identify the banks position regarding Loans disbursed,
reimbursed and non-performing asset by MSME and made suggestions to improve the
existing recovery system.
Keywords: Credit Appraisal, MSME, NPA, Lakshmi Vilas Bank.
INTRODUCTION
Credit Appraisal is a process to ascertain the risks associated with the extension of the credit
facility. It is generally carried by the financial institutions which are involved in providing
financial funding to its customers. Credit risk is a risk related to non repayment of the credit
obtained by the customer of a bank. Thus it is necessary to appraise the credibility of the
customer in order to mitigate the credit risk. Proper evaluation of the customer is performed in
order to measures the financial condition and the ability of the customer to repay back the
loan in future. Generally the credits facilities are extended against the security know as
collateral. But even though the loans are backed by the collateral, banks are normally
interested in the actual loan amount to be repaid along with the interest. Thus, the customer's
cash flows are ascertained to ensure the timely payment of principal and the interest15.
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Research Article

MICRO AND SMALL ENTERPRISE


A healthy SME sector contributes prominently to the economy through creating more
employment opportunities, generating higher production volumes, increasing exports and
introducing innovation and entrepreneurship skills. According to Bashir Ahmad Fida1 (2008),
SMEs are the first step towards development in economies towards industrialization. The
dynamic role of SMEs in developing countries positions SMEs as engines through which the
growth objectives of developing countries can be achieved a role that has long been
recognised. One of the significant characteristics of a flourishing and growing economy is a
vibrant and blooming SME sector. SMEs play a pivotal role in the development of a nation.
They contribute to socioeconomic development in various ways; namely, by creating
employment for a rural and urban growing labour force and providing desirable sustainability
and innovation in the economy as a whole15,16.
INDUSTRY PROFILE
The Indian banking industry has evolved and transformed itself from a socialist licensed raj
business to a liberalized, modernized & technology oriented white elephant of India. Banking
industry is the backbone for any economy & is the key indicator to see & analyze the level of
development of a country. The banking sector of India has an annual growth rate of 23
percent, contributing nearly 6 percent of GDP & employing nearly 7.4 million people & has
outperformed most banking indices in the world with highest total returns to shareholders at
36.76%. The Indian banks even braved the subprime crises that rocked the global financial
sector in 2008. The Indian banks ability to protect asset health through prudent lending
helped them emerge from this crisis unscathed. The Indian banking sector has a large market
still unexplored with the Indian households being one of the highest savers in the world
accounting for 69% of India gross national saving of which only 47% is accessed by the
banks. On the other hand there are many challenges as well which the Indian banking industry
has to face in the road ahead like that of financial inclusion, deregulation of interest rates on
saving deposits, slow industrial growth, a large government deficit, increased stress on some
sectors (such as, State utilities, airlines, and microfinance) & the implementation of Basel
III13.
Nevertheless seeing the credentials of the Indian Banks one can safely conclude that the
industry might have many stumbling blocks in the 'Road Ahead' but when ever encountered
with such blocks in the past it has used them as a stepping stone & has always 'Transformed'
itself ( for the better) and 'Evolved' as a winner. In 2012-13, Indian Bank's net profit rose by
23.15 per cent to Rs 70,331 crore compared to Rs 57,109 crore in the previous year. Total
income during the year expanded by 15.53 per cent to Rs 5, 71,230 crore against Rs 4, 94,664
crore in 2009-10. Net Interest Margin of the bank improved to 2.92 per cent in FY'2011 from
2.17 per cent in the previous fiscal. As the Indian financial System is bank dominated their
wellbeing is a must for the economy of India. India currently has a total of 74, 505 ATM of
which 66.42 % are owned by public sector & 31.74% by private sector banks with a total of
227 million debit cards issued13.
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Research Article

COMPANY PROFILE
The Lakshmi Vilas Bank Limited (LVB) was founded eight decades ago ( in 1926) by seven
people of Karur under the leadership of Shri V.S.N. RamalingaChettiar, mainly to cater to the
financial needs of varied customer segments. The bank was incorporated on November 03,
1926 under the Indian Companies Act, 1913 and obtained the certificate to commence
business on November 10, 1926, The Bank obtained its license from RBI in June 1958 and in
August 1958 it became a Scheduled Commercial Bank. At present, with a network of 312
branches and 8 extension counters, spread over 15 states and the union territory of
Pondicherry, the Bank's focus is on customer delight, by maintaining high standards of
customer service and amidst all these new challenges, the bank is progressing admirably. LVB
has a strong and wide base in the state of Tamil Nadu, one of the progressive states in the
country, has a vibrant industrial environment. LVB has been focusing on retail banking,
corporate banking and bancassurance, is rendering high-tech services. To facilitate all the
financial services under one roof, the bank has tied up for a bancassurance pact with Life
Insurance Corporation of India for marketing life insurance products, Bajaj Allianz General
Insurance Co. Ltd for General Insurance distribution business and arrangements for
distributing the mutual fund products of 13 various reputed AMCs. The Bank believes in cost
effective service delivery powered by appropriate technology to enhance value to
customers. All our bank branches are in the state-of-the-art core banking software viz.
Flexcube14.
RESEARCH REVIEW
Banks have credit policies that guide them in the process of awarding credit. The policy sets
the rules on who should access credit, when and why one should obtain the credit including
repayment arrangements and necessary collaterals. The method of assessment and evaluation
of risk of each prospective applicant are part of a credit control policy (Payle, 1997)9.
A firms credit policy may be lenient or stringent. In the case of a lenient policy, the firm
lends liberally even to those whose credit worthiness is questionable. This minimizes costs
and losses from bad debts but might reduce revenue earning from loans, profitability and cash
flow Simonson and Hempel (1999) 11, Hsiu-Kwang (1969) 4 and IMF (1997) 5 observe that
sound credit policy would help improve prudential oversight of asset quality, establish a set of
minimum standards, and apply a common language and methodology (assessment of risk,
pricing, documentation, securities, authorization, and ethics), for measurement and reporting
of nonperforming assets, loan classification and provisioning.
Chen and Shimerda (1981)2 review 26 articles that classify 100 financial indicators, 65 of
them financial ratios. They report that 41 financial ratios are considered important, given
citation in one more of the 26 articles. In identifying bankrupt firms: Their final model,
however, includes only seven financial indicators, namely, return on investment, debt ratio,
the current ratio, cash position, net working capital turnover, inventory turnover and accounts
receivable turnover. The bankruptcy model for industrial companies adds to these factors a
cash flow measure.
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Asian Research Journal of Business Management Issue 1 (Vol.2)2014

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Research Article

Sun and Li (2006) 12 have developed a model to predict companies financial distress, testing
35 financial ratios for 135 pairs of listed companies. Their final distress prediction model
includes net profit growth rate, liabilities to tangible net assets, accounts receivable turnover,
liabilities to cash flow, liabilities to equity market value, total asset turnover and gross profit
margin. Giacomino and Mielke (1993)3 propose nine cash flow ratios to evaluate a company's
performance and use than to evaluate US companies in the chemical, food and electronic
industries, calculating three-year averages per industry. The industries were chosen had the
largest number of companies among the Fortune 500. The extensive research on financial
ratios reveals their importance in many important decisions, including financing and
investment decisions.
Sathya Varathan et al (2012)10 intended to study the credit policy and credit appraisal of the
bank process Credit rating methods followed by the bank for different credit ranges are also
analyzed. The bank must bring more transparency in appraisal of the project there should be
explanation for a appraisal of the project that was sanctioned by higher authority. Banks
concerned should continuously monitor loans to identify accounts that have potential to
become non-performing. Nancy Arora et al (2013) 8 research paper discussed the Credit Risk
Assessment Model of SBI Bank and check process of the commercial, financial & technical
viability of the project proposed & its funding pattern. The paper studied the movements to
reduce various risk parameters which are broadly categorized into financial risk, business risk,
industrial risk & management risk.
STATEMENT OF THE PROBLEM
A study on the credit appraisal process of capital financing to MSME special reference to
Lakshmi Vilas Bank Limited (LVB), Chennai. The study has been made as high amount of
loans have been lend to MSME. Also huge amount of NPA have been reported for MSME.
OBJECTIVE OF THE STUDY

To study the credit appraisal system for working capital finance to SMEs.
To understand the credit appraisal procedure followed to grant loans for MSME.
To calculate the disbursement of loans to MSME during the past five financial years.
To examine the reimbursement of loans by MSME to bank.
To explore the causes for default in returning the loans by MSME to bank and suggest
measures to reduce NPA.
To assess the total amount lend by the bank for past 5 years and assist the bank in
improving their financial performance.

SCOPE OF THE STUDY

The study aims at forecasting its future position in few aspects such as disbursement,
reimbursement and NPA of loans.
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Asian Research Journal of Business Management Issue 1 (Vol.2)2014

Issn:2321-9246
Research Article

The study is done to analyze the procedures to MSME to sanction the grant loans by LVB.
The study also aims to identify the various reasons for delay in repayment and nonpayment of loans by MSME to LVB.
The study aims at analyzing the overall profitability and NPA of the enterprises during the
period of 5 years from 2009 to 2013.

RESEARCH DESIGN
The research design followed for the study is descriptive and analytical in nature as the study
describes the existing facts and figures. The study is based on secondary data like loans to
MSMEs for the last five years. The secondary data was collected with the help of internal
banks websites, journals, magazines and manuals and through personal discussion with the
LVB Bank officials. The collected data were analysed using statistical tools like regression,
correlation, risk analysis etc.
PROCEDURE FOR ASSESSMENT OF CREDIT TO MSME UNITS

A simplified procedure has been adopted for sanction of working capital limits. 20% of the
projected and accepted annual turnover will be extended as working capital limit to MSE
units requiring aggregate fund based working capital limits up to Rs.7.5 crore. Borrower
has to bring in 5% of the accepted turnover as margin. Current Ratio of 1.25 will be
acceptable in such cases.
For MSE units requiring working capital limits above Rs.7.5 crore and up to Rs.10 crore,
the Maximum Permissible Bank Finance (MPBF) method based on Credit Monitoring
Arrangement (CMA) data will be followed.
For MSE units requiring working capital limits over Rs.10 crore, Cash budget system or
MPBF method, at the option of the borrower, will continue to be followed.
A combined working capital limit will be allowed against the stock and receivables without
any sub limit for CC against receivables. However, different margins will be fixed for stock
and receivables.
Lending will be based on scoring model for advances upto Rs.2 crores. Information
required for scoring model will be incorporated in the application form itself. No individual
risk rating is required in such cases.
If the bank sanction term loan solely or jointly with one or more Banks, working capital
limit will also be sanctioned solely or jointly (in the ratio of term loan) to avoid delay in
commencement of commercial production. It will also be ensured that there are no cases
where term loan has been sanctioned but sanction of working capital facilities is awaited.
The interest payable up to six months after commercial production will be included as part
of the project cost for assessment of credit requirements. Sufficient moratorium period say,
upto six months, after commencement of commercial production, will be allowed for
repayment of principal amount wherever required, to enable the unit establish itself in the
market.
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Research Article

Margin Norms
No margin is required for loans up to Rs.50000/ Minimum margin requirements for loans/credit facilities above Rs.50000/- are as under:
A. Term Loans
For loans above Rs.50000/- and up to Rs.5 Lac 10%
For loans above Rs.5 Lac
15%
In case of Term Loans for acquiring second hand machineries, higher margin may be
stipulated on case-to-case basis.
B. Working Capital Finance
Working Capital against hypothecation of raw materials, work in Process, finished goods
etc.,
Above Rs.50000/- and up to Rs.5 Lac
15%
Above Rs.5 Lac
20%
Working Capital against Book Debts/Receivables
Margin to be taken as per our Banks general loan policy document, without any
concession.
C. Minimum cash margin of 10% will be prescribed in respect of non fund based limits
such as LG and LC.
D. For loans under Government sponsored schemes and Banks special credit schemes;
margin will be obtained as stipulated in the scheme even if it is different from the levels
indicated above.
E. In exceptional cases, margins lesser than indicated above can be prescribed with the
approval of the appropriate authority as per powers delegated in banks concession
policy.
Security Norms
1. No collateral security or third party guarantee is required for loans to micro and small
enterprises upto Rs.5 lacs (up to Rs.10 Lacs for loans sanctioned after May 2010). Such
loans will invariably be covered under Credit Guarantee Scheme of CGTMSE
2. Loans above Rs.5 lacs (above Rs.10 Lacs for loans sanctioned after May 2010) and upto
Rs.100 lacs (to micro and small enterprises will also be sanctioned without collateral
security or third party guarantee subject to following conditions:
The unit should be eligible to be covered under Credit Guarantee Scheme of CGTMSE
The bank is fully satisfied with regard to viability of project and track record of the
promoter/units.
In all other cases of credit facilities to micro and small enterprises (other than a and b)
suitable collateral security and or third party guarantee will be obtained based on risk
perception and judgment of sanctioning authority.
Even when the loan is eligible to be covered under the Guarantee cover of CGTMSE, if the
borrower prefers to bring acceptable collateral security and third party guarantee, in lieu of
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Asian Research Journal of Business Management Issue 1 (Vol.2)2014

Issn:2321-9246
Research Article

the CGTMSE Guarantee Cover, the same will be considered. All collateral free loans above
Rs.5 lacs and upto Rs.100 lacs will be brought under cover of Credit Guarantee Scheme of
CGTMSE.
3. As per General Loan Policy Document secured advances can be sanctioned by Branch
Managers upto the level of Scale IV only by taking collateral securities to a minimum
extent of 75% of the credit limits sanctioned. This will be relaxed in respect of MSE
advance and Branch Managers upto the level of Scale IV will be allowed to sanction
secured advances to MSE sector by taking collateral securities to a minimum extent of
60% of the credit limits sanctioned. Such sanctions should be supported by sound
reasoning.
4. All branch Managers can sanction collateral free loans to MSE sector with CGTMSE
Guarantee cover up to their per borrower limits.
5. The Banks calculation method for providing credit is like Turnover method, Traditional
method, whichever is high will be taken for consideration by the bank authorities for
further proceedings.
DATA ANALYSIS
Table 1: Disbursement Of Loans For Micro Enterprises

YEAR

Quarters
Q1
(1-3m)
Q2
(4-6m)
Q3
(7-9m)
Q4
(10-12m)
TOTAL

2009
No Of
Customer

2010

2011

2012

2013

Micro
Amount

No Of
Customer

Micro
Amount

No Of
Customer

Micro
Amount

No Of
Customer

Micro
Amount

No Of
Customer

Micro
Amount

962000

467000

42000

222200

20

2500000

290000

10

1517000

157600

306000

35000

132000

15

1621000

216000

536000

40000

583000

12

956099

50000

14

179700

10

542000

20

2274000

40

2956899

33

307200

During maximum disbursement of loans are made to the extent in quarter 1 about Rs
25,00,000 in year 2013, quarter 2, Rs 15,17,000 in year 2011, quarter 3, Rs 2,16,000 in year
2013, quarter 4 Rs 9,56,099 in year 2012, The minimum disbursement has taken place to the
extent of Rs 40000 in year 2010. In two years 2009 and 2010 no disbursement has been
happened.

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Research Article

Table 2: Non Performing Asset By Micro Enterprises


YEAR

2009

Quarters
Q1
(1-3m)
Q2
(4-6m)
Q3
(7-9m)
Q4
(10-12m)
TOTAL

2010

Amount

2011

2012

2013

Amount

Amount

Amount

Amount

200680

20.86%

189290

40.53%

0.00%

132747

59.74%

1198450

47.94%

108457

37.40%

0.00%

637750

42.04%

87671

55.62%

198326

64.81%

0.00%

0.00%

37828

28.66%

665272

41.04%

136144

63.02%

305857

57.06%

19971

49.92%

291438

49.99%

710076

74.27%

39641

79.28%

614994

34.40%

209261

38.61%

967016

42.52%

1595766

53.97%

1572561

51.19%

The maximum potential NPA of loans in 2009 is Rs 305857 (Quarter 4) , in 2010 Rs. 189290
(quarter 1), in 2011 is Rs 637750 (quarter 2), Rs. 710076 in 2012 (quarter 4), Rs 1198450 in
2013 (quarter 1). The minimum potential NPA has taken place of Rs 37828 in 2012 for
quarter 3 and Rs 39641 in 2013 for quarter 4. During quarter 3 of 2009, quarter 2 & 3 of 2010
NPA has not recorded.
Table 3: Disbursement Of Loans Enterprises To Small Enterprises
YEAR

Quarters
Q1
(1-3m)
Q2
(4-6m)
Q3
(7-9m)
Q4
(10-12m)
TOTAL

2009
No Of
Customer

2010

2011

2012

2013

Micro
Amount

No Of
Customer

Micro
Amount

No Of
Customer

Micro
Amount

No Of
Customer

Micro
Amount

No Of
Customer

Micro
Amount

1500000

467000

1000000

2000000

1150000

500000

1000000

35000

40000

500000

1000000

265000

10

542000

1500000

3500000

1000000

The table above depicts the loan disbursement for the small enterprises by the bank. Only few
small enterprises have taken the loan from the bank. The maximum amount has been
dispersed in the year 2012 for the Rs. 3500000, in 2013 just Rs 1000000 which is Rs 2500000
lakhs less than previous year has been dispersed to one customer.

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Asian Research Journal of Business Management Issue 1 (Vol.2)2014

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Research Article

Table 4 : Non Performing Asset By Small Enterprises


YEAR /

Quarters
Q1
(1-3m)
Q2
(4-6m)
Q3
(7-9m)
Q4
(10-12m)
TOTAL

2009

2010

2011

2012

2013

Amount

Amount

Amount

Amount

Amount

952568

63.50%

0.00%

597148

59.71%

1147355

57.37%

0.00%

66028

5.74%

856660

85.67%

268544

53.21%

574329

57.43%

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

372346

74.47%

564764

56.48%

1018596

38.43%

856660

85.67%

865692

57.71%

2094030

59.82%

564764

56.48%

The maximum potential NPA of loans in 2009 is Rs 952568 (Quarter 1), in 2010 Rs 856660
(quarter 2), in 2011 is Rs 597148 (quarter 1), Rs 1147355 in 2012 (quarter 1), Rs 564764 in
2013 (quarter 4). The low level of NPA recorded in the year 2009 for the quarter 2 of Rs
66028 and in the year 2013 Rs 564764.
Table 5: Risk Analysis For Micro Enterprises
YEAR

LD

NPA

% of NPA on LD

2009

1788000

614994

34.40

2010

542000

209261

38.61

2011

2274000

967016

42.52

2012

2956899

1595766

53.97

2013

3072000

1572561

51.19

TOTAL

10632899

4959598

220.69

Source: Secondary data


AVERAGE NPA = NPA/5 =220.69/5=44.14
Average NPA for micro enterprises 44.14% i.e. the loans disbursed turn out to be nonperforming asset, which shows that the bank is at risk in collecting the loans lent to MSME.

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Asian Research Journal of Business Management Issue 1 (Vol.2)2014

Issn:2321-9246
Research Article

Table 6: Risk Analysis For Small Enterprises


YEAR

LD

NPA

% of NPA on LD

2009

2650000

1018596

38.44

2010

1000000

856660

85.67

2011

1500000

865692

57.71

2012

3500000

2094030

59.83

2013

1000000

564764

56.48

TOTAL

9650000

5399742.00

298.12

Source: Secondary data


AVERAGE NPA = NPA/5 = 298.12/5 = 59.62
Average NPA for small enterprise is 59.62% i.e. the loans disbursed turn out to be nonperforming asset, which shows that the bank is at risk in collecting the loans lent to MSME.
FINDINGS
Disbursement of loans to Micro enterprises is maximum during 2013 and minimum during
2010. Reimbursement of loans is maximum during 2013 and minimum during 2009. Nonperforming asset of loans is maximum during 2012 and minimum during 2010. Disbursement
of loans to Small enterprises is maximum during 2012 and minimum during 2010 and 2013.
Reimbursement of loans is maximum during 2013 and minimum during 2009. Nonperforming asset of loans is maximum during 2009 and minimum during 2010.
As non-performing assets (NPA) is high due to loans not returned by Micro and Small
enterprises, the net profit (NP) of LVB is low. The loan disbursement and reimbursement for
2014 is estimated to be Rs 3518093.08 and Rs 141567.72. The non-performing asset by Micro
enterprises for 2014 is estimated to be Rs 2036525.36. The loan disbursement to Small
enterprises for 2014 is estimated to be Rs -1256039.32. The loan reimbursement to Small
enterprises for 2014 is estimated to be Rs 2759015.99. The loan non-reimbursement by Small
enterprises for 2014 is estimated to be Rs.1268304.96.
On an average 44.14%of the loans lent to Micro enterprises would turn out to be NPA. On an
average 59.62% of the loans lent to Small enterprises would turn out to be NPA. The raise in
percentage of NPA with Micro and Small enterprises clearly indicates decreasing profitability
of the bank. Therefore, it is the need of the hour to reduce NPA in order to improve the
profitability status of the bank. From Correlation and Regression analysis it is clear that there
is a least positive correlation between non-performing asset and loan disbursed of the bank,
which implies as the non-performing asset increases, loan disbursed decrease.

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SUGGESTIONS

Loans disbursement of LVB to MSME shall be done only according to the credit appraisal
procedure of the bank.
LVB may adopt zero tolerance procedure for any deviation by MSME from the rules and
regulations stated in the credit appraisal procedure.
The creditability of MSME shall be appraised by the bank based on the past transactions
with the enterprises and by conducting status enquires of the borrower.
Bank may strengthen the credit collection system, so that loans lent are collected on time
from MSME.
The recovery system of banks should be improved in order to reduce the NPA percentage
and increase profitability of the bank.

CONCLUSION
This study on the Credit appraisal procedure and disbursement of loans to MSME with special
reference to Lakshmi vilas bank,kodambakkam Branch, Chennai. Credit Appraisal is a
process to ascertain the risks associated with the extension of the credit facility. It is generally
carried by the financial institutions, which are involved in providing financial funding to its
customers. Credit risk is a risk related to non-repayment of the credit obtained by the
customer of a bank. Thus it is necessary to appraise the credibility of the customer in order to
mitigate the credit risk. Proper evaluation of the customer is performed this measures the
financial condition and the ability of the customer to repay back the Loan in future. Generally
the credits facilities are extended against the security know as collateral. But even though the
Loans are backed by the collateral, banks are normally interested in the actual Loan amount to
be repaid along with the interest. Thus, the customer's cash flows are ascertained to ensure the
timely payment of principal and the interest.
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Corresponding Author: Dr. R. Akila, 1Professor, Department of Management


Studies, Jeppiaar Engineering College, Rajiv Gandhi Salai, Chennai, India

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