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CREDIT APPRAISAL IN BANKING SECTOR

CHAPTER-1
INTRODUCTION TO BANKING
SECTOR & SBI

HISTORY OF BANKING INDUSTRY:

The Reserve Bank of India (RBI), as the central bank of the country, closely monitors
developments in the whole financial sector.

The banking sector is dominated by Scheduled Commercial Banks (SBCs). As at end-March


2002, there were 296 Commercial banks operating in India. This included 27 Public Sector
Banks (PSBs), 31 Private, 42 Foreign and 196 Regional Rural Banks. Also, there were 67
scheduled co-operative banks consisting of 51 scheduled urban co-operative banks and 16
scheduled state co-operative banks.

Scheduled commercial banks touched, on the deposit front, a growth of 14% as against 18%
registered in the previous year. And on advances, the growth was 14.5% against 17.3% of the
earlier year.

State Bank of India is still the largest bank in India with the market share of 20% ICICI and its
two subsidiaries merged with ICICI Bank, leading creating the second largest bank in India with
a balance sheet size of Rs. 1040bn.

Higher provisioning norms, tighter asset classification norms, dispensing with the concept of
‘past due’ for recognition of NPAs, lowering of ceiling on exposure to a single borrower and
group exposure etc., are among the measures in order to improve the banking sector.

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A minimum stipulated Capital Adequacy Ratio (CAR) was introduced to strengthen the ability of
banks to absorb losses and the ratio has subsequently been raised from 8% to 9%. It is proposed
to hike the CAR to 12% by 2004 based on the Basle Committee recommendations.

Retail Banking is the new mantra in the banking sector. The home loans alone account for nearly
two-third of the total retail portfolio of the bank. According to one estimate, the retail segment is
expected to grow at 30-40% in the coming years.

Net banking, phone banking, mobile banking, ATMs and bill payments are the new buzz words
that banks are using to lure customers.

With a view to provide an institutional mechanism for sharing of information on borrowers /


potential borrowers by banks and Financial Institutions, the Credit Information Bureau (India)
Ltd. (CIBIL) was set up in August 2000. The Bureau provides a framework for collecting,
processing and sharing credit information on borrowers of credit institutions. SBI and HDFC are
the promoters of the CIBIL.

The RBI is now planning to transfer of its stakes in the SBI, NHB and National bank for
Agricultural and Rural Development to the private players. Also, the Government has sought to
lower its holding in PSBs to a minimum of 33% of total capital by allowing them to raise capital
from the market.

Banks are free to acquire shares, convertible debentures of corporate and units of equity-oriented
mutual funds, subject to a ceiling of 5% of the total outstanding advances (including commercial
paper) as on March 31 of the previous year.

The finance ministry spelt out structure of the government-sponsored ARC called the Asset
Reconstruction Company (India) Limited (ARCIL), this pilot project of the ministry would pave
way for smoother functioning of the credit market in the country. The government will hold 49%
stake and private players will hold the rest 51%- the majority being held by ICICI Bank (24.5%).

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CREDIT APPRAISAL IN BANKING SECTOR

REFORMS IN THE BANKING SECTOR:

The first phase of financial reforms resulted in the nationalization of 14 major banks in 1969 and
resulted in a shift from Class banking to Mass banking. This in turn resulted in a significant
growth in the geographical coverage of banks. Every bank has to earmark a minimum percentage
of their loan portfolio to sectors identified as “priority sectors”. The manufacturing sector also
grew during the 1970s in protected environs and the banking sector was a critical source. The
next wave of reforms saw the nationalization of 6 more commercial banks in 1980. Since then
the number scheduled commercial banks increased four-fold and the number of banks branches
increased eight-fold.

After the second phase of financial sector reforms and liberalization of the sector in the early
nineties, the Public Sector Banks (PSB) s found it extremely difficult to complete with the new
private sector banks and the foreign banks. The new private sector banks first made their
appearance after the guidelines permitting them were issued in January 1993. Eight new private
sector banks are presently in operation. These banks due to their late start have access to state-of-
the-art technology, which in turn helps them to save on manpower costs and provide better
services.

During the year 2000, the State Bank of India (SBI) and its 7 associates accounted for a 25%
share in deposits and 28.1% share in credit. The 20 nationalized banks accounted for 53.5% of
the deposits and 47.5% of credit during the same period. The share of foreign banks ( numbering
42 ), regional rural banks and other scheduled commercial banks accounted for 5.7%, 3.9% and
12.2% respectively in deposits and 8.41%, 3.14% and 12.85% respectively in credit during the
year 2000.

CLASSIFICATION OF BANKS:

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The Indian banking industry, which is governed by the Banking Regulation Act of India, 1949
can be broadly classified into two major categories, non-scheduled banks and scheduled banks.
Scheduled banks comprise commercial banks and the co-operative banks. In terms of ownership,
commercial banks can be further grouped into nationalized banks, the State Bank of India and its
group banks, regional rural banks and private sector banks (the old / new domestic and foreign).
These banks have over 67,000 branches spread across the country. The Indian banking industry
is a mix of the public sector, private sector and foreign banks. The private sector banks are again
spilt into old banks and new banks.

Banking System in India

Reserve bank of India (Controlling Authority)

Development Financial institutions Banks

IFCI IDBI ICICI NABARD NHB IRBI EXIM Bank ISIDBI

Commercial Regional Rural Land Development Co-operative


Banks Banks Banks Banks

Public Sector Banks Private Sector Banks

SBI Groups Nationalized Banks Indian Banks Foreign Banks

ABOUT SBI:

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The State Bank of India, the country’s oldest Bank and a premier in terms of balance sheet size,
number of branches, market capitalization and profits is today going through a momentous phase
of Change and Transformation – the two hundred year old Public sector behemoth is today
stirring out of its Public Sector legacy and moving with an agility to give the Private and Foreign
Banks a run for their money.

The bank is entering into many new businesses with strategic tie ups – Pension Funds, General
Insurance, Custodial Services, Private Equity, Mobile Banking, Point of Sale Merchant
Acquisition, Advisory Services, structured products etc – each one of these initiatives having a
huge potential for growth.

The Bank is forging ahead with cutting edge technology and innovative new banking models, to
expand its Rural Banking base, looking at the vast untapped potential in the hinterland and
proposes to cover 100,000 villages in the next two years.

It is also focusing at the top end of the market, on whole sale banking capabilities to provide
India’s growing mid / large Corporate with a complete array of products and services. It is
consolidating its global treasury operations and entering into structured products and derivative
instruments. Today, the Bank is the largest provider of infrastructure debt and the largest
arranger of external commercial borrowings in the country. It is the only Indian bank to feature
in the Fortune 500 list.

The Bank is changing outdated front and back end processes to modern customer friendly
processes to help improve the total customer experience. With about 8500 of its own 10000
branches and another 5100 branches of its Associate Banks already networked, today it offers the
largest banking network to the Indian customer. The Bank is also in the process of providing
complete payment solution to its clientele with its over 8500 ATMs, and other electronic
channels such as Internet banking, debit cards, mobile banking, etc.

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With four national level Apex Training Colleges and 54 learning Centres spread all over the
country the Bank is continuously engaged in skill enhancement of its employees. Some of the
training programes are attended by bankers from banks in other countries.

The bank is also looking at opportunities to grow in size in India as well as internationally. It
presently has 82 foreign offices in 32 countries across the globe. It has also 7 Subsidiaries in
India – SBI Capital Markets, SBICAP Securities, SBI DFHI, SBI Factors, SBI Life and SBI
Cards - forming a formidable group in the Indian Banking scenario. It is in the process of raising
capital for its growth and also consolidating its various holdings.

Throughout all this change, the Bank is also attempting to change old mindsets, attitudes and
take all employees together on this exciting road to Transformation. In a recently concluded mass
internal communication programme termed ‘Parivartan’ the Bank rolled out over 3300 two day
workshops across the country and covered over 130,000 employees in a period of 100 days using
about 400 Trainers, to drive home the message of Change and inclusiveness. The workshops
fired the imagination of the employees with some other banks in India as well as other Public
Sector Organizations seeking to emulate the programme.The Bank is actively involved since
1973 in non-profit activity called Community Services Banking. All their branches and
administrative offices throughout the country sponsor and participate in large number of welfare
activities and social causes.

Their business is more than banking because they touch the lives of people anywhere in many
ways. Their commitment to nation-building is complete & comprehensive.

TRANSFORMATION JOURNEY IN STATE BANK OF INDIA:

The State Bank of India, the country’s oldest Bank and a premier in terms of balance sheet size,
number of branches, market capitalization and profits is today going through a momentous phase
of Change and Transformation – the two hundred year old Public sector behemoth is today

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stirring out of its Public Sector legacy and moving with an agility to give the Private and Foreign
Banks a run for their money.

The bank is entering into many new businesses with strategic tie ups – Pension Funds, General
Insurance, Custodial Services, Private Equity, Mobile Banking, Point of Sale Merchant
Acquisition, Advisory Services, structured products etc – each one of these initiatives having a
huge potential for growth.

It is also focusing at the top end of the market, on whole sale banking capabilities to provide
India’s growing mid / large Corporate with a complete array of products and services. It is
consolidating its global treasury operations and entering into structured products and derivative
instruments. Today, the Bank is the largest provider of infrastructure debt and the largest
arranger of external commercial borrowings in the country. It is the only Indian bank to feature
in the Fortune 500 list.

The Bank is changing outdated front and back end processes to modern customer friendly
processes to help improve the total customer experience. With about 8500 of its own 10000
branches and another 5100 branches of its Associate Banks already networked, today it offers the
largest banking network to the Indian customer. The Bank is also in the process of providing
complete payment solution to its clientele with its over 8500 ATMs, and other electronic
channels such as Internet banking, debit cards, mobile banking, etc.

With four national level Apex Training Colleges and 54 learning Centers spread all over the
country the Bank is continuously engaged in skill enhancement of its employees. Some of the
training programmes are attended by bankers from banks in other countries.

The bank is also looking at opportunities to grow in size in India as well as internationally. It
presently has 82 foreign offices in 32 countries across the globe. It has also 7 Subsidiaries in
India – SBI Capital Markets, SBICAP Securities, SBI DFHI, SBI Factors, SBI Life and SBI
Cards - forming a formidable group in the Indian Banking scenario. It is in the process of raising
capital for its growth and also consolidating its various holdings.

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Throughout all this change, the Bank is also attempting to change old mindsets, attitudes and
take all employees together on this exciting road to Transformation. In a recently concluded mass
internal communication programme termed ‘Parivartan’ the Bank rolled out over 3300 two day
workshops across the country and covered over 130,000 employees in a period of 100 days using
about 400 Trainers, to drive home the message of Change and inclusiveness. The workshops
fired the imagination of the employees with some other banks in India as well as other Public
Sector Organizations seeking to emulate the programme.

The CNN IBN, Network 18 recognized this momentous transformation journey, the State Bank
of India is undertaking, and has awarded the prestigious Indian of the Year – Business, to its
Chairman, Mr. O. P. Bhatt in January 2008.

State Bank of India (SBI) has history of more than 200 years of existence. SBI is the largest
commercial bank in India and accounts for approximately 18% of the total Indian banking
business and the group account for 25% of the total Indian banking business.

• The central bank, Reserve Bank of India (RBI) is the largest shareholder in the bank with59.7%
stake followed by overseas investors including GDRs with 19.78% shareholdingas on September
06. RBI’s stake in the bank is likely to be transferred to the Governmentof India (GOI).

• SBI has the largest distribution network in India spread across every nook and corner of India.
As on September 06, the bank has 14,061 branches which include 4,755 branches of its
associated banks. The bank also has the largest network of 5,624 ATMs.

Background:

State Bank of India is the largest and one of the oldest commercial bank in India, in existence for
more than 200 years. The bank provides a full range of corporate, commercial and retail banking
services in India. Indian central bank namely Reserve Bank of India (RBI) is the major share

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holder of the bank with 59.7% stake. The bank is capitalized to the extent of Rs.646bn with the
public holding (other than promoters) at 40.3%.

SBI has the largest branch and ATM network spread across every corner of India. Thebank has a
branch network of over 14,000 branches (including subsidiaries). Apart fromIndian network it
also has a network of 73 overseas offices in 30 countries in all time zones, correspondent
relationship with 520 International banks in 123 countries. In recent past, SBI has acquired banks
in Mauritius, Kenya and Indonesia. The bank had total staff strength of 198,774 as on 31st
March, 2006. Of this, 29.51% are officers, 45.19% clerical staff and the remaining 25.30% were
sub-staff. The bank is listed on the Bombay Stock Exchange, National Stock Exchange, Kolkata
Stock Exchange, Chennai Stock Exchange and Ahmedabad Stock Exchange while its GDRs are
listed on the London Stock Exchange.

SBI group accounts for around 25% of the total business of the banking industry while itaccounts
for 35% of the total foreign exchange in India. With this type of strong base, SBI has displayed a
continued performance in the last few years in scaling up its efficiency levels. Net Interest
Income of the bank has witnessed a CAGR of 13.3% during the last five years. During the same
period, net interest margin (NIM) of the bank has gone up from as low as 2.9% in FY02 to 3.40%
in FY06 and currently is at 3.32%.

EVOLUTION OF SBI:

The origin of the State Bank of India goes back to the first decade of the nineteenth century
with the establishment of the Bank of Calcutta in Calcutta on 2 June 1806. Three years later the
bank received its charter and was re-designed as the Bank of Bengal (2 January 1809). A unique
institution, it was the first joint-stock bank of British India sponsored by the Government of

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Bengal. The Bank of Bombay (15 April 1840) and the Bank of Madras (1 July 1843) followed
the Bank of Bengal. These three banks remained at the apex of modern banking in India till their
amalgamation as the Imperial Bank of India on 27 January 1921.

Imperial Bank

The Imperial Bank during the three and a half decades of its existence recorded an impressive
growth in terms of offices, reserves, deposits, investments and advances, the increases in some
cases amounting to more than six-fold. The financial status and security inherited from its
forerunners no doubt provided a firm and durable platform. But the lofty traditions of banking
which the Imperial Bank consistently maintained and the high standard of integrity it observed in
its operations inspired confidence in its depositors that no other bank in India could perhaps then
equal. All these enabled the Imperial Bank to acquire a pre-eminent position in the Indian
banking industry and also secure a vital place in the country's economic life.

When India attained freedom, the Imperial Bank had a capital base (including reserves) of
Rs.11.85 crores, deposits and advances of Rs.275.14 crores and Rs.72.94 crores respectively and
a network of 172 branches and more than 200 sub offices extending all over the country.

Key Areas of Operations:

The business operations of SBI can be broadly classified into the key income generating areas
such as National Banking, International Banking, Corporate Banking, & Treasury operations.
The functioning of some of the key divisions is enumerated below:

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a) CORPORATE BANKING

The corporate banking segment of the bank has total business of around Rs1,193bn. SBI has
created various Strategic Business Units (SBU) in order to streamline its operations.

These SBUs are as follows:

1) Corporate Accounts

This SBU is important for the bank as its loan portfolio constituted about 27.05% of thebank’s
commercial and institutional non-food credit and 12.85% of the total domestic credit portfolio as
on 31st March 2006.

Some of the products under corporate accounts SBU are as follows:

• SBI-FAST, which is the cash management product offered by this SBU, had a turnover of
Rs.4,705.75bn as of 31st March 2006. This product is now comprehensive cash management
solution, offering payments in addition to collections.

• Vendor financing activity is being integrated with core banking through the internet platform.
This is identified as a focus area to capture the credit portfolio of vendors.

• The foreign exchange business grew by around 55% y-o-y and reached Rs.1,747.70bn as of
31st March 2006. This SBU now handles nearly 12% of the country’s visible trade and about
43% of bank’s forex business.

2) Leasing

This SBU is not writing any leases since the past few years as unfavorable business climate and
availability of alternative funding options at cheaper cost. As at the end March 2006, the
disbursements and capitalization were zero and profit amounted to Rs.245.9mn.

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3) Project Finance

This SBU focuses on funding core projects like power, telecom, roads, ports, airports, special
economic zones and others. During FY06, total sanctions for 18 projects involving a total State
Bank of India, Corporate Banking, National Banking, International Banking, Treasury
Operations Associates & Subsidiaries amount of Rs.42.11bn were in place as against 13 projects
involving Rs.25.08bn in the previous year. It also handles non-infrastructure projects with certain
ceilings on minimum project costs. During FY06 sanctions for 29 projects involving a total
amount of Rs.55.80bn were in place as against 27 projects involving Rs.51.63bn in the previous
year. As a whole, this SBU achieved total sanctions of Rs.238.86bn (fund based and non fund
based) including syndication amount of Rs.140.95bn during the period ended March 2006.
During FY06, this SBU entered into financing of aviation sector actively by sanctioning loans for
modernization of airports and acquisition of aircrafts.

4) Mid Corporate Group

The Mid Corporate Group (MCG) created in June 2004 has 7 MCG Regional Officescontrolling
28 large branches with high concentration of Mid Corporate (MC) business.The entire Off-Site
MC business of all branches at 31 identified centres has been broughtunder the fold of MCG.
The average processing time of credit proposals is about 15 daysand quicker decision making on
credit proposals of the Mid Corporate units has resulted in greater customer satisfaction. As of
March 2006, 21 MCG branches have been migrated to core banking platform. New technology
products like RTGS, CINB, Multi-City cheque facility and Core Power have been introduced in
all these branches. These technology products coupled with quick Turn Around Time (TAT)
have enabled Mid-Corporate Group to increase its business substantially and generate higher
income, both interest and fee based.

5) Stressed Assets Management

During FY06, the banking industry witnessed a major policy initiative by Reserve Bank of India
with the opening up of sale / purchase of non performing assets to banks, FIs and non-banking
finance companies (NBFCs). During FY06, the bank sold NPAs to the tune of Rs.8.9bn against
security receipts and Rs.11.41bn on cash basis to Asset Reconstruction Company (ARCIL). The
progress in enforcing the security interest has somewhat slowed down due to the requirement of

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withdrawing suits pending before the tribunal prior to action being initiated against the defaulting
borrowers under the SARFAESI Act.

b) NATIONAL BANKING

The national banking group has 14 administrative circles encompassing a vast network of 9,177
branches, 4 sub-offices, 12 exchange bureaus, 104 satellite offices and 679 extension counters, to
reach out to customers, even in the remotest corners of the country. Out of the total branches, 809
are specialized branches. This group consists of four business group which are enumerated
below:

1) Personal Banking SBU

This SBU is mainly responsible for retail business. During FY06, personal banking advances
increased from Rs.464.51bn to Rs.610.67bn, showing a growth of Rs.146.16bn at the rate of
31.47 % against a growth rate of 40.12% in the previous year.

On the home loan front, several new products were introduced, tailored to fit the needs of
specific customer segments, such as SBIMaxgain (minimize interest burden, earn on savings, at
no extra cost), SBI NRI-Home Loans, SBI Freedom Home Loans (Loans given without mortgage
of property, but against alternate securities, instead), SBI Tribal Plus Home Loans. The auto
loans portfolio has shown a growth of Rs.17.74bn in absolute terms and 65% which is
considerably higher than last year’s growth, mainly due to implementation of well planned
strategies.

2) Small & Medium Enterprises

The SME Business Unit implemented comprehensive strategies, revamped business processes
and with its focus on market dynamics and customer preferences, achieved commendable
business growth. The initiative was implemented by focusing on specific industry segments, and
concentrating on various players in the value chain. Debt restructuring mechanism for units in
SME sector has been devised to ensure restructuring of debt of all eligible Small and Medium
Enterprises (SMEs) on favorable terms.

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Focused on the SME sector, projects under Uptech are taken up in location specific and activity
specific industry clusters. So far the bank has taken 28 projects for modernization under the
Project Uptech covering industries like foundry, pumps, glass, auto components, and knitwear,
etc. The bank has also covered agro based industries like rice mills, sago and starch and
horticulture activities like Apple Orchards and grape farming under the scheme. The deposits of
the SME SBU increased to Rs.1,042.70bn as at the end of March 2006 from Rs.890.60bn of
previous year recording a growth of 17.08% during the year. SME advances increased to
Rs.456.53bn from Rs.328.30bn of previous year, recording a growth of 39.06 %. The criteria laid
down by the Government of India for growth in SME advances is 20%.

3) Agricultural Banking

This SBU is accountable for agricultural credit both traditional and new thrust areas like contract
farming, farmers financed through Agri Export Zones (AEZs) and value chain financing.
Increase in disbursements during FY06 was 83% against the Govt. of India target of 30%.
Agricultural advances grew from a level of Rs.205.26bn in FY05 to Rs.305.16bn as at the end of
March 06. As on November 2006, agriculture loans contribute 11% of the total loan book.

4) Government Banking

With the establishment of the government business unit and the consequent focus on marketing,
business turnover of this segment has grown substantially over the years. Bank’s business
turnover from the government business segment during 2004-05 was Rs.8,843.81bn. The
turnover increased by 10.52 % to Rs.9,773.90bn during FY06.

c) INTERNATIONAL BANKING

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SBI has a network of 73 overseas offices in 30 countries in all time zones and correspondent
relationship with 520 international banks in 123 countries. The bank is keen to implement core
banking solution to its international branches also. During FY06, 25 foreign offices were
successfully switched over to Finacle software. SBI has installed ATMs at Male, Muscat and
Colombo Offices. In recent years, SBI acquired 76% shareholding in Giro Commercial Bank
Limited in Kenya and PT Indomonex Bank Ltd. in Indonesia. The bank incorporated a company
SBI Botswana Ltd. at Gaborone.

d) TREASURY

The bank manages an integrated treasury covering both domestic and foreign exchange markets.
In recent years, the treasury operation of the bank has become more active amidst rising interest
rate scenario, robust credit growth and liquidity constraints. The bank diversified its operations
more actively into alternative assets classes with a view to diversify the portfolio and build
alternative revenue streams in order to offset the losses in fixed income portfolio. Reorganization
of the treasury processes at domestic and global levels is also being undertaken to leverage on the
operational synergy between business units and network. The reorganization seeks to enhance
the efficiencies in use of manpower resources and increase maneuverability of banks operations
in the markets both domestic as well as international

e) ASSOCIATES & SUBSIDIARIES

The State Bank Group with a network of 14,061 branches including 4,755 branches of its seven
Associate Banks dominates the banking industry in India. In addition to banking, the Group,
through its various subsidiaries, provides a whole range of financial services which includes Life
Insurance, Merchant Banking, Mutual Funds, Credit Card, Factoring, Security trading and
primary dealership in the Money Market.

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1) Associates Banks:

SBI has seven associate banks namely

• State Bank of Indore

• State Bank of Travancore

• State Bank of Bikaner and Jaipur

• State Bank of Mysore

• State Bank of Patiala

• State Bank of Hyderabad

• State Bank of Saurashtra

All associate banks have migrated to Core Banking (CBS) platform. Single window delivery
system has been introduced in all associate banks. SBI’s seven associate banks are the first
amongst the public sector banks in India to get fully networked through CBS, providing anytime-
anywhere banking to its customers to facilitate a bouquet of innovative customer offerings.

2) Non-Banking Subsidiaries/Joint Ventures

i) SBI Life:

SBI Life is the third largest private insure with the market share of 10.21% among the private
players and number one in terms of number of lives insured amongst private players (no. of lives
insured and policies is 25mn). In H1FY07 gross premium was Rs.7.68bn.

ii) SBI Capital Markets Limited (SBICAP)

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SBI Caps forged ahead in issue management, project advisory and structured finance, sales and
distribution. To capitalize on the emerging opportunities, SBI Caps has promoted four wholly
owned subsidiaries viz. SBICAP Securities Ltd. for undertaking stock broking activities,
SBICAPS Ventures Limited, SBICAP Trustee Company Limited for undertaking venture capital
business and SBI CAP (UK) LTD., for carrying on the Financial Services Authority (FSA)
regulated activities. On the international front, the expertise of SBI Caps in the infrastructure and
project advisory has received international acclaim. In addition, the company has been placed
11th globally in the Mandated Project Advisor league tables by Thompson’s, and one of the
projects handled by the company has been selected as the Asia Pacific Infrastructure deal of the
year for FY06. SBI Caps booked gross income amounting to Rs.1.79bn in FY06 as against
Rs.1.75bn in the previous year, while PAT of the company was at Rs.906.2mn in FY06 as
against Rs.881.2mn in the last year.

iii) SBI DFHI LTD

SBI group holds 67.01% of the company’s paid up capital, while other nationalized banks hold
22.46%. All India financial institutions and private sector banks hold 5.84% and the Asian
Development Bank holds 4.69% as on March 31, 2006. For the year ended 31st March, 2006, the
company has earned a PAT of Rs.24.4mn. Total secondary market turnover of the company was
Rs.285.39bn which amounted to a market share of 12.89% among all primary dealers.

iv) SBI Cards & Payments Services Pvt. Ltd. (SBICSPL)

SBICSPL is ranked 2nd in industry with cards in force over 3mn as on September 06. During
FY06, the aggregate revenue generated by the SBICSPL was Rs.5.27bn while pre-tax profit was
Rs.558.6mn.

v) SBI Funds Management (P) Ltd. (SBIFMPL)

SBI Mutual Fund is the mutual funds arm of the bank. SBIFMPL reported a total inflow of
Rs.481.67bn in the various schemes during the year. The total assets under management are
Rs.132.49bn. The company reported a net profit of Rs.186.4mn as at the end of March, 2006.

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f) Human Resources

The bank had total staff strength of 198,774 on the 31st March, 2006. Of this, 29.51% are

officers, 45.19% clerical staff and the remaining 25.30% were sub-staff. SBI had launched VRS
scheme for its employees in FY01 in which it has reduced it staff by approximately 5,000 and
estimates natural retirement of another 5,000 employees in next 4-5 year.

NON BANKING SUBSIDIARIES:

The Bank has the following Non-Banking Subsidiaries in India :

SBI Capital Markets Ltd

SBI Funds Management Pvt Ltd

SBI Factors & Commercial Services Pvt Ltd

SBI DFHI Ltd

State Bank of Travancore (SBT)

INVESTOR RELATIONS:

State Bank of India, the country’s largest commercial Bank in terms of profits, assets, deposits,
branches and employees, welcomes you to its ‘Investors Relations’ Section. SBI, with its
heritage dating back to the year 1806, strives to continuously provide latest and upto date
information on its financial performance. It is our endeavor to walk on the path of transparency
and allow complete access to all the stakeholders enabling total awareness about the Bank. The
Bank communicates with the stakeholders through a variety of channels, such as through e-mail,
website, conference call, one-on-one meeting, analysts’ meet and attendance at Investor
Conference throughout the world.

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Please find below Bank’s financial results, analysis of performance and other highlights which
will be of interest to Investors, Fund Managers and Analysts. SBI has always been fundamentally
strong in its core business which is mirrored in its results – year after year.

State Bank of India has an extensive administrative structure to oversee the large network of
branches in India and abroad. The Corporate Centre is in Mumbai and 14 Local Head Offices
and 57 Zonal Offices are located at important cities spread throughout the country. The
Corporate Centre has several other establishments in and outside Mumbai, designated to cater to
various functions. Our Colleges/Institutes/Training Centres are the seats of learning and research
and development to spread the wings of knowledge not only to our employees but also other
banks/establishments in India and abroad.

The Corporate Accounts Group is a Strategic Business Unit of the Bank set up exclusively to
fulfil the specialised banking needs of top corporates in the country.

State Bank of India has 52 foreign offices in 34 countries across the globe.
State Bank of India invites you to take a journey to understand the potential of not just a large
but truly global organisation.

CHAPTER-2
BRIEF OVERVIEW OF CREDIT
APPRAISAL
Credit appraisal means an investigation/assessment done by the bank prior before providing any
loans & advances/project finance & also checks the commercial, financial & technical viability
of the project proposed its funding pattern & further checks the primary & collateral security
cover available for recovery of such funds.

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CREDIT APPRAISAL IN BANKING SECTOR

Brief overview of credit:

Credit Appraisal is a process to ascertain the risks associated with the extension of the credit
facility. It is generally carried by the financial institutions which are involved in providing
financial funding to its customers. Credit risk is a risk related to non repayment of the credit
obtained by the customer of a bank. Thus it is necessary to appraise the credibility of the
customer in order to mitigate the credit risk. Proper evaluation of the customer is performed
which measures the financial condition and the ability of the customer to repay back the loan in
future. Generally the credit facilities are extended against the security know as collateral. But
even though the loans are backed by the collateral, banks are normally interested in the actual
loan amount to be repaid along with the interest. Thus, the customer's cash flows are ascertained
to ensure the timely payment of principal and the interest.

It is the process of appraising the credit worthiness of a loan applicant. Factors like age, income,
number of dependents, nature of employment, continuity of employment, repayment capacity,
previous loans, credit cards, etc. are taken into account while appraising the credit worthiness of
a person. Every bank or lending institution has its own panel of officials for this purpose.

However the 3 ‘C’ of credit are crucial & relevant to all borrowers/ lending which must be kept
in mind at all times.

• Character

• Capacity

• Collateral

If any one of these are missing in the equation then the lending officer must question the viability
of credit.

There is no guarantee to ensure a loan does not run into problems; however if proper credit
evaluation techniques and monitoring are implemented then naturally the loan loss probability /
problems will be minimized, which should be the objective of every lending officer.

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CREDIT APPRAISAL IN BANKING SECTOR

Credit is the provision of resources (such as granting a loan) by one party to another party where
that second party does not reimburse the first party immediately, thereby generating a debt, and
instead arranges either to repay or return those resources (or material(s) of equal value) at a later
date. The first party is called a creditor, also known as a lender, while the second party is called a
debtor, also known as a borrower.

Credit allows you to buy goods or commodities now, and pay for them later. We use credit to buy things
with an agreement to repay the loans over a period of time. The most common way to avail credit is by
the use of credit cards. Other credit plans include personal loans, home loans, vehicle loans, student loans,
small business loans, trade.

A credit is a legal contract where one party receives resource or wealth from another party and
promises to repay him on a future date along with interest. In simple terms, a credit is an
agreement of postponed payments of goods bought or loan. With the issuance of a credit, a debt
is formed.

BASIC TYPES OF CREDIT

There are four basic types of credit. By understanding how each works, you will be able to get
the most for your money and avoid paying unnecessary charges.

Service credit is monthly payments for utilities such as telephone, gas, electricity, and water.
You often have to pay a deposit, and you may pay a late charge if your payment is not on time.

Loans let you borrow cash. Loans can be for small or large amounts and for a few days or
several years. Money can be repaid in one lump sum or in several regular payments until the
amount you borrowed and the finance charges are paid in full. Loans can be secured or
unsecured.

Installment credit may be described as buying on time, financing through the store or the easy
payment plan. The borrower takes the goods home in exchange for a promise to pay later. Cars,
major appliances, and furniture are often purchased this way. You usually sign a contract, make a
down payment, and agree to pay the balance with a specified number of equal payments called

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CREDIT APPRAISAL IN BANKING SECTOR

installments. The finance charges are included in the payments. The item you purchase may be
used as security for the loan.

Credit cards are issued by individual retail stores, banks, or businesses. Using a credit card can
be the equivalent of an interest-free loan--if you pay for the use of it in full at the end of each
month.

BRIEF OVERVIEW OF LOANS

Credit can be of two types fund base & non-fund base:

FUND BASED includes:

• Working Capital
• Term Loan

NON-FUND BASED includes:

• Letter of Credit
• Bank Guarantee

FUND BASED:-

WORKING CAPITAL:-

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1. GENERAL

The objective of running any industry is earning profits. An industry will require funds to acquire
“Fixed assets” like land, building, plant, machinery, equipments, vehicles, tools etc., & also to
run the business i.e. its day to day operations.

Funds required for day to-day working will be to finance production & sales. For production,
funds are needed for purchase of raw materials/ stores/ fuel, for employment of labour, for power
charges etc., for storing finishing goods till they are sold out & for financing the sales by way of
sundry debtors/ receivables.

Capital or funds required for an industry can therefore be bifurcated as fixed capital & working
capital. Working capital in this context is the excess of current assets over current liabilities. The
excess of current assets over current liabilities is treated as net working capital or liquid surplus
& represents that portion of the working capital which has been provided from the long term
source.

2. Definition

Working capital is defined as the funds required to carry the required levels of current assets to
enable the unit to carry on its operations at the expected levels uninterruptedly.

Thus Working Capital Required is dependent on

(a) The volume of activity (viz. level of operations i.e. Production & sales)

(b) The activity carried on viz. mfg process, product, production programme, the materials &
marketing mix.

3. METHODS & APPLICATION

SEGMENT LIMITS METHOD

SSI Upto Rs 5 cr Traditional Method & Nayak Committee method


Above Rs 5 cr Projected Balance Sheet Method

SBF All loans Traditional / Turnover Method

C&I Trade & Upto Rs 1 cr Traditional Method for Trade &


Services Projected Turnover Method

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CREDIT APPRAISAL IN BANKING SECTOR

Above Rs 1 cr Projected Balance Sheet Method &


& upto Rs 5 cr Projected Turnover Method
Above Rs 5 cr Projected Balance Sheet Method
C&I Industrial Below Traditional Method
Units Rs 25 lacs
Rs 25 lacs & Projected Balance Sheet Method &
Over but upto Projected Turnover Method
Rs 5 cr
Above Rs 5 cr Projected Balance Sheet Method

4. OPERATING CYCLE METHOD

a) Any manufacturing activity is characterized by a cycle of operations consisting of purchase


of purchase of raw materials for cash, converting these into finished goods & realizing cash
by sale of these finished goods.

b) Diagrammatically, the OPERATING CYCLE is represented as under

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CREDIT APPRAISAL IN BANKING SECTOR

Raw Stock in
Materials Process

Finished
Cash Goods

Bills

c) The time that lapses between cash outlay & cash realization by sale of finished goods &
realization of sundry debtors is known as the length of the operating cycle.

d) That is, the operating cycle consists of:

• Time taken to acquire raw materials & average period for which they are in store.

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CREDIT APPRAISAL IN BANKING SECTOR

• Conversion process time

• Average period for which finished goods are in store &

• Average collection period of receivables (Sundry Debtors)

Operating cycle is also called the cash-to-cash cycle & indicates how cash is converted into
raw material, stocks in process, finished goods, bills (receivables) & finally back to cash.
Working capital is the total cash that is circulating in this cycle. Therefore, working capital
can be turned over or redeployed after completing the cycle.

e) The length of the operating cycle = a+b+c+d (as in 4.4)

If a = 60 days
b = 10 days
c = 20 days
d = 30 days

The operating cycle is 120 days (nearly 4 months). This means there are 365/120 = 3 cycles
of operations in a year.

Sales = Rs. 1,00,000 per annum


Operating expenses = Rs. 72,000 per annum

But the working capital requirement, as you know, is not Rs. 72,000.

In these cases, there are 3 operating cycles in a year. That means each rupee of working
deployed in the unit is turned over 3 times in a year. (This is also known as working capital
turnover ratio).

Therefore WCR = Operating Expenses = Rs. 72,000/- = Rs. 24,000/-


No. of cycles per annum 3

WCR is therefore not Rs. 72,000/- but only Rs. 24,000/-

Assessment of Working Capital Requirement & Permissible Bank Finance using


Operating Cycle Concept

Let us consider a case of a unit where:

Sales = Rs. 20,000 p.m. (A)

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CREDIT APPRAISAL IN BANKING SECTOR

Raw Materials = Rs. 14,000 p.m.


Wages = Rs. 2,000 p.m.

Other manufacturing

Expenses = Rs. 3,000 p.m.


Total expenses = Rs. 19,000 p.m. (B)
Profit = Rs. 1,000 P.m. (C)

The operating cycle is

Raw Materials = 15 days


Stock in Process = 2 days
FG = 3 days
Sundry Debtors = 15 days
The total length of
Operating cycle = 35 days (D)

WCR = B * D = 19,000 * 35 = Rs. 22,167/- (approx.)


30 30

Where B = Operating Expenses; &


D = Length of Operating cycle

TERM LOAN
1. A term loan is granted for a fixed term of not less than 3 years intended normally for
financing fixed assets acquired with a repayment schedule normally not exceeding 8
years.

2. A term loan is a loan granted for the purpose of capital assets, such as purchase of land,
construction of, buildings, purchase of machinery, modernization, renovation or

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CREDIT APPRAISAL IN BANKING SECTOR

rationalization of plant, & repayable from out of the future earning of the enterprise, in
installments, as per a prearranged schedule.

From the above definition, the following differences between a term loan & the working
capital credit afforded by the Bank are apparent:

• The purpose of the term loan is for acquisition of capital assets.

• The term loan is an advance not repayable on demand but only in installments
ranging over a period of years.

• The repayment of term loan is not out of sale proceeds of the goods & commodities
per se, whether given as security or not. The repayment should come out of the
future cash accruals from the activity of the unit.

• The security is not the readily saleable goods & commodities but the fixed assets of
the units.

3. It may thus be observed that the scope & operation of the term loans are entirely different
from those of the conventional working capital advances. The Bank’s commitment is for
a long period & the risk involved is greater. An element of risk is inherent in any type of
loan because of the uncertainty of the repayment. Longer the duration of the credit,
greater is the attendant uncertainty of repayment & consequently the risk involved also
becomes greater.

4. However, it may be observed that term loans are not so lacking in liquidity as they appear
to be. These loans are subject to a definite repayment programme unlike short term loans
for working capital (especially the cash credits) which are being renewed year after year.
Term loans would be repaid in a regular way from the anticipated income of the industry/
trade.

5. These distinctive characteristics of term loans distinguish them from the short term credit
granted by the banks & it becomes necessary therefore, to adopt a different approach in
examining the applications of borrowers for such credit & for appraising such proposals.

6. The repayment of a term loan depends on the future income of the borrowing unit. Hence,
the primary task of the bank before granting term loans is to assure itself that the
anticipated income from the unit would provide the necessary amount for the repayment
of the loan. This will involve a detailed scrutiny of the scheme, its financial aspects,
economic aspects, technical aspects, a projection of future trends of outputs & sales &
estimates of cost, returns, flow of funds & profits.

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CREDIT APPRAISAL IN BANKING SECTOR

7. Appraisal of Term Loans

Appraisal of term loan for, say, an industrial unit is a process comprising several
steps.
There are four broad aspects of appraisal, namely

• Technical Feasibility - To determine the suitability of the technology selected &


the adequacy of the technical investigation & design;

• Economic Feasibility - To ascertain the extent of profitability of the project & its
sufficiency in relation to the repayment obligations pertaining to term assistance;

• Financial Feasibility - To determine the accuracy of cost estimates, suitability of


the envisaged pattern of financing & general soundness of the capital structure; &

• Managerial Competency – To ascertain that competent men are behind the project
to ensure its successful implementation & efficient management after
commencement of commercial production.

7.1 Technical Feasibility

The examination of this item consists of an assessment of the various requirement of the
actual production process. It is in short a study of the availability, costs, quality &
accessibility of all the goods & services needed.

a) The location of the project is highly relevant to its technical feasibility & hence
special attention will have to be paid to this feature. Projects whose technical
requirements could have been taken care of in one location sometimes fail because
they are established in another place where conditions are less favorable. One project
was located near a river to facilitate easy transportation by barge but lower water level
in certain seasons made essential transportation almost impossible. Too many projects
have become uneconomical because sufficient care has not been taken in the location
of the project, e.g. a woolen scouring & spinning mill needed large quantities of good
water but was located in a place which lacked ordinary supply of water & the limited
water supply available also required efficient softening treatment. The accessibility to
the various resources has meaning only with reference to location. Inadequate
transport facilities or lack of sufficient power or water for instance, can adversely
affect an otherwise sound industrial project.

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CREDIT APPRAISAL IN BANKING SECTOR

b) Size of the plant – One of the most important considerations affecting the feasibility
of a new industrial enterprise is the right size of the plant. The size of the plant will be
such that it will give an economic product which will be competitive when compared
to the alternative product available in the market. A smaller plant than the optimum
size may result in increased production costs & may not be able to sell its products at
competitive prices.

c) Type of technology – An important feature of the feasibility relates to the type of


technology to be adopted for a project. A new technology will have to be fully
examined & tired before it is adopted. It is equally important to avoid adopting
equipment or processes which are absolute or likely to become outdated soon. The
principle underlying the technological selection is that “a developing country cannot
afford to be the first to adopt the new nor yet the last to cast the old aside”.

d) Labour – The labour requirements of a project, need to be assessed with special care.
Though labour in terms of unemployed persons is abundant in the country, there is
shortage of trained personnel. The quality of labour required & the training facilities
made available to the unit will have to be taken into account

e) Technical Report – A technical report using the Bank’s Consultancy Cell, external
consultants, etc., should be obtained with specific comments on the feasibility of
scheme, its profitability, whether machinery proposed to be acquired by the unit under
the scheme will be sufficient for all stages of production, the extent of competition
prevailing, marketability of the products etc., wherever necessary.

7.2 Economic Feasibility

An economic feasibility appraisal has reference to the earning capacity of the project. Since
earnings depend on the volume of sales, it is necessary to determine how much output or the
additional production from an established unit the market is likely to absorb at given prices.

a) A thorough market analysis is one of the most essential parts of project investigation.
This involves getting answers to three questions.

a) How big is the market?

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CREDIT APPRAISAL IN BANKING SECTOR

b) How much it is likely to grow?

c) How much of it can the project capture?

The first step in this direction is to consider the current situation, taking account of the total
output of the product concerned & the existing demand for it with a view to establishing whether
there is unsatisfied demand for the product. Care should be taken to see that there is no idle
capacity in the existing industries.

ii) Future – possible future changes in the volume & patterns of supply & demand will have to
be estimated in order to assess the long term prospects of the industry. Forecasting of demand is
a complicated matter but one of the vital importance. It is complicated because a variety of
factors affect the demand for product e.g. technological advances could bring substitutes into
market while changes in tastes & consumer preference might cause sizable shifts in demand.

iii) Intermediate product – The demand for “Intermediate product” will depend upon the demand
& supply of the ultimate product (e.g. jute bags, paper for printing, parts for machines, tyres for
automobiles). The market analysis in this case should cover the market for the ultimate product.

7.3 Financial Feasibility

The basis data required for the financial feasibility appraisal can be broadly grouped under the
following heads

i) Cost of the project including working capital

ii) Cost of production & estimates of profitability

iii) Cash flow estimates & sources of finance.

The cash flow estimates will help to decide the disbursal of the term loan. The estimate of
profitability & the breakeven point will enable the banker to draw up the repayment programme,
start-up time etc. The profitability estimates will also give the estimate of the Debt Service
Coverage which is the most important single factor in all the term credit analysis.

A study of the projected balance sheet of the concern is essential as it is necessary for the
appraisal of a term loan to ensure that the implementation of the proposed scheme.

Break-even point:

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CREDIT APPRAISAL IN BANKING SECTOR

In a manufacturing unit, if at a particular level of production, the total manufacturing cost equals
the sales revenue, this point of no profit/ no loss is known as the break-even point. Break-even
point is expressed as a percentage of full capacity. A good project will have reasonably low
break-even point which not be encountered in the projections of future profitability of the unit.

Debt/ Service Coverage:


The debt service coverage ratio serves as a guide to determining the period of repayment of a
loan. This is calculated by dividing cash accruals in a year by amount of annual obligations
towards term debt. The cash accruals for this purpose should comprise net profit after taxes with
interest, depreciation provision & other non cash expenses added back to it.

Debt Service = Cash accruals


Coverage Ratio Maturing annual obligations

This ratio is valuable, in that it serves as a measure of the repayment capacity of the project/ unit
& is, therefore, appropriately included in the cash flow statements. The ratio may vary from
industry to industry but one has to view it with circumspection when it is lower than the
benchmark of 1.75. The repayment programme should be so stipulated that the ratio is
comfortable.

7.4 Managerial Competence

In a dynamic environment, the capacity of an enterprise to forge ahead of its competitors depends
to a large extent, on the relative strength of its management. Hence, an appraisal of management
is the touchstone of term credit analysis.

If there is a change in the administration & managerial set up, the success of the project may be
put to test. The integrity & credit worthiness of the personnel in charge of the management of the
industry as well as their experience in management of industrial concerns should be examined. In
high cost schemes, an idea of the unit’s key personnel may also be necessary.

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CREDIT APPRAISAL IN BANKING SECTOR

NON-FUND BASED:-
LETTER OF CREDIT
Introduction

The expectation of the seller of any goods or services is that he should get the payment
immediately on delivery of the same. This may not materialize if the seller & the buyer are at
different places (either within the same country or in different countries). The seller desires to
have an assurance for payment by the purchaser. At the same time the purchaser desires that the
amount should be paid only when the goods are actually received. Here arises the need of Letter
of Credit (LCs). The objective of LC is to provide a means of payment to the seller & the
delivery of goods & services to the buyer at the same time.

Definition

A Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at the request
& on the instructions of the customer (the applicant) or on its own behalf,

i. is to make a payment to or to the order of a third party (the beneficiary), or is to accept &
pay bills of exchange (drafts drawn by the beneficiary); or

ii. authorizes another bank to effect such payment, or to accept & pay such bills of
exchanges (drafts); or

iii. authorizes another bank to negotiate against stipulated document(s), provided that the
terms & conditions of the credit are complied with.

Basic Principle:

The basic principle behind an LC is to facilitate orderly movement of trade; it is therefore


necessary that the evidence of movement of goods is present. Hence documentary LCs is those
which contains documents of title to goods as part of the LC documents. Clean bills which do not
have document of title to goods are not normally established by banks. Bankers and all
concerned deal only in documents & not in goods. If documents are in order issuing bank will
pay irrespective of whether the goods are of expected quality or not. Banks are also not
responsible for the genuineness of the documents & quantity/quality of goods. If importer is your
borrower, the bank has to advice him to convert all his requirements in the form of documents to
ensure quantity & quality of goods.

Parties to the LC

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CREDIT APPRAISAL IN BANKING SECTOR

1) Applicant – The buyer who applies for opening LC

2) Beneficiary – The seller who supplies goods

3) Issuing Bank – The Bank which opens the LC

4) Advising Bank – The Bank which advises the LC after confirming authenticity

5) Negotiating Bank – The Bank which negotiates the documents

6) Confirming Bank – The Bank which adds its confirmation to the LC

7) Reimbursing Bank – The Bank which reimburses the LC amount to negotiating bank

8) Second beneficiary – The additional beneficiary in case of transferable LCs

Confirming bank may not be there in a transaction unless the beneficiary demand confirmation
by his own bankers & such a request is made part of LC terms. A bank will confirm an LC for
his beneficiary if opening bank requests this as part of LC terms. Reimbursing bank is used in an
LC transaction by an opening bank when the bank does not have a direct correspondent/branch
through whom the negotiating bank can be reimbursed. Here, the opening bank will direct the
reimbursing bank to reimburse the negotiating bank with the payment made to the beneficiary. In
the case of transferable LC, the LC may be transferred to the second beneficiary & if provided in
the LC it can be transferred even more than once.

Types of Letter of Credit:-

a) Revocable & Irrevocable:

As the name suggests, revocable LCs are those that can be revoked by the issuing bank &
hence are not in commercial use. Irrevocable LCs cannot be revoked/ cancelled/ amended
without the prior concern of all the parties to the LC.

b) Confirmed LC:

The seller may ask for the confirmation of the LC by a bank in his own country if he is
not satisfied about the issuing bank’s credentials.

c) Sight/ Usance LCs:

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CREDIT APPRAISAL IN BANKING SECTOR

In case of the sight LCs beneficiary gets immediate payment upon presentation of the
documents while in the case of usance, the payment is made after a certain period as per
the LC terms. Sight LCs have to be paid by the drawee (buyer) immediately whereas he
gets credit as per LC terms under Usance LCs.

d) LC with advance payment to the seller:

The LC which authorizes the advising bank to advance a part of LC amount to the seller
to meet pre-shipment expenses is known as Red Clause Letter of Credit. The seller gives
the receipt & an undertaking to present the documents before the LC expires. Advance
amount would be adjusted from the proceeds of the export documents. However, the risk
is assumed by the buyer. When the Red Clause LC provides for the cost of shortage
facilities at the port of shipment in addition to the pre-shipment advance to the
beneficiary it is called Green Clause LC. The goods are stored in the name of the issuing
bank.

e) Revolving LC:

Under this, the issuing bank undertakes to restore the credit to the original amount after it
has been utilized. Number of such utilization & the period of time by which this should
take place are stipulated in the LC. On receipt of bill payment advise the LC amount gets
reinstated.

f) Transferable LCs:

Transferable LC are transferable in whole or in part to one or more beneficiaries


depending on the terms of LC. As per UCPDC stipulated in the LC, all LC are not
transferable.

g) Back to back LCs:

When the bank opens new LCs against the backing of an LC received by a beneficiary
having the first LC as security for the new LCs opened, the transaction is referred to as
Back to Back. For example let us assume a customer A, who exports marine products by
buying them from a number of suppliers. If A receives an LC for USD 100000 for
shipment of marine products & he approaches the Bank for opening LCs in favour of his
suppliers of marine products within the original value & in keeping with the terms of the
original LC these new LCs are opened against the backing of the original LC. This is the
back to back transaction. However, it may be noted that this arrangement is not under the
provisions of UCPDC though the individual LCs are governed by it.

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Illustration for computation of LC limit

M/S XYZ Co Ltd


Letter of credit limit of Rs. 20 crore

(Rs. in crores)
Total purchase of raw material 172.64
Purchase of raw materials under LC 69.41

Average monthly purchase of raw material under LC (A) 5.78


Average holding of imported raw materials (2.2 months’ consumption) 11.30
Average usance period (B) 3 months
Lead time & transit period (C) 1 month
Total of (B) & (C) (D) 4 months
The requirement of LC limit (A) * (D) 23.12

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CREDIT APPRAISAL IN BANKING SECTOR

Limit recommended say 23.00

Explanatory notes:

1) While calculating the amount of raw materials purchases on LC basis, the following
points need to be noted. (Amount in rupees)

a) Raw material consumption

b) Add: Closing stock of raw material

c) Less: Opening stock of raw material

d) Total Purchases during the period

e) Purchases on LC basis as % of total purchases

f) Purchases on LC basis in rupees

g) Import duty payable, if any

h) Purchases on LC basis net on import duty (CIF value) (f-g)

2) Transit time should be treated as ‘nil’ if usance period starts from shipment date.

BANK GUARANTEES
A contract of guarantee is defined as ‘a contract to perform the promise or discharge the liability
of the third person in case of the default’. The parties to the contract of guarantees are:

a) Applicant: The principal debtor – person at whose request the guarantee is executed

b) Beneficiary: Person to whom the guarantee is given & who can enforce it in case of
default.

c) Guarantee: The person who undertakes to discharge the obligations of the applicant in
case of his default.

Thus, guarantee is a collateral contract, consequential to a main contract between the


applicant & the beneficiary.

Purpose of Bank Guarantees

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CREDIT APPRAISAL IN BANKING SECTOR

Bank Guarantees are used to for both both preventive & remedial purposes. The guarantees
executed by banks comprises both performance guarantees & financial guarantees. The
guarantees are structured according to the terms of agreement, viz., security, maturity & purpose.

Branches may issue guarantees generally for the following purposes:

a) In lieu of security deposit/earnest money deposit for participating in tenders;


b) Mobilization advance or advance money before commencement of the project by the
contractor & for money to be received in various stages like plant layout, design/drawings
in project finance;
c) In respect of raw materials supplies or for advances by the buyers;
d) In respect of due performance of specific contracts by the borrowers & for obtaining full
payment of the bills;
e) Performance guarantee for warranty period on completion of contract which would
enable the suppliers to realize the proceeds without waiting for warranty period to be
over;
f) To allow units to draw funds from time to time from the concerned indenters against part
execution of contracts, etc.
g) Bid bonds on behalf of exporters
h) Export performance guarantees on behalf of exporters favouring the Customs Department
under EPCG scheme.
Guidelines on conduct of Bank Guarantee business

Branches, as a general rule, should limit themselves to the provision of financial guarantees &
exercise due caution with regards to performance guarantee business. The subtle difference
between the two types of guarantees is that under a financial guarantee, a bank guarantee’s a
customer financial worth, creditworthiness & his capacity to take up financial risks. In a
performance guarantee, the bank’s guarantee obligations relate to the performance related
obligations of the applicant (customer).

While issuing financial guarantees, it should be ensured that customers should be in a position to
reimburse the Bank in case the Bank is required to make the payment under the guarantee. In
case of performance guarantee, branches should exercise due caution & have sufficient
experience with the customer to satisfy themselves that the customer has the necessary
experience, capacity, expertise, & means to perform the obligations under the contract & any
default is not likely to occur.

Branches should not issue guarantees for a period more than 18 months without prior reference
to the controlling authority. Extant instructions stipulate an Administrative Clearance for issue of

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CREDIT APPRAISAL IN BANKING SECTOR

BGs for a period in excess of 18 months. However, in cases where requests are received for
extension of the period of BGs as long as the fresh period of extension is within 18 months. No
bank guarantee should normally have a maturity of more than 10 years. Bank guarantee beyond
maturity of 10 years may be considered against 100% cash margin with prior approval of the
controlling authority.

More than ordinary care is required to be executed while issuing guarantees on behalf of
customers who enjoy credit facilities with other banks. Unsecured guarantees, where furnished
by exception, should be for a short period & for relatively small amounts. All deferred payment
guarantee should ordinarily be secured.

Appraisal of Bank Guarantee Limit

Proposals for guarantees shall be appraised with the same diligence as in the case of fund-base
limits. Branches may obtain adequate cover by way of margin & security so as to prevent default
on payments when guarantees are invoked. Whenever an application for the issue of bank
guarantee is received, branches should examine & satisfy themselves about the following
aspects:

a) The need of the bank guarantee & whether it is related to the applicant’s normal
trade/business.
b) Whether the requirement is one time or on the regular basis
c) The nature of bank guarantee i.e., financial or performance
d) Applicant’s financial strength/ capacity to meet the liability/ obligation under the bank
guarantee in case of invocation.
e) Past record of the applicant in respect of bank guarantees issued earlier; e.g., instances of
invocation of bank guarantees, the reasons thereof, the customer’s response to the
invocation, etc.

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CREDIT APPRAISAL IN BANKING SECTOR

f) Present o/s on account of bank guarantees already issued


g) Margin
h) Collateral security offered
Format of Bank Guarantees

Bank guarantees should normally be issued on the format standardized by Indian Banks
Association (IBA). When it is required to be issued on a format different from the IBA format, as
may be demanded by some of the beneficiary Government departments, it should be ensured that
the bank guarantee is

a) for a definite period,


b) for a definite objective enforceable on the happening of a definite event,
c) for a specific amount
d) in respect of bona fide trade/ commercial transactions,
e) contains the Bank’s standard limitation clause
f) not stipulating any onerous clause, &
g) not containing any clause for automatic renewal of the bank guarantee on its expiry
Specimen of the First Page of Bank Guarantee

(To be stamped as an agreement in accordance with the Stamp Act in force)

STATE BANK OF INDIA


…………………….Branch (Stamp)

Form No. ……….


……………………………
…………………………….
…………………………….
…………………………….

Dear Sir,

Guarantee No.
Amount of Guarantee Rs……………….
Guarantee cover from 1.1.20*0 to 31.3.20*1
Last date for lodgement of claim – 31.3.20*1

This Deed of guarantee executed by the State Bank Of India constituted under the State Bank of
India Act, 1955 having its Central Office at Nariman Point, Mumbai & amongst other places, a

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CREDIT APPRAISAL IN BANKING SECTOR

branch at……………………………….(hereinafter referred to as ‘the Bank’) in favour


of…………………………(hereinafter referred to as ‘the Beneficiary’) for an amount not
exceeding Rs……………..(Rupees ……………………………………………………..only) at
the request of…………………….(hereinafter referred to as ‘the Contractor/(s)).

This guarantee is issued subject to the condition that the liability of the bank under this
Guarantee is limited to a maximum of Rs. …………… (Rupees………………………..only) &
the Guarantee shall remain in full force up to 31.3.20*1 (date of expiry) & cannot be invoked
otherwise than by a written demand or claim under this Guarantee served on the Bank on or
before the 31.3.20*1, last date of claim).

SUBJECT TO AS AFORESAID

(Main Guarantee matter may be typed hereafter)

CREDIT APPRAISAL PROCESS

Receipt of application from applicant


|
Receipt of documents
(Balance sheet, KYC papers, Different govt. registration no., MOA, AOA, and
Properties documents)
|
Pre-sanction visit by bank officers
|
Check for RBI defaulters list, willful defaulters list, CIBIL data, ECGC caution
list, etc.
|
Title clearance reports of the properties to be obtained from empanelled advocates
|
Valuation reports of the properties to be obtained from empanelled
valuer/engineers
|
Preparation of financial data

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CREDIT APPRAISAL IN BANKING SECTOR

|
Proposal preparation
|
Assessment of proposal
|
Sanction/approval of proposal by appropriate sanctioning authority
|
Documentations, agreements, mortgages
|
Disbursement of loan
|
Post sanction activities such as receiving stock statements, review of accounts,
renew of accounts, etc
(on regular basis)

CHAPTER-3
RESEARCH METHODOLOGY
INTRODUCTION TO CREDIT APPRAISAL:

Credit appraisal means an investigation/assessment done by the bank prior before providing any
loans & advances/project finance & also checks the commercial, financial & technical viability
of the project proposed its funding pattern & further checks the primary & collateral security
cover available for recovery of such funds.

PROBLEM STATEMENT:

To study the Credit Appraisal System in SME sector, at State Bank of India (SBI), Ahmedabad.

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CREDIT APPRAISAL IN BANKING SECTOR

OBJECTIVES

• To study the Credit Risk Assessment Models.


• To observe the movements to reduce various risk parameters which are broadly
categorized into financial risk, business risk, industrial risk & management risk.
• To check the commercial, financial & technical viability of the project proposed & its
funding pattern.
• To check the primary & collateral security cover available for recovery of
such funds.

RESEARCH DESIGN - Analytical in nature

COVERAGE

Study of credit appraisal in banking sector at State Bank of India, Ahmedabad

DATA COLLECTION

Secondary Data

• Books & magazines


• Database at SBI
• Library research
• Websites
• E-circulars of SBI

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CREDIT APPRAISAL IN BANKING SECTOR

LIMITATION OF STUDY

• Due to the constraint limited study on the project has been done

• Access to data ( Credit Appraisal data in detail is not available)

EXPECTED CONTRIBUTION OF THE STUDY:

This study will help in understanding the credit appraisal system in banks & to reduce various
risk parameters, which are broadly categorized into financial risk, business risk, industrial risk &
management risk associated in providing any loans or advances or project finance.

CHAPTER-4
INTRODUCTION OF SME
SME

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CREDIT APPRAISAL IN BANKING SECTOR

4.1 Concept:
The small-scale industries (SSI) produce about 8000 products, contribute 40% of the industrial
output and offer the largest employment after agriculture. The sector, therefore, presents an
opportunity to the nation to harness local competitive advantages for achieving global
dominance.

4.2 From SSI to SME:

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CREDIT APPRAISAL IN BANKING SECTOR

Defining the New Paradigm2.1 Government policy as well as credit policy has so far
concentrated on manufacturing units in the small-scale sector. The lowering of trade barriers
across the globe has increased the minimum viable scale of enterprises. The size of the unit and
technology employed for firms to be globally competitive is now of a higher order. The
definition of small-scale sector needs to be revisited and the policy should consider inclusion of
services and trade sectors within its ambit. In keeping with global practice, there is also a need to
broaden the current concept of the sector and include the medium enterprises in a composite
sector of Small and Medium Enterprises (SMEs). A comprehensive legislation, which would
enable the paradigm shift from small-scale industry to small and medium enterprises under
consideration of Parliament. The Reserve Bank of India had meanwhile set up an Internal Group
which has recommended:” Current SSI/tiny industries definition may continue. Units with
investment in plant and machinery in excess of SSI limit and up to Rs.10 crore may be treated as
Medium Enterprises (ME). The definition may be reviewed after enactment of the Small and
Medium Enterprises Development Bill.

4.3 Definition of SMEs-


“ At present, a small scale industrial unit is an undertaking in which investment in plant and
machinery, does not exceed Rs.1 crore, except in respect of certain specified items under hosiery,
hand tools, drugs and pharmaceuticals, stationery items and sports goods, where this investment
limit has been enhanced to Rs 5 crore. Units with investment in plant and machinery in excess of
SSI limit and up to Rs. 10 crore may be treated as Medium Enterprises (ME). “

The Government of India has enacted the Micro, Small and Medium Enterprises Development
(MSMED) Act 2006 which was notified on October 2, 2006. The definition of the small and
medium enterprises as provided in the Act (Annex VII) will have immediate effect.

4.4 Eligibility criteria


(i) These guidelines would be applicable to the following entities, which are viable or
potentially viable:

a) All non-corporate SMEs irrespective of the level of dues to banks.

b) All corporate SMEs, which are enjoying banking facilities from a single bank, irrespective of
the level of dues to the bank.

c) All corporate SMEs, which have funded and non-funded outstanding up to Rs.10 crore under
multiple/ consortium banking arrangement.

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CREDIT APPRAISAL IN BANKING SECTOR

(ii) Accounts involving willful default, fraud and malfeasance will not be eligible for
restructuring under these guidelines.

(iii) Accounts classified by banks as “Loss Assets” will not be eligible for restructuring.

(iv) In respect of BIFR cases banks should ensure completion of all formalities in seeking
approval from BIFR before implementing the package.

SME: At present, a small scale industrial unit is an industrial undertaking in which investment in
plant and machinery, does not exceed Rs.1 crore except in respect of certain specified items
under hosiery, hand tools, drugs and pharmaceuticals, stationery items and sports goods where
this investment limit has been enhanced to Rs.5 crore. A comprehensive legislation which would
enable the paradigm shift from small scale industry to small and medium enterprises is under
consideration of Parliament. Pending enactment of the above legislation, current SSI/tiny
industries definition may continue. Units with investment in plant and machinery in excess of
SSI limit and up to Rs.10 crore may be treated as Medium Enterprises (ME). Only SSI financing
will be included in Priority Sector.

All banks may fix self-targets for financing to SME sector so as to reflect a higher disbursement
over the immediately preceding year, while the sub-targets for financing tiny units and smaller
units to the extent of 40% and 20% respectively may continue. Banks may arrange to compile
data on outstanding credit to SME sector as on March 31, 2005 as per new definition and also
showing the break up separately for tiny, small and medium enterprises.

Banks may initiate necessary steps to rationalize the cost of loans to SME sector by adopting a
transparent rating system with cost of credit being linked to the credit rating of enterprise.

SIDBI has developed a Credit Appraisal & Rating Tool (CART) as well as a Risk Assessment
Model (RAM) and a comprehensive rating model for risk assessment of proposals for SMEs. The
banks may consider to take advantage of these models as appropriate and reduce their transaction
costs.

In order to increase the outreach of formal credit to the SME sector, all banks, including
Regional Rural Banks may make concerted efforts to provide credit cover on an average to at
least 5 new small/medium enterprises at each of their semi urban/urban branches per year.

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CREDIT APPRAISAL IN BANKING SECTOR

A debt restructuring mechanism for nursing of sick units in SME sector and a One Time
Settlement (OTS) Scheme for small scale NPA accounts in the books of the banks as on March
31, 2004 are being introduced.

4.5 CHALLENGES FACED BY SME:

The challenges being faced by the small and medium sector may be briefly set out as follows-

a) Small and Medium Enterprises (SME), particularly the tiny segment of the small enterprises
have inadequate access to finance due to lack of financial information and non-formal business
practices. SMEs also lack access to private equity and venture capital and have a very limited
access to secondary market instruments.

b) SMEs face fragmented markets in respect of their inputs as well as products and are
vulnerable to market fluctuations.

c) SMEs lack easy access to inter-state and international markets.

d) The access of SMEs to technology and product innovations is also limited. There is lack of
awareness of global best practices.

e) SMEs face considerable delays in the settlement of dues/payment of bills by the large scale
buyers. With the deregulation of the financial sector, the ability of the banks to service the credit
requirements of the SME sector depends on the underlying transaction costs, efficient recovery
processes and available security. There is an immediate need for the banking sector to focus on
credit and SMEs.

CHAPTER-5
CREDIT RISK ASSESSMENT
FOR A BANK, WHAT IS RISK?

• Risk is inability or unwillingness of borrower-customer or counter-party to meet their


repayment obligations/ honor their commitments, as per the stipulated terms.

LENDER’ TASK

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CREDIT APPRAISAL IN BANKING SECTOR

• Identify the risk factors, and

• Mitigate the risk

HOW DOES RISK ARISE IN CREDIT?

In the business world, Risk arises out of

• Deficiencies / lapses on the part of the management (Internal factor)

• Uncertainties in the business environment (External factor)

• Uncertainties in the industrial environment (External factor)

• Weakness in the financial position (Internal factor)

To put in another way, success factors behind a business are: -

• Managerial ability

• Favorable business environment

• Favorable industrial environment

• Adequate financial strength

As such, these are the broad risk categories or risk factors built into our CRA models. CRA takes
into account the above types of risks associated with the borrowal unit. The eventual CRA rating
awarded to a unit (based on a score of 100) is a single-point risk indicator of an individual credit
exposure, & is used to indentify, to measure & to monitor the credit risk of an individual
proposal. At the corporate level, CRA is also used to track the quality of Bank’s credit portfolio.

CREDIT & RISK

• Go hand in hand.

• They are like twin brothers.

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CREDIT APPRAISAL IN BANKING SECTOR

• They can be compared to two sides of the same coin.

• All credit proposals have some inherent risks, excepting the almost negligible volume of
lending against liquid collaterals with adequate margin.

LENDING DESPITE RISKS:

• So, risk should not deter a Banker from lending.

• A banker’s task is to identify/ assess the risk factors/ parameters & manage / mitigate
them on a continuous basis.

• But it’s always prudent to have some idea about the degree of risk associated with any
credit proposal.

• The banker has to take a calculated risk, based on risk-absorption/ risk-hedging capacity
& risk-mitigation techniques of the Bank.

IMPORTANCE OF CREDIT RISK ASSESSMENT

Credit is a core activity of banks & an important source of their earnings, which go to pay
interest to depositors, salaries to employees & dividend to shareholders

In credit, it is not enough that we have sizable growth in quantity/ volume, it is also necessary to
ensure that we have only good quality growth.

To ensure asset quality, proper risk assessment right at the beginning, that is, at the time of taking
an exposure, is extremely important.

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CREDIT APPRAISAL IN BANKING SECTOR

Moreover, with the implementation of Basle-II accord4, capital has to be allocated for loan assets
depending on the risk perception/ rating of respective assets. It is, therefore, extremely important
for every bank to have a clear assessment of risks of the loan assets it creates, to become Basle-II
compliant.

That is why Credit Risk Assessment (CRA) system is an essential ingredient of the Credit
Appraisal exercise.

INDIAN SCENARIO:

• In Indian banks, there was no systematic method of Credit Risk Assessment till late
1980’s/ early 1990’s.

• Health Code System (1985) / IRAC norms (1993) are Asset (loan) classification systems,
not CRA systems.

• RBI came out with its guidelines on Risk Management Systems in Banks in 1999 &
Guidance Note on Management of Credit in October, 2002.

SBI SCENARIO:

However, like in many other fields, in the field of Credit Risk Assessment too, our Bank played a
proactive & pioneering role. We had our Credit Rating System (CRA) in 1988. Then, the CRA
system was introduced in the Bank in 1996. The first CRA model was rolled out in 1996 to take
care of exposures to the C & I (Manufacturing) segment. Thereafter, separate models for SSI &
AGL segments were introduced in 1998, when the C&I (Mfg) CRA model was developed for
Non Banking Finance Companies (NBFCs).

As of now, in SBI, CRA is the most important component of the Credit Appraisal exercise for all
exposures > 25 lacs & a very important tool in decision-making (a Decision Support System) as
well as in pricing. The review of the existing CRA Model for NBFCs is under process.

CREDIT RISK ASSESSMENT (CRA) – MINIMUM SCORES / HURDLE RATES

1. The CRA models adopted by the Bank take into account all possible factors which go
into appraising the risks associated with a loan. These have been categorized broadly into
financial, business, industrial & management risks and are rated separately. To arrive at
the overall risk rating, the factors duly weighted are aggregated & calibrated to arrive at a
single point indicator of risk associated with the credit decision.

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CREDIT APPRAISAL IN BANKING SECTOR

2. Financial parameters: The assessment of financial risk involves appraisal of the


financial strength of the borrower based on performance & financial indicators. The
overall financial risk is assessed in terms of static ratios, future prospects & risk
mitigation (collateral security / financial standing).

3. Industry parameters: The following characteristics of an industry which pose varying


degrees of risk are built into Bank’s CRA model:

• Competition

• Industry outlook

• Regulatory risk

• Contemporary issues like WTO etc.

4. Management parameters: The management of an enterprise / group is rated on the


following parameters:

• Integrity (corporate governance)

• Track record

• Managerial competence / commitment

• Expertise

• Structure & systems

• Experience in the industry

• Credibility : ability to meet sales projections

• Credibility : ability to meet profit (PAT) projections

• Payment record

• Strategic initiatives

• Length of relationship with the Bank

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CREDIT APPRAISAL IN BANKING SECTOR

5. The risk parameters as mentioned above are individually scored to arrive at an aggregate
score of 100 (subject to qualitative factors – negative parameters). The overall score thus
obtained (out of a max. of 100) is rated on a 8 point scale from SB1/SBTL1 to SB 8
/SBTL8.

SALIENT FEATURES OF CRA MODELS:

(a) Type of Models

S. Exposure Level (FB + NFB Non – Trading Sector Trading Sector


No. Limits ) (C&I , SSI , AGL) ( Trade & Services)
(i) Over Rs. 5.00 crore Regular Model Regular Model
(ii) Rs 0.25 crore to Rs. 5.00 crore Simplified Model Simplified Model

(b) Type of Ratings

S. No. Model Type of Rating


(i) Regular Model Borrower Rating
Facility Rating
(ii) Simplified Model Borrower Rating

New Rating Scales – Borrower Rating: 16 Rating Grades

There are different rating given to the different banks. For example

S. Borrower Range of Risk level Comfort Level


No. Rating scores

1 SB1 94-100 Virtually Zero risk Virtually Absolute safety


2 SB2 90-93 Lowest Risk Highest safety
3 SB3 86-89 Lower Risk Higher safety
4 SB4 81-85 Low Risk High safety
5 SB5 76-80 Moderate Risk with Adequate safety
Adequate Cushion
6 SB6 70-75 Moderate Risk Moderate Safety

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CREDIT APPRAISAL IN BANKING SECTOR

7 SB7 64-69
8 SB8 57-63 Average risk Above Safety Threshold
9 SB9 50-56
10 SB10 45-49 Acceptable Risk Safety Threshold
(Risk Tolerance Threshold)
11 SB11 40-44 Borderline risk Inadequate safety
12 SB12 35-39 High Risk Low safety
13 SB13 30-34 Higher risk Lower safety
14 SB14 25-29 Substantial risk Lowest safety
15 SB15 <24 Pre-Default Risk (extremely Nil
Vulnerable to default)
16 SB16 - Default Grade

Bank has introduced New Rating Scales for borrower for giving loans. Rating is given on the
basis of scores out of 100. Bank gives loans to the borrower as per their rating like SBI gives
loans to the borrower up to SB8 rating as it has average risk till SB8 rating. From SB9 rating the
risk increases. So banks does not give loans after SB8 rating.

New Rating Scales - Facility Rating : 16 Rating Grades

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CREDIT APPRAISAL IN BANKING SECTOR

S FACILITY RANGE RISK LEVEL COMFORT


NO GRADES OF LEVEL
SCORES
1 FR1 94-100 Virtually Zero Risk Virtually Absolute Safety
2 FR2 87-93 Lowest Risk Highest Safety
3 FR3 80-86 Lower Risk Higher Safety
4 FR4 73-79 Low Risk High Safety
5 FR5 66-72 Moderate Risk with Adequate Safety
Adequate Cushion
6 FR6 59-65 Moderate Moderate
7 FR7 52-58 Risk Safety
8 FR8 45-51 Average Risk Above Safety
9 FR9 38-44 Threshold
Acceptable Risk Safety Threshold
10 FR10 31-37 (Risk Tolerance Threshold)
11 FR11 24-30 High Risk Low Safety
12 FR12 17-23 Higher Risk Lower Safety

13 FR13 11-16 Substantial Risk Lowest Safety


14 FR14 5-10
15 FR15 1-4 Highest Risk
16 FR16 0 NIL

CHAPTER-6

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CREDIT APPRAISAL IN BANKING SECTOR

SBI NORMS FOR CREDIT


APPRAISAL

Credit appraisal means an investigation/assessment done by the bank prior before providing any
loans & advances/project finance & also checks the commercial, financial & technical viability
of the project proposed its funding pattern & further checks the primary & collateral security
cover available for recovery of such funds.

LOAN POLICY – AN INTRODUCTION

1.1 State Bank of India’s (SBI) Loan Policy is aimed at accomplishing its mission of retaining
the bank’s position as a Premier Financial Services Group, with World class standards &
significant global business, committed to excellence in customer, shareholder & employee
satisfaction & to play a leading role in the expanding & diversifying financial services
sector, while continuing emphasis on its Development Banking role.

1.2 The Loan Policy of the any bank has successfully withstood the test of time and with in-
built flexibilities, has been able to meet the challenges in the market place. The policy exits
& operates at both formal & informal levels. The formal policy is well documented in the
form of circular instructions, periodic guidelines & codified instructions, apart from the
Book of Instructions, where procedural aspects are highlighted.

1.3 The policy, at the holistic level, is an embodiment of the Bank’s approach to sanctioning,
managing & monitoring credit risk & aims at making the systems & controls effective.

1.4 The Loan Policy also aims at striking a balance between underwriting assets of high quality,
and customer oriented selling. The objective is to maintain Bank’s undisputed leadership in
the Indian Banking scene.

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CREDIT APPRAISAL IN BANKING SECTOR

1.5 The Policy aims at continued growth of assets while endeavoring to ensure that these remain
performing & standard. To this end, as a matter of policy the Bank does not take over any
Non-Performing Asset (NPA) from other banks.

1.6 The Central Board of the Bank is the apex authority in formulating all matters of policy in
the bank. The Board has permitted setting up of the Credit Policy & Procedures Committee
(CPPC) at the Corporate Centre of the Bank of which the Top Management are members, to
deal with issues relating to credit policy & procedures on a Bank-wide basis. The CPPC sets
broad policies for managing credit risk including industrial rehabilitation, sets parameters
for credit portfolio in terms of exposure limits, reviews credit appraisal systems, approves
policies for compromises, write offs, etc. & general management of NPAs besides dealing
with the issues relating to Delegation of Powers.

Based on the present indications, following exposure levels are prescribed:

Individuals as borrowers Maximum aggregate credit facilities of


Rs. 20 crores
( Fund based & non-fund based )

Non-corporates Maximum aggregate credit facilities of


Rs. 80 crores
( e.g. Partnerships, JHF, Associations ) ( Fund based & non-fund based )

Corporates Maximum aggregate credit facilities as


per prudential norms of RBI on exposures

CREDIT APPRAISAL STANDARDS

1 (A) Qualitative:

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CREDIT APPRAISAL IN BANKING SECTOR

At the outset, the proposition is examined from the angle of viability & also from the Bank’s
prudential levels of exposure to the borrower, Group & Industry. Thereafter, a view is taken
about our past experience with the promoters, if there is a track record to go by. Where it is a
new connection for the bank but the entrepreneurs are already in business, opinion reports from
existing bankers & published data if available are carefully pursued. In case of a maiden venture,
in addition to the drill mentioned heretofore, an element of subjectively has to be perforce
introduced as scant historical data weightage to be placed on impressions gained out of the
serious dialogues with the promoter & his business contacts.

1 (B) Quantitative:

(a) Working capital:

The basis quantitative parameters underpinning the Bank’s credit appraisal are as follows:-

Sector/ Parameters Mfg Others


Liquidity 1.33 1.20
Current Ratio (min.) (For FBWC limits above Rs. 5 cr.)
1.00
(For FBWC limits upto Rs. 5 cr.))
Financial Soundness 3.00 5.00
TOL/TNW (max.)
DSCR
Net (min.) 2:1 2:1
Gros (min.) 1.75:1 1.75:1
Gearing
D/E (max.) 2:1 2:1
Promoters’ contribution 30% of equity 20% of equity
(min.)

(i) Liquidity:

Current Ratio (CR) of 1.33 will generally be considered as a benchmark level of liquidity.
However the approach has to be flexible. CR of 1.33 is only indicative & may not be deemed

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CREDIT APPRAISAL IN BANKING SECTOR

mandatory. In cases where the CR is projected at a lower than the benchmark or a slippage in the
CR is proposed, it alone will not be a reason for rejection for the loan proposal or for the sanction
of the loan at a lower level. In such cases, the reason for low CR or slippage should be carefully
examined & in deserving cases the CR as projected may be accepted. In cases where projected
CR is found acceptable, working capital finance as requested may be sanctioned. In specific
cases where warranted, such sanction can be with the condition that the borrower should bring in
additional long-term funds to a specific extent by a given future date. Where it is felt that the
projected CR is not acceptable but the borrower deserves assistance subject to certain conditions,
suitable written commitment should be obtained from the borrower to the effect that he would be
bringing in required amounts within a mutually agreed time frame

(ii) Net Working Capital:

Although this is a corollary of current ratio, the movements in NWC are watched to ascertain
whether there is a mismatch of long term sources vis-à-vis long term uses for purposes which
may not be readily acceptable to the Bank so that corrective measures can be suggested.

(iii) Financial Soundness:

This will be dependent upon the owner’s stake or the leverage. Here again the benchmark will be
different for manufacturing, trading, hire-purchase & leasing concerns. For industrial ventures a
Total Outside Liability/ Tangible Net worth ratio of 3.0 is reasonable but deviations in selective
cases for understandable reasons may be accepted by the sanctioning authority.

(iv) Turn-Over:

The trend in turnover is carefully gone into both in terms of quantity & valve as also market
share wherever such data are available. What is more important to establish a steady output if not
a rising trend in quantitative terms because sales realization may be varying on account of price
fluctuations.

(v) Profits:

While net profit is ultimate yardstick, cash accruals, i.e., profit before depreciation & taxation
conveys the more comparable picture in view of changes in rate of depreciation & taxation,
which have taken place in the intervening years. However, for the sake of proper assessment, the

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CREDIT APPRAISAL IN BANKING SECTOR

non-operating income is excluded, as these are usually one time or extraordinary income.
Companies incurring net losses consistently over 2 or more years will be given special attention,
their accounts closely monitored, and if necessary, exit options explored.

(vi) Credit Rating:

Wherever the company has been rated by a Credit Rating Agency for any instrument such as
CP / FD this will be taken into account while arriving at the final decision. However as the credit
rating involves additional expenditure, we would not normally insist on this and only use this
tool if such an agency had already looked into the company finances.

(b) Term Loan

(i) In case of term loan & deferred payment guarantees, the project report is obtained from
the customer, which may be compiled either in-house or by a firm of consultants/
merchant bankers. The technical feasibility & economic viability is vetted by the bank &
wherever it is felt necessary, the Credit Officer would seek the benefit of a second
opinion either from the Bank’s Technical Consultancy cell or from the consultants of the
Bank/ SBI Capital Markets Ltd.

(ii) Promoter’s contribution of at least 20% in the total equity is what we normally expect.
But promoters’ contribution may vary largely in mega projects. Therefore there cannot be
a definite benchmark. The sanctioning authority will have the necessary discretion to
permit deviations.

(iii) The other basic parameter would be the net debt service coverage ratio i.e.
exclusive of interest payable, which should normally not go below 2. On a gross basis
DSCR should not be below 1.75. These ratios are indicative & the sanctioning authority
may permit deviations selectively.

(iv)As regards margin on security, this will depend on Debt: Equity gearing for the project,
which should preferably be near about 1.5: 1 & should not in any case be above 2:1, i.e.,
Debt should not be more than 2 times the Equity contribution. The sanctioning authority
in exceptional cases may permit deviations from the norm very selectively.

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CREDIT APPRAISAL IN BANKING SECTOR

(v) Other parameters governing working capital facilities would also govern Term Credit
facilities to the extent applicable.

(C) Lending to Non-Banking Financial Companies (NBFCs)

(D) Financing of infrastructure projects

(E) Lease Finance

(F) Letter of Credit, Guarantees & bills discounting

(G) Fair Practices for lenders

REQUIREMENT OF DOCUMENTS FOR PROCESS OF LOAN

1. Application for requirement of loan

2. Copy of Memorandum & Article of Association

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CREDIT APPRAISAL IN BANKING SECTOR

3. Copy of incorporation of business

4. Copy of commencement of business

5. Copy of resolution regarding the requirement of credit facilities

6. Brief history of company, its customers & supplies, previous track records, orders in
hand. Also provide some information about the directors of the company

7. Financial statements of last 3 years including the provisional financial statement for the
year 2007-08

8. Copy of PAN/TAN number of company

9. Copy of last Electricity bill of company

10. Copy of GST/CST number

11. Copy of Excise number

12. Photo I.D. of all the directors

13. Address proof of all the directors

14. Copies related to the property such as 7/12 & 8A utara, lease/ sales deed, 2R permission,
Allotment letter, Possession

15. Bio-data form of all the directors duly filled & notarized

16. Financial statements of associate concern for the last 3 years

PRICING (FACTORS DECIDING INT. RATES & OTHER CHARGES)

1. Pricing in the Bank can be divided into interest pricing and non-interest pricing. Pricing of
loans up to Rs.2 lacs will be as prescribed by RBI. In line with RBI guidelines, he Bank
announces from time to time its single Benchmark Prime Lending Rate (BPLR), i.e., reference /

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CREDIT APPRAISAL IN BANKING SECTOR

indicative rates at which the Bank would lend to its best customers. The BPLR would be referred
to as State Bank Advance Rate (SBAR) in our Bank. Interest rate without reference to SBAR
could be charged in respect of certain categories of loan / credit like discounting of bills, lending
to intermediary agencies etc. Interest rates below SBAR could be offered to exporters or other
credit worthy borrowers including public enterprises on the lines of a transparent and objective
policy approved by the Bank's Board. All other loans are to be priced on the basis of Bank's
SBAR with the pricing being linked to grade of the risk in the exposure. The maximum spread
over SBAR which could be charged by the Bank will be decided by the Bank from time to time.
Within such ceiling, the pricing for various credit facilities, schemes, products, credit related
services etc., including sub-SBAR pricing would be determined by ALCO or COCC, as
considered appropriate. Bank may also price floating rate products by using market benchmarks
(e.g. G-Sec rates, MIBOR etc.) in a transparent manner as per Board approved policies.

2. An internal Credit Risk Rating system covering all advances of Rs.25 lacs and above in C&I,
SSI and AGL segments has been put in place to facilitate structured assessment of credit risks.
The system enables evaluation of the fundamental strength of the borrower so as to charge a
graded rate of interest based on different ratings. However, taking into consideration the trends in
movement of interest rates and market competition, the Bank has also adopted an appropriate
authority structure to facilitate competitive pricing of loan products linked both to risk rating and
overall business considerations.

3. Bank has introduced fixed interest rates in respect of certain categories of loans in personal
segment, e.g. housing term loans to individuals. Fixed interest rates are also extended for
commercial loans, albeit highly selectively.

4. Market related charges and a discretionary structure that enables branches to effectively face
competition are in place. These would be reviewed periodically based on feedback from
operating units and the market.

5. Pricing of Bank's funds and services while being basically market driven is also determined by
two important considerations, i.e., minimum desired profitability and risk inherent in the
transaction. At the corporate level, the applicable price for a particular advance or service is fixed
taking into account the marginal cost of Bank's funds and desired rate of return as calculated
from indices like profitability levels and return on capital employed. In case of corporate
relationship where the value of connections and overall potential for profitability from a
particular account are more important than a particular transaction, the price is fine tuned even to

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level of no-loss-no-profit in the transaction. For long term exposures, the factors that weigh are
the rate charged by the financial institutions, the period of exposure, the pattern of volatility in
the interest rates and the expected movement of the rates in the long term perspective.

REVIEW / RENEWAL OF ADVANCES

1. Working capital facilities are granted by the Bank for a period of 1 year and thereafter they are
required to be renewed each year, i.e., fresh sanction is accorded for the limits. Where, however,
renewal is not possible for some reason, sanction for the continuance of the limits is obtained in
each case by reviewing the facilities.

2. Term loans which are irregular will be reviewed once in six months.

A separate authority structure, as given below, has been prescribed for above noted half-yearly
review of term loans:

3. In the case of all listed companies with credit rating of SB4/SBTL4 and below, a brief review
is to be put up on the basis of half-yearly working results published by them duly incorporating
comments such as extent of exposure, conduct of the account etc. Such review is to be submitted
to the respective GE in respect of ECCB sanctions, to the CGM (Circle) / CGM (CAG-Cen.) in
respect of COCC-I&II sanctions and to the GM (Network) in all other cases.

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4. There will be no CRA rating review for term loans. However, in respect of term loans, the
following set of financial covenants is to be stipulated:

(i) Current Ratio


(ii) TOL/TNW
(iii) Interest Coverage Ratio
(iv) Default in payment of interest / installment
(v) Cross Default (default in payment of instalment/ interest to other institutions/ banks)

Default of these covenants would attract penal interest of 1% as under:

(a) Any adverse deviation by more than 20% from the stipulated levels in respect of any two
of the items (i) to (iii) above - penal interest to be levied for the period of non-adherence
subject to a minimum period of 1 year.
(b) Default in payment of interest/installments to the Bank or to other FI/Banks-penal
interest to be levied for the period of such defaults.

TAKE OVER OF ADVANCES

1. Bank needs to aggressively market for good quality advances. One of the strategies for
increasing good quality assets in the Bank's loan portfolio, would be to take over advances from
other banks/FIs. Keeping this in view and with the prime objective of adding only good quality
assets, a common set of norms / guidelines for C&I, SSI and AGL segments has been laid down
for take over of advances.

A. Advances under SSI / C&I Segments

(i) The advance to be taken over should be rated SB3/SBTL3 or above.

(ii) The unit should score the minimum scores as prescribed, under the various risk
segments, in the Credit Risk Assessment.

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(iii) The account should have been a standard asset in the books of the other bank/FI
during the preceding 3 years. (If this information is not forthcoming from the bank/FI, a
certificate should be obtained from the borrower’s Auditor that the loan has been a
standard asset during the preceding 3 years in the books of the bank/FI in terms of the
asset classification norms of RBI. The services of statutory auditors of our Bank may also
be sought for this purpose). However, if a unit is not having a track record for 3 years, as
it has been in existence for a shorter duration, takeover can be considered based on the
track record for the available period, which should be at least one year.

(iv) The unit should have earned net profits (post tax) in each of the immediately preceding 3
years. However, if the unit has been in existence for a lesser period, it should have earned
net profit (post tax) in the preceding year of operation.

(v) The Term Loan proposed to be taken-over should not have been rephased, generally, by
the existing FI/Bank after commencement of commercial production. However, if a
rephasement was necessitated due to external factors and viability of the unit is not in
doubt, such proposals may also be considered for sanction on a case to case basis.

(vi)The remaining period of scheduled repayment of the term loan should be at least 2 years,
when only TLs are taken over.

For takeover of existing TLs, while the original time frame for repayment will be generally
adhered to, flexibility may be allowed in the quantum of periodical repayments. If sanction of
fresh term loan is proposed along with the takeover, the schedule of repayment for the existing
term loans, if necessary, may be permitted to extend up to 8 years. [The norms at (v), (vi) and
(vii) above are not applicable for take-over of working capital advances]

Note 1 : In the case of take-over proposals involving advances up to Rs.25 lacs, the ratingshould
be carried out, as per the scoring model prescribed under SME Smart Score (Refer page 170,
Chapter 34, Part III, Volume III of Manual on Loans & Advances). Other factors that may be
kept in view are: -

• Continued viability
• Track record
• Standing in the market of the unit/ promoter.

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Note 2: Take-over of units from our Associate Banks is not permitted.

Note 3 : In the cases of working capital finance through consortium or multiple banking,
increasing our share, and joining a consortium (or when a member bank exits consortium and we
join the consortium in its place), are not reckoned as take-over of advances from other banks.

B. Advances under Trade and Services Sector:

i) The current ratio and TOL/TNW ratio should be at acceptable levels, as per audited balance
sheet not older than 12 months. Current ratio of not below 1 is acceptable up to FBWC limit of
Rs.5 cr. For FBWC limits of above Rs.5 Cr. the current ratio of 1.33 will be indicative. It may be
considered acceptable up to 1.20, depending on the activity. TOL/TNW ratio higher than 3
would be permissible depending on the type of activity.

ii) The unit should have earned post-tax profits in each of the immediately preceding 3 years.
However, if the unit has been in existence for a lesser period, it should have earned net profit
(post-tax) in the preceding year of operation.

C. Other Guidelines:

(i) In all cases of take-over of advances from other banks, the credit information report in the
format prescribed by IBA should be obtained. The experience of the present banker (item 13 of
the format) should show satisfactory dealings with the unit. Where, from the point of
competition, it is necessary not to alert the bank concerned, the report may be obtained after the
sanction of facilities but before release of the facilities.

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(ii) In all cases of take-over, branches should ensure proper documentation and other formalities
to protect the interest of our Bank.

(iii) In all cases of take-over, branches should assess the requirements of the borrower and obtain
sanction for the proposed limits before actually taking over the outstanding liability of the
borrower to their existing bank/ FI.

(iv) The following aspects should invariably be examined in each case of take-over.

• Reasons for take-over


• Market perception including the existing bank’s/FI’s perception regarding the unit
and its management. (For this, the appraising officials may record briefly on their
enquiries with market sources/other bank/FI);
• Potential ancillary business accruing to the Bank;
• Terms and conditions stipulated by the existing bank and those proposed by our
Bank, particularly to ensure against dilution of security cover. No takeover of
advances from any Public Sector Bank will be resorted to by quoting finer rates

(v) The credit rating should be done based on the audited balance sheet which is not older than
12 months. However if the audited balance sheet is more than 12 months old and the proposal
has to be considered from the business angle, then a provisional balance sheet as on a recent date
may be obtained from the unit and the CRA exercise done based on these figures, additionally.
Unit should clear the stipulated hurdle rate in both the exercises.

D. Administrative Clearance (AC)

In all the cases of take-over proposals, AC is required to be obtained. For this purpose, a brief
proposal containing, inter alia, the comments on compliance with the norms and the other
guidelines as above should be submitted to the appropriate authority as under:

(i) For take-over of units complying with all the norms prescribed:

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(ii) For take-over of units not complying with any one or more of the norms prescribed:

E. While take over of 'P' segment advances is not generally encouraged, in consideration of
larger business interests / valuable connections, take over of housing loans is considered
selectively after due diligence and precautions, in cases where possession of the house / flat has
been taken, repayment of existing loan has already commenced and installments have been paid
as per terms of sanction.

CREDIT FACILITIES TO COMPANIES WHOSE DIRECTORS ARE IN THE


DEFAULTERS' LIST OF RBI:

1. The Directors of any company may be classified as promoter / elected / professional/


nominee / honorary directors. RBI has been collecting and circulating information on defaulting
companies amongst banks / FIs, including names of directors of such companies. Though RBI's
defaulters' list is given due cognizance in the appraisal process, a general policy on the issues
relating to sanction / continuation of credit facilities to such companies whose directors are in the
RBI's defaulters' list needs to be put in place.

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Accordingly, it has been decided to adopt the following approach:

The above policy on defaulters will be a broad framework for sanction / continuation of credit
facilities to companies whose directors are in the RBI's list of defaulting borrowers of banks / FIs
with dues of Rs.1 Cr. and above. When the list of such defaulters is circulated by CIBIL instead
of RBI), the same Policy would continue to apply.

2. Willful default & action there against - The penal measures would be made applicable to all
borrowers identified as willful defaulters or the promoters involved in diversion / siphoning of

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funds with outstanding balance of Rs.25 lacs or more without any exception. Similarly, the limit
of Rs.25 lacs will also be applied for the purpose of taking cognizance of instances of siphoning
and diversion of funds.

3. Where a Letter of Comfort or guarantee furnished by the companies within a Group in favour
of a willfully defaulting unit is not paid when invoked by the Bank, such Group companies also
may be reckoned as willful defaulters.

4. In cases of project financing, Bank would endeavour to ensure end-use of funds by, inter alia,
obtaining certification from Chartered Accountants. In case of short term corporate/clean loans,
such an approach would be supplemented by due diligence on the part of the Bank. It shall be the
endeavor of the Bank to ensure that such loans are limited to borrowers whose integrity and
reliability are above board. Bank will also retain the right to get investigative audit conducted
whenever it is prima facie satisfied that there is a case for such investigative audit to detect
siphoning/ diversion of funds or other malfeasance.

5. No additional facilities shall be granted by the Bank to the listed willful defaulters. Further,
entrepreneurs / promoters of companies where the Bank has identified siphoning /diversion of
funds, mis-representation, falsification of accounts and fraudulent transactions shall be debarred
from Bank finance for floating new ventures for a period of 5 years from the date the name of the
willful defaulter is published by RBI / CIBIL.

6. The legal process, wherever warranted, against the borrowers / guarantors and foreclosure of
recovery of dues should be initiated expeditiously. The Bank may also initiate criminal action
against willful defaulters, where necessary.

7. Where possible, Bank shall adopt a proactive approach for a change of management of the
willfully defaulting borrowing unit.

CREDIT MONITORING & SUPERVISION

1. Broadly, the objectives of post-sanction follow up, supervision and monitoring are as under:

(a) Follow up function:

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• To ensure the end-use of funds


• To relate the outstandings to the assets level on a continuous basis
• To correlate the activity level to the projections made at the time of the sanction / renewal
of the credit facilities
• To detect deviation from terms of sanction.
• To make periodic assessment of the health of the advances by noting some of the key
indicators of performance like profitability, activity level, and management of the unit
and ensure that the assets created are effectively utilized for productive purposes and are
well maintained.
• To ensure recovery of the installments of the principal in case of term loans as per the
scheduled repayment programme and all interest.
• To identify early warning signals, if any, and initiate remedial measures thereby averting
the incidence of incipient sickness.

(b) Supervision function:

• To ensure that effective follow up of advances is in place and asset quality of good order
is maintained.
• To look for early warning signals, identify ‘incipient sickness’ and initiate proactive
remedial measures.

(c) Monitoring function :

• To ensure that effective supervision is maintained on loans / advances and appropriate


responses are initiated wherever early warning signals are seen.
• To monitor on an ongoing basis the asset portfolio by tracking changes from time to time.
• Chalking out and arranging for carrying out specific actions to ensure high percentage of
‘Standard Assets’.

2. Detailed operative guidelines on the following aspects of effective credit monitoring are in
place:

• Post-sanction responsibilities of different functionaries

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• Reporting for control


• Security documents, Statement of stocks and book debts
• Computation of drawing power (DP) on eligible current assets and maintaining of DP
register
• Verification of assets
• Inspection by branch functionaries – frequency, reporting, register etc.
• Stock Audit
• Follow up based on information systems
• Follow up during project implementation stage
• Follow up post-commercial production
• Monitoring and control
• Detection and prevention of diversion of working capital finance
• Monitoring of large withdrawals
• Allocation of limit
• Handling of NPA accounts etc.

LOAN ADMINISTRATION - PRE-SANCTION PROCESS

APPRAISAL, ASSESSMENT AND SANCTION FUNCTIONS

1. APPRAISAL

A. Preliminary appraisal

1.1 Sound credit appraisal involves analysis of the viability of operations of a business and the
capacity of the promoters to run it profitably and repay the bank the dues as and then they fall

1.2. Towards this end the preliminary appraisal will examine the following aspects of a proposal.
Bank’s lending policy and other relevant guidelines/RBI guidelines,

• Prudential Exposure norms,


• Industry Exposure restrictions,
• Group Exposure restrictions,

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CREDIT APPRAISAL IN BANKING SECTOR

• Industry related risk factors,


• Credit risk rating,
• Profile of the promoters/senior management personnel of the project,
• List of defaulters,
• Caution lists,
• Acceptability of the promoters,
• Compliance regarding transfer of borrower accounts from one bank to
another, if applicable;
• Government regulations/legislation impacting on the industry; e.g., ban on
financing of industries producing/ consuming Ozone depleting substances;
• Applicant’s status vis-à-vis other units in the industry,
• Financial status in broad terms and whether it is acceptable

The company’s Memorandum and Articles of Association should be scrutinized carefully to


ensure (i) that there are no clauses prejudicial to the Bank’s interests, (ii) no limitations have
been placed on the Company’s borrowing powers and operations and (iii) the scope of activity of
the company.

1.3. Further, if the proposal is to finance a project, the following aspects have to be examined:

• Whether project cost is prima facie acceptable

• Debt/equity gearing proposed and whether acceptable

• Promoters’ ability to access capital market for debt/equity support

• Whether critical aspects of project - demand, cost of production, profitability, etc. are prima
facie in order

1.4. After undertaking the above preliminary examination of the proposal, the branch will arrive
at a decision whether to support the request or not. If the branch (a reference to the branch
includes a reference to SECC/CPC etc. as the case may be) finds the proposal acceptable, it will
call for from the applicant(s), a comprehensive application in the prescribed proforma, along
with a copy of the proposal/project report, covering specific credit requirement of the company
and other essential data/ information. The information, among other things, should include:

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• Organizational set up with a list of Board of Directors and indicating the qualifications,
experience and competence of the key personnel in charge of the main functional areas e.g.,
purchase, production, marketing and finance; in other words a brief on the managerial resources
and whether these are compatible with the size and scope of the proposed activity.

• Demand and supply projections based on the overall market prospects together with a copy of
the market survey report. The report may comment on the geographic spread of the market where
the unit proposes to operate, demand and supply gap, the competitors’ share, competitive
advantage of the applicant, proposed marketing arrangement, etc.

• Current practices for the particular product/service especially relating to terms of credit sales,
probability of bad debts, etc.

• Estimates of sales, cost of production and profitability.

• Projected profit and loss account and balance sheet for the operating years during the
currency of the Bank assistance.

• If request includes financing of project(s), branch should obtain additionally

(i)appraisal report from any other bank/financial institution in case appraisal has been done by
them, (ii) ‘No Objection Certificate’ from term lenders if already financed by them and

(iii) Report from Merchant bankers in case the company plans to access capital market, wherever
necessary.

1.5. In respect of existing concerns, in addition to the above, particulars regarding the history of
the concern, its past performance, present financial position, etc. should also be called for. This
data/information should be supplemented by the supporting statements such as:

a) Audited profit loss account and balance sheet for the past three years (if the latest audited
balance sheet is more than 6 months old, a pro-forma balance sheet as on a recent date should be
obtained and analysed). For non-corporate borrowers, irrespective of market segment, enjoying

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CREDIT APPRAISAL IN BANKING SECTOR

credit limits of Rs.10 lacs and above from the banking system, audited balance sheet in the IBA
approved formats should be submitted by the borrowers.

b) Details of existing borrowing arrangements, if any,

c) Credit information reports from the existing bankers on the applicant Company, and

d) Financial statements and borrowing relationship of Associate firms/Group Companies.

B. Detailed Appraisal

1.6 The viability of a project is examined to ascertain that the company would have the ability to
service its loan and interest obligations out of cash accruals from the business. While appraising
a project or a loan proposal, all the data/information furnished by the borrower should be counter
checked and, wherever possible, inter-firm and inter-industry comparisons should be made to
establish their veracity.

1.7 The financial analysis carried out on the basis of the company’s audited balance sheets and
profit and loss accounts for the last three years should help to establish the current viability.

1.8 In addition to the financials, the following aspects should also be examined:

• The method of depreciation followed by the company-whether the company is following


straight line method or written down value method and whether the company has changed the
method of depreciation in the past and, if so, the reason therefore;

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CREDIT APPRAISAL IN BANKING SECTOR

• Whether the company has revalued any of its fixed assets any time in the past and the present
status of the revaluation reserve, if any created for the purpose;

• Record of major defaults, if any, in repayment in the past and history of past sickness, if any;

• The position regarding the company’s tax assessment - whether the provisions made in the
balance sheets are adequate to take care of the company’s tax liabilities;

• The nature and purpose of the contingent liabilities, together with comments thereon;

• Pending suits by or against the company and their financial implications (e.g. cases relating to
customs and excise, sales tax, etc.);

• Qualifications/adverse remarks, if any, made by the statutory auditors on the company’s


accounts;

• Dividend policy;

• Apart from financial ratios, other ratios relevant to the project;

• Trends in sales and profitability, past deviations in sales and profit projections, and
estimates/projections of sales values

• Production capacity & use: past and projected;

• Estimated requirement of working capital finance with reference to acceptable build up of


inventory/ receivables/ other current assets;

• Projected levels: whether acceptable; and

• Compliance with lending norms and other mandatory guidelines as applicable

1.9. Project financing:

If the proposal involves financing a new project, the commercial, economic and Financial
viability and other aspects are to be examined as indicated below:

• Statutory clearances from various Government Depts./ Agencies

• Licenses/permits/approvals/clearances/NOCs/Collaboration agreements, as applicable

• Details of sourcing of energy requirements, power, fuel etc.

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CREDIT APPRAISAL IN BANKING SECTOR

• Pollution control clearance

• Cost of project and source of finance

• Build-up of fixed assets (requirement of funds for investments in fixed assets to be critically
examined with regard to production factors, improvement in quality of products, economies of
scale etc.)

• Arrangements proposed for raising debt and equity

• Capital structure (position of Authorised, Issued/ Paid-up Capital, Redeemable Preference


Shares, etc.)

• Debt component i.e., debentures, term Loans, deferred payment facilities, unsecured loans/
deposits. All unsecured loans/ deposits raised by the company for financing a project should be
subordinate to the term loans of the banks/ financial institutions and should be permitted to be
repaid only with the prior approval of all the banks and the financial institutions concerned.
Where central or state sales tax loan or developmental loan is taken as source of financing the
project, furnish details of the terms and conditions governing the loan like the rate of interest (if
applicable), the manner of repayment, etc.

• Feasibility of arrangements to access capital market

• Feasibility of the projections/ estimates of sales, cost of production and profits covering the
period of repayment

• Break Even Point in terms of sales value and percentage of installed capacity under a normal
production year

• Cash flows and fund flows

• Proposed amortisation schedule

• Whether profitability is adequate to meet stipulated repayments with reference to Debt Service
Coverage Ratio, Return on Investment

• Industry profile & prospects

• Critical factors of the industry and whether the assessment of these and management plans in
this regard are acceptable

• Technical feasibility with reference to report of technical consultants, if available

• Management quality, competence, track record

• Company’s structure & systems

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CREDIT APPRAISAL IN BANKING SECTOR

• Applicant’s strength on inter-firm comparisons

For the purpose of inter-firm comparison and other information, where necessary, source data
from Stock Exchange Directory, financial journals/ publications, professional entities like CRIS-
INFAC, CMIE, etc. with emphasis on following aspects:

• Market share of the units under comparison

• Unique features

• Profitability factors

• Financing pattern of the business

• Inventory/Receivable levels

• Capacity utilisation

• Production efficiency and costs

• Bank borrowings patterns

• Financial ratios & other relevant ratios

• Capital Market Perceptions

• Current price

• 52week high and low of the share price

• P/E ratio or P/E Multiple

• Yield (%)- half yearly and yearly

Also examine and comment on the status of approvals from other term lenders, market view (if
anything adverse), and project implementation schedule. A pre-sanction inspection of the project
site or the factory should be carried out in the case of existing units. To ensure a higher degree of
commitment from the promoters, the portion of the equity / loans which is proposed to be
brought in by the promoters, their family members, friends and relatives will have to be brought
upfront. However, relaxation in this regard may be considered on a case to case basis for genuine
and acceptable reasons. Under such circumstances, the promoter should furnish a definite plan
indicating clearly the sources for meeting his contribution. The balance amount proposed to be
raised from other sources, viz., debentures, public equity etc., should also be fully tied up.

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CREDIT APPRAISAL IN BANKING SECTOR

C. Present relationship with Bank:

Compile for existing customers, profile of present exposures:

• Credit facilities now granted

• Conduct of the existing account

• Utilisation of limits - FB & NFB

• Occurrence of irregularities, if any

• Frequency of irregularity i.e., number of times and total number of days the account was
irregular during the last twelve months

• Repayment of term commitments

• Compliance with requirements regarding submission of stock statements, Financial Follow-up


Reports, renewal data, etc.

• Stock turnover, realisation of book debts

• Value of account with break-up of income earned

• Pro-rata share of non-fund and foreign exchange business

• Concessions extended and value thereof

• Compliance with other terms and conditions

• Action taken on Comments/observations contained in RBI Inspection Reports:

CO Inspection & Audit Reports

Verification Audit Reports

Concurrent Audit Reports

Stock Audit Reports

Spot Audit Reports

Long Form Audit Report (statutory audit)

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CREDIT APPRAISAL IN BANKING SECTOR

D. Credit risk rating: Draw up rating for (i) Working Capital and (ii) Term Finance.

E. Opinion Reports: Compile opinion reports on the company, partners/ promoters and the
proposed guarantors.

F. Existing charges on assets of the unit: If a company, report on search of charges with ROC.

G. Structure of facilities and Terms of Sanction:

Fix terms and conditions for exposures proposed - facility wise and overall:

o Limit for each facility – sub-limits

o Security - Primary & Collateral, Guarantee

o Margins - For each facility as applicable

o Rate of interest

o Rate of commission/exchange/other fees

o Concessional facilities and value thereof

o Repayment terms, where applicable

o ECGC cover where applicable

o Other standard covenants

H. Review of the proposal: Review of the proposal should be done covering

(i) strengths and weaknesses of the exposure proposed

(ii) risk factors and steps proposed to mitigate them

(iii) deviations, if any, proposed from usual norms of the Bank and the reasons therefore.

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CREDIT APPRAISAL IN BANKING SECTOR

I. Proposal for sanction: Prepare a draft proposal in prescribed format with required backup
details and with recommendations for sanction.

J. Assistance to Assessment: Interact with the assessor, provide additional inputs arising

from the assessment, incorporate these and required modifications in the draft proposal and
generate an integrated final proposal for sanction.

2. ASSESSMENT: Indicative List of Activities Involved in Assessment Function is given


below:

• Review the draft proposal together with the back-up details/notes, and the borrower’s
application, financial statements and other reports/documents examined by the appraiser.

• Interact with the borrower and the appraiser.

• Carry out pre-sanction visit to the applicant company and their project/factory site.

• Peruse the financial analysis (Balance Sheet/ Operating Statement/ Ratio Analysis/ Fund Flow
Statement/ Working Capital assessment/Project cost & sources/ Break Even analysis/Debt
Service/Security Cover, etc.) to see if this is prima facie in order. If any deficiencies are seen,
arrange with the appraiser for the analysis on the correct lines.

• Examine critically the following aspects of the proposed exposure.

o Bank’s lending policy and other guidelines issued by the Bank from time to time

o RBI guidelines

o Background of promoters/ senior management

o Inter-firm comparison

o Technology in use in the company

o Market conditions

o Projected performance of the borrower vis-à-vis past estimates and performance

o Viability of the project

o Strengths and Weaknesses of the borrower entity.

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CREDIT APPRAISAL IN BANKING SECTOR

o Proposed structure of facilities.

o Adequacy/ correctness of limits/ sub limits, margins, moratorium and repayment schedule

o Adequacy of proposed security cover

o Credit risk rating

o Pricing and other charges and concessions, if any, proposed for the facilities

o Risk factors of the proposal and steps proposed to mitigate the risk

o Deviations proposed from the norms of the Bank and justifications therefore

• To the extent the inputs/comments are inadequate or require modification, arrange for
additional inputs/ modifications to be incorporated in the proposal, with any required
modification to the initial recommendation by the Appraiser

• Arrange with the Appraiser to draw up the proposal in the final form.

• Recommendation for sanction: Recapitulate briefly the conclusions of the appraisal and state
whether the proposal is economically viable. Recount briefly the value of the company’s (and the
Group’s) connections. State whether, all considered, the proposal is a fair banking risk. Finally,
give recommendations for grant of the requisite fund-based and non-fund based credit facilities.

3. SANCTION: Indicative list of activities involved in the sanction function is given below:

• Peruse the proposal to see if the report prima facie presents the proposal in a comprehensive
manner as required. If any critical information is not provided in the proposal, remit it back to the
Assessor for supply of the required data/clarifications.

• Examine critically the following aspects of the proposed exposure in the light of

corresponding instructions in force:

o Bank’s lending policy and other relevant guidelines

o RBI guidelines

o Borrower’s status in the industry

o Industry prospects

o Experience of the Bank with other units in similar industry

o Overall strength of the borrower

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CREDIT APPRAISAL IN BANKING SECTOR

o Projected level of operations

o Risk factors critical to the exposure and adequacy of safeguards proposed there against

o Value of the existing connection with the borrower

o Credit risk rating

o Security, pricing, charges and concessions proposed for the exposure and covenants

stipulated vis-à-vis the risk perception.

• Accord sanction of the proposal on the terms proposed or by stipulating modified or additional
conditions/ safeguards, or Defer decision on the proposal and return it for additional
data/clarifications, or Reject the proposal, if it is not acceptable, setting out the reasons.

LOAN ADMINISTRATION - POST SANCTION CREDIT PROCESS

GENERAL

1. NEED

Lending decisions are made on sound appraisal and assessment of credit worthiness. Past record
of satisfactory performance and integrity are no guarantee for future though they serve as a
useful guide to project the trend in performance. Credit assessment is made based on promises
and projections. A loan granted on the basis of sound appraisal may go bad because the borrower
did not carry out his promises regarding performance. It is for this reason that proper follow up
and supervision is essential. A banker cannot take solace in sufficiency of security for his loans.
He has to -

a) make a proper selection of borrower

b) Ensure compliance with terms and conditions

c) Monitor performance to check continued viability of operations

d) Ensure end use of funds.

e) Ultimately ensure safety of funds lent.

2. Stages of post sanction process

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CREDIT APPRAISAL IN BANKING SECTOR

The post-sanction credit process can be broadly classified into three stages viz., follow-up,
supervision and monitoring, which together facilitate efficient and effective credit management
and maintaining high level of standard assets. The objectives of the three stages of post sanction
process are detailed below.

TYPES OF LENDING ARRANEMENTS

INTRODUCTION

Business entities can have various types of borrowing arrangements. They are

• One Borrower – One Bank


• One Borrower – Several Banks (with consortium arrangement)
• One Borrower – Several Banks (without consortium arrangements – Multiple Banking
• One Borrower – Several Banks (Loan Syndication)

A. ONE BANK

The most familiar amongst the above for smaller loans is the One Borrower-One Bank
arrangement where the borrower confines all his financial dealings with only one bank.
Sometimes, units would prefer to have banking arrangements with more than one bank on
account of the large financial requirement or the resource constraint of his own banker or due to
varying terms & conditions offered by different banks or for sheer administrative convenience.
The advantages to the bank in a multiple banking arrangement/ consortium arrangement are that
the exposure to an individual customer is limited & risk is proportionate. The bank is also able to
spread its portfolio. In the case of borrowing business entity, it is able to meet its funds
requirement without being constrained by the limited resource of its own banker. Besides this,
consortium arrangement enables participating banks to save man power & resources through
common appraisal & inspection & sharing credit information.

The various arrangements under borrowings from more than one bank will differ on account of
terms & conditions, method of appraisal, coordination, documentation & supervision & control.

B. CONSORTIUM LENDING

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CREDIT APPRAISAL IN BANKING SECTOR

When one borrower avails loans from several banks under an arrangement among all the lending
bankers, this leads to a consortium lending arrangements. In consortium lending, several banks
pool banking resourses & expertise in credit management together & finance a single borrower
with a common appraisal, common documentation & joint supervision & follow up. The
borrower enjoys the advantage similar to single window availing of credit facalities from several
banks. The arrangement continues until any one of the bank moves out of the consortium. The
bank taking the highest share of the credit will usually be the leader of consortium. There is no
ceiling on the number of banks in a consortium.

C. MULTIPLE BANKING ARRANGEMENT

Multiple Banking Arrangement is one where the rules of consortium do not apply & no inter se
agreement among banks exists. The borrower avails credit facility from various banks providing
separate securities on different terms & conditions. There is no such arrangement called
‘Multiple Banking Arrangement’ & the term is used only to donote the existence of banking
arrangement with more than one bank.

Multiple Banking Arrangement has come to stay as it has some advantages for the borrower &
the banks have the freedom to price their credit products & non-fund based facility according to
their commercial judgment. Consortium arrangement occasioned delays in credit decisions & the
borrower has found his way around this difficulty by the multiple banking arrangement.
Additionally, when units were not doing well, consensus was rarely prevalent among the
consortium members. If one bank wanted to call up the advance & protect the security, another
bank was interested in continuing the facility on account of group considerations.

Points to be noted in case of multiple banking arrangements

• Though no formal arrangement exists among the financing banks, it is preferable to have
informal exchange of information to ensure financial discipline

• Charges on the security given to the bank should be created with utmost care to guard
against dilution in our security offered & to avoid double financing

• Certificates on the outstandings with the other banks should be obtained on the periodical
basis & also verified from the Balance sheet of the unit to avoid excess financing

D. CREDIT SYNDICATION

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A syndicated credit is an agreement between two or more lending institutions to provide a


borrower a credit facility using common loan documentation. It is a convenient mode of raising
long-term funds.

The borrower mandates a lead manager of his choice to arrange a loan for him. The mandate
spells out the terms of the loan & the mandated bank’s rights & responsibilities. The mandated
banker – the lead manger – prepares an information memorandum & circulates among
prospective lender banks soliciting their participation in the loan. On the basis of the
memorandum & on their own independent economic & financial evolution the leading banks
take a view on the proposal. The mandated bank convenes the meeting to discuss the syndication
strategy relating to coordination, communication & control within the syndication process &
finalises deal timing, management fees, cost of credit etc. The loan agreement is signed by all the
participating banks. The borrower is required to give prior notice to the lead manger about loan
drawal to enable him to tie up disbursements with the other lending banks.

Features of syndicated loans

• Arranger brings together group of banks

• Borrower is not required to have interface with participating banks, thus easy & hassle
fee

• Large loans can be raised through syndication by accessing global markets

• For the borrower, the competition among the lenders leads to finer terms

• Risk is shared

• Small banks can also have access to large ticket loans & top class credit appraisal &
management

Advantages

• Strict, time-bound delivery schedule & drawals

• Streamlined process of documentation with clearly laid down roles & responsibilities

• Market driven pricing linked to the risk perception

• Competitive pricing but scope for fee-based income is also available

• Syndicated portions can be sold to another bank, if required

• Fixed repayment schedule & strict monitoring of default by markets which punish
indiscipline

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CREDIT APPRAISAL IN BANKING SECTOR

CHAPTER-7
CASE STUDY OF SBI

(1). Details of case study

Company:- Janak Transport Co.

Firm:- Partnership

* Shri Harisinghbhai Lavjibhai Chaudhari;

* Shri Jesangbhai Lavjibhai Chaudhari;

* Shri Vinodkumar Lavjibhai Chaudhari;

* Shri Pratapbhai Lavjibhai Chaudhari;&

* Shri Janakkumar Jesangbhai Chaudhari

Industry:- Transport Activity

Segment:- C& I

Date of Incorporation:- 03.09.82

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CREDIT APPRAISAL IN BANKING SECTOR

Banking with SBI since:- 16 years as a current A/C holder

Banking arrangement:- Multiple Banking Arrangement

Regd. & Admin. Office:- Opp. Simandhar Flat,


Nr. Pashabhai Petrol Pump,
Highway, Mehsana.

Janak Transport Co. is a partnership firm established in 1982 for carrying a transport business.

As the company is in this business since incorporation & the unit has good contracts with ONGC
since last 26 years so it has a good repo with ONGC.

As the company has a good repo with ONGC, the ONGC outlook of the business is considered
positive.

The firm has approached for term loan of Rs. 295 lacs to finance the purchase of Mahindra-
Bolero. The total project cost is estimated to be Rs. 363.44 lacs.

Brief of Contract:

(1). Fixed hire charges/ taxi/ month: Rs. 29150


(with fixed 3000 Km run/ month & 12 hours duty/ day)

(2). Additional/ km charges beyond 3000 km. Rs. 3.57

(3). Duration of contract = 3 Years

Proposed Credit Requirement:

Fund Based = Rs. 295 lacs

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CREDIT APPRAISAL IN BANKING SECTOR

Performance Details

a) PERFORMANCE AND FINANCIAL INDICATORS:


(Rs. in lacs)

Aud. Aud. Esti. Proj. Proj. Proj. Proj.

31st March 2007 2008 2009 2010 2011 2012 2013

Net Sales 501.78 546.65 713.82 898.65 898.65 898.65 898.65

Operating Profit (after


interest) 149.64 182.92 234.24 326.69 374.32 404.08 425.06

PBT 1.20 2.90 22.48 92.62 125.47 143.51 151.96

PBT/Sales (%) 0.24 0.53 3.15 10.31 13.96 15.97 16.91

PAT 1.20 2.90 22.48 92.62 125.47 143.51 151.96

Cash Accruals 39.05 40.51 129.25 233.74 224.25 212.66 200.36

PBDIT 54.44 52.41 150.01 266.99 247.21 226.20 203.72

Paid up Capital 21.04 22.56 91.00 113.48 181.10 256.57 340.08

TNW 21.04 22.56 113.48 181.10 256.57 340.08 427.04

Adjusted TNW 21.04 22.56 113.48 181.10 256.57 340.08 427.04

TOL/TNW 12.22 12.80 5.04 2.15 1.01 0.47 0.27

TOL/Adjusted TNW 12.22 12.80 5.04 2.15 1.01 0.47 0.27

Current Ratio 1.57 1.42 2.22 2.53 2.71 3.80 6.47

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CREDIT APPRAISAL IN BANKING SECTOR

Current Ratio (Excl. TL 2.34 1.97 3.93 4.49 5.66 5.83 6.47
instalments)

NWC 100.20 103.87 386.14 349.18 323.80 361.29 438.25

b) Synopsis of Balance Sheet :

Sources of funds 31.03.2007 31.03.2008


Share Capital 21.04 22.56
Reserves and Surplus

Secured Loans : short term 2.57 14.66


: long term 102.87 100.10
Unsecured Loans 39.92 36.21
Deferred Tax Liability
Total 166.40 173.53
Application of Funds
Fixed Assets (Gross Block)
Less Depreciation
Net Block
Capital Work in Progress
Investments 52.48 39.3
Inventories (Movable Assets) 110.59 134.66
Sundry debtors 92.61 78.70
Cash & bank balances 11.93 48.15
Loans & advances to
subsidiaries and group companies
Loans & advances to others 10.58 10.49
( Less : Current liabilities ) 109.22 136.74
(Less : Provisions ) 2.57 1.03
Net Current Assets 113.92 134.23
Misc. Expenditure
(To the extent not written off or adjusted )
Total 166.40 173.53

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CREDIT APPRAISAL IN BANKING SECTOR

c) Movement in TNW (Rs. in lacs)

2007 2008 2009 2010 2011 2012 2013

Opening TNW 17.63 21.04 22.56 113.48 181.10 256.57 340.08

Add PAT 1.20 2.90 22.48 92.62 125.47 143.51 151.96

Add. Increase in equity / 8.42 10.17 68.44


premium
Add./Subtract change in
intangible assets
Adjust prior year
expenses
Deduct Dividend 6.21 11.55 25.00 50.00 60.00 65.00
Payment /Withdrawals
Closing TNW 21.04 22.56 113.48 181.10 256.57 340.08 427.04

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CREDIT APPRAISAL IN BANKING SECTOR

Appraisal Memorandum for term loan:

Circle: Ahmedabad

Branch: Mehsana

Company: Janak Transport Company(JTC)

Term Loan :

a) Proposal: Term Loan of Rs.295.00 lacs under the Transport Plus Scheme.

b) Project / Purpose: To purchase 59 new Mahindra Bolero under tie-up arrangement with
ONGC.

c) Appraised by: Inhouse examined by the Branch and found to be economically viable

d) Cost of Project & Means of finance:

Cost Means
MAHINDRA Bolero DI-2WD 328.6 Equity : 68.44
3
Insurance 15.34
RTO Tax 19.47
WC Margin Debt: 295.00
Total 363.4 Total 363.44
4

e) Remarks on Cost of project & Means of finance (in brief):

Each vehicle shall cost Rs. 6.16 lacs as per details given below:

Basic Price: Rs. 5.57 lacs

RTO : Rs. 0.33 lacs

Insurance : Rs. 0.26 lacs

The cost mentioned above is as per the quotation submitted by Shrijee Motors,
Mehsana.

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CREDIT APPRAISAL IN BANKING SECTOR

The firm is required to purchase 59 Mahindra Bolero for this purpose. Total cost
of vehicle including the insurance and R.T.O. is Rs.363.44 lacs.

The project is proposed to be financed by way of medium term loan of Rs.295.00


lacs and firm shall raise capital of Rs. 68.44 lacs as a margin.

Break-even and sensitivity analysis and whether acceptable:

Break even analysis 31/03/09 31/03/10 31/03/11 31/03/12 31/03/13

Net Sales (A) 713.82 898.65 898.65 898.65 898.65


Variable costs
Power and Fuel 223.76 253.68 253.68 253.68 253.68
Other operating Exp. 44.89 47.39 48.89 50.89 55.98
Total Variable Cost(B) 268.65 301.07 302.57 304.57 309.66
Fixed Costs
Direct Labour 72.40 85.52 87.52 90.72 94.07
Selling, Admin. & General
Expenses 8.50 9.50 10.50 11.50 12.50
Interest Expenses 20.76 33.25 22.96 13.54 3.36
Depreciation 106.77 141.12 98.78 69.15 48.40
Total Fixed Cost ( C) 208.43 269.39 219.76 184.91 158.33
Contribution (D=A-B) 445.17 597.58 596.08 594.08 588.99
Contribution ratio (E=D/A) 0.62 0.66 0.66 0.66 0.66
BE sales (F=C/E) 336.18 408.17 332.97 280.17 239.89
BE sales as % of Net Sales 47.10 45.42 37.05 31.18 26.69
Fixed cost with out
depriciation G 101.66 128.27 120.98 115.76 109.93
Contribution (H=A-B) 445.17 597.58 596.08 594.08 588.99
Contribution ratio (I=D/A) 0.62 0.66 0.66 0.66 0.66
Cash BE sales (J=G/I) 163.97 194.35 183.30 175.39 166.56
CASHBE sales as % of Net
Sales 22.97 21.63 20.40 19.52 18.53

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CREDIT APPRAISAL IN BANKING SECTOR

Commercial viability:

Year ending 31st March 2009 2010 2011 2012 2013 Total
Capacity utilisation % 100% 100% 100% 100% 100%
Sales 713.82 898.65 898.65 898.65 898.65
Net Profit 22.48 92.62 125.47 143.51 151.96 536.04
Depreciation 106.77 141.12 98.78 69.15 48.40 464.22
Cash Accruals 129.25 233.74 224.25 212.66 200.36 1000.26
Interest 20.76 33.25 22.96 13.54 3.36 93.87
TOTAL 150.01 266.99 247.21 226.20 203.72 1094.13
TL / DPG repayments 83.75 132.92 94.58 93.85 43.02 448.12
Interest 20.76 33.25 22.96 13.54 3.36 93.87
TOTAL 104.51 166.17 117.54 107.39 46.38 541.99
Gross DSCR 1.44 1.61 2.10 2.11 4.39
Net DSCR 1.54 1.76 2.37 2.27 4.66
Average Gross DSCR 2.02

Average Net DSCR 2.23

Deviations in Loan Policy/ Scheme:

Parameters Indicative Company's level as on


Min/Max level as per 31/03/2008
Scheme
Liquidity Min. 1.33 1.42
TOL/TNW Max. 3.00 12.80*
Average gross DSCR (TL) Min. 2.00 2.002
Promoters contribution (under tie- Min. 10 % 18.86%
up)
profits in the last two Min. Rs.3.00 lacs with Actual profit Rs. 1.20 lacs
rising trend for year 2006-07 and Rs.2.90 lacs
for year 2007-08*
Others Nil Nil

RATE OF INTEREST:

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CREDIT APPRAISAL IN BANKING SECTOR

As applicable to “Transport Plus Scheme”. At present 14.00 % (0.25% above SBAR-presently


13.75% wef 12/08/2008) with monthly rests. This is subject to change as per Bank’s Instruction.

Analysis:-

• Janak Transport Company is an existing profit making unit

• The main chunk behind giving loan is that Janak Transport Company is doing contract
with ONGC since incorporation

• The promoters are having considerable experience as transport contractor with ONGC

• The unit has got confirm order/ tie-up with ONGC

• A letter of authority from ONGC was received, that if Janak Transport Company will not
make the payment than ONGC will directly make the payment to the bank

• The promoters contribution to the project is 18.86% which is above the margin
requirement

• The current ratio is 1.42 that is satisfactory

• Profits in the last two years:-

Min. Rs. 3 lacs with rising trend

Actual profit Rs. 1.20 lacs for year 2006-07 & Rs. 2.90 lacs for the 2007-08

If the partners remuneration & interest is included, the profit for the year ended 31.03.07
& 31.03.08 is Rs. 4.81 lacs & Rs. 6.21 lacs

• TOL/TNW should be max. 3 which is 12.80 here, as the co. has done multiple banking
arrangement it has o/s loans with other banks also but the co. is regularly making the
payment of loans of principal amount along with the interest so the loan is given.

• Also the contract awarded is backed by guarantee from ONGC regarding direct payment
of monthly bills to SBI. Hence, surety of repayment is assured.

• The bank also checks commercial viability of the company & found that the DSCR for
term loan is 2.02 which is considered satisfactory

• Despite that the bank has also done B.E. analysis & found that the B.E. sales was 47.10%
of net sales for this current year

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CREDIT APPRAISAL IN BANKING SECTOR

• The net sales & PAT of the company is increasing year after year so overall profitability
is good

• The overall projected performance & financial of the unit are considered satisfactory
(2). Details of case study

Company:- Akshat Polymers

Firm:- Partnership Firm (M/S Umiya Polymers)

* Shri Amrutbhai Laljibhai Desai

* Shri Gunvantbhai Ambaramdas Patel

* Shri Natvarlal Mohanlal Patel

* Shri Dharamsinhbhai Lallubhai Desai

* Shri Kanjibhai Maljibhai Desai

Industry:- Manufacturing

Activity:- Maufacturing of HDPP woven sacks

Segment:- SSI

Date of Incorporation:- 19.11.07

Banking arrangement:- Sole Banking

Regd. & Admin. Office:- RS No. 840,


Kadi Thol Road,
Tal-Kadi, Dist-Mehsana

The unit will have installed capacity of 2520 MT. The unit is expected to start commercial
production from first week of September, 2008. The capacity utilization for the year 2008-09 has
been projected at 70% of installed capacity in terms of the utilization of the machines.
Accordingly the unit is projected to achieve a sale of Rs.9.26 crores for the year 2008-09 in the
first six months of operations.

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CREDIT APPRAISAL IN BANKING SECTOR

Further, the unit is projected to achieve capacity utilization of 80% during the year 2009-10 (the
first full year of operations) and accordingly the sale for the year is projected at Rs.19.77 crores.
The projections are considered acceptable in view of the following factors:

i) The unit plans to initially market its product in Gujarat, Maharastra, Rajasthan and
sale to Central Govt. who purchases the HDPP woven sacks for grains through open
tenders. The unit has started negotiating for booking of the orders for the proposed
plant and results are promising as advised.

ii) HDPP woven sacks are widely used as packaging material in Cement, Fertiliser,
storage of the AGL commodities. All these segments are reported to have good
demand for the HDPP/PE woven sacks in the Indian market.

iii) As per ICRA report, grading and research services (2006) Flexible packaging sector
is expected to grow at the rate of 12.40%.

iv) The promoters have sufficient experience in the line of activity. The promoters had
already made negotiations of the some of the industries as detailed under for selling
the HDPP woven sacks:

• Indian Farmers Fertilizers Company Limited


• Gujaco masol
• Birala cement
• Sanghi Cement
• Ambuja cement
• Various grain & Food Export units of Gujarat, etc.

v) The firm has also started marketing activity for their products by making personnel
contacts & writing introductory letters to potential customers & as the promoters are
in the same line of business activity for the last 15 years they are having very good
market contacts for the sales of the Finished Goods.

vi) The orders worth Rs.2.50 crores is expected to be finalized by end of Agust, 2008 and
before commissioning of the plant as advised.

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CREDIT APPRAISAL IN BANKING SECTOR

Proposal:
Sanction for;
i) FBWC limits of Rs.2.25 crores
ii) Fresh Term Loan of Rs.2.00 crores
Approval for:
i) CRA rating of SB- 6 (71 marks) based on projected financials as on 31.03.2010.
ii) Pricing for WC facilities @1.00% above SBAR as applicable for SB-5 minimum @13.75and for
TL 1.50% above SBAR minimum @14.25%

Performance & Financial Indicators: (Rs. in Crores)

Year 2009 2010 2011 2012 2013 2014


Installed cap Qty. 2520 2520 2520 2520 2520 2520
(MT/pa.)
Net Sales Qty.
(approx) (MT) 1029 2016 2091 2142 2217 2268
Net Sales (Value) 9.26 19.77 20.58 21.09 21.82 22.34
(Export) 0.00 0.00 0.00 0.00 0.00 0.00
Operating profit 0.44 1.18 1.19 1.23 1.31 1.33
Profit before tax 0.43 1.17 1.18 1.22 1.30 1.32

PBT/Net sales (%) 4.64 5.92 5.73 5.78 5.96 5.91

Profit after tax 0.29 0.78 0.79 0.82 0.87 0.88

Cash accruals 0.66 1.10 1.09 1.15 1.24 1.32

PBDIT 1.20 2.04 1.96 1.97 2.02 2.05

Paid up capital 0.95 0.95 0.95 0.95 0.95 0.95

Tangible net worth 1.23 2.01 2.80 3.62 4.49 5.38

Adjusted TNW
1.73 2.51 3.30 4.12 4.99 5.88
TOL/TNW 4.11 2.50 1.67 1.19 0.88 0.66

TOL/Adjusted TNW
2.64 1.80 1.27 0.92 0.81 0.62
Current ratio 1.34 1.52 1.53 1.53 1.57 1.81

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CREDIT APPRAISAL IN BANKING SECTOR

NWC 1.01 1.71 2.40 2.57 2.74 3.28

Balance Sheet: (Rs. In crores)

Sources of funds 31.03.2009 31.03.2010


Share Capital 0.95 0.95
Reserves and Surplus 0.29 1.07
Secured Loans : short term CC 2.25 2.25
: long term TL 2.00 1.60
Unsecured Loans 0.50 0.50
Deferred Tax Liability
Total 5.99 6.37
Application of Funds
Fixed Assets (Gross Block) 2.67 2.67
Less Depreciation 0.37 0.69
Net Block 2.30 1.98
Capital Work in Progress
Investments
Inventories 1.73 2.13
Sundry debtors 1.85 2.40
Cash & bank balances 0.15 0.15
Loans & advances to suppliers of 0.14 0.12
Raw material / spares
Advance tax 0.10 0.23
( Less : Current liabilities ) 0.31 0.67
(Less : Provisions )
Net Current Assets 3.66 4.36
Misc. Expenditure
(To the extent not written off or adjusted )
Non-Current Assets/ Deposits 0.03 0.03
Total 5.99 6.37

Movement in TNW:-

Movement in TNW Projected


31.03.2009 31.03.2010 31.03.2011
Opening TNW 0.00 1.23 2.01
+ PAT 0.29 0.78 0.79
+ Inc. in Equity / Premium 0.95
+/- Change in Int. Assets -0.01
+/- Adj. of prior year exp.
- Dividend payment

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CREDIT APPRAISAL IN BANKING SECTOR

Closing in TNW 1.23 2.01 2.80


Bank Income Analysis (Rs. in crores)
From Projection Projection
31.03.2009 31.03.2010
WC Int. 0.16 0.27
TL Int. 0.14 0.29
LC - -
BG - -
Bill - -
Others loan processing 0.03 0.01
Total 0.33 0.57

Deviations in Loan Policy:


Parameters Indicative Min/Max level Company's Company's level as
as per loan policy level as on on 31.03.2010
31.03.2009 @
Liquidity 1.33 1.34 1.52
TOL/TNW 3.00 4.11 2.50
TOL/Adj. TNW 2.64 1.80
Average gross DSCR (TL) 1.75 2.54 2.54
Debt / equity 2:1 2.01:1 1.03:1
Debt/Quasi equity 1.15:1 0.64:1
Any others - - -

Defaulters List:-
About unit and the promoters:
Whether names of promoters, directors, company, group concerns figure in :
RBI defaulters’ list dated 30.09.2007 No
Wilful defaulters’ list dated 31.12.2007 No
ECGC caution list No
Warning signals / Major irregularities in
Credit audit:
inspection report : Not applicable new unit
Other audit reports :
Adverse observations in Balance sheet Not applicable new unit

Adverse observations in Auditors report Nil.

Any NPAs among associate concerns None

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CREDIT APPRAISAL IN BANKING SECTOR

AKSHAT POLYMERS (AP) has been established as a partnership firm on 19th November, 2007
at Kadi. The partnership was constituted for manufacturing and selling of HDPP woven sacks to
be manufactured from HDPP granules.

The firm consists of total six partners. The brief background of the partners is as follows :

Name Age Brief Background


M/s Umiya Polymers 46 Sri Prahaladbhai Hargovandas Patel is the
main partner in M/s Umiya Polymers with 30
share. Sri Prahaladbhai is SSC and have 10
years of experience as Production Manager in
Asia Woven Sacks Ltd., Kadi who are
engaged in similar activity. M/s Umiya
Polymers are engaged in plastic waste
recycling at Kadi.

Sri Amrutbhai Laljibhai Desai 43 Sri Desai is SSC and have 15 years of
experience as Production Manager in reputed
Gopala Polyplast Ltd., Santej. He had good
contacts in the market and will look after
production department & raw material
purchases.
Shri Dharamsingbhai Lallubhai Desai 35 Sri Dharamsinhbhai is a partner in the local
unit M/s Ajay Ginning Industries, Kadi
Shri Kanjibhai Malibhai Desai 44 Sri Kanjibhai is a farmer by profession and
sleeping partner.
Shri Gunvantbhai Ambaramdas Patel 42 Sri Gunvantbhai also is a partner in M/s Ajay
ginning Industires, Kadi and has been
inducted in the partnership as a investment
partner.
Shri Natvarlal Mohanlal Patel 48 Shri Natvarlal Patel is a B.Com. and has 10
years of experience in accounting. He is also
partner in M/s Shiv Shakti Steel, Kadi. He
will be looking after general administration
and accounts of the firm.

The overall quality of the management is considered satisfactory.

Commercial viability : (Rs.in crores)


Year ending 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 Total

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CREDIT APPRAISAL IN BANKING SECTOR

31st March
Net Sales 9.26 19.77 20.58 21.09 21.82 22.34
Net Profit 0.29 0.78 0.79 0.82 0.87 0.88
Cash Accruals 0.66 1.10 1.09 1.15 1.24 1.32 6.56
Interest on TLs 0.16 0.27 0.22 0.16 0.11 0.05 0.97
Sub Total (A) 0.82 1.37 1.31 1.31 1.35 1.37 7.53
Total repayment 0.00 0.40 0.40 0.40 0.40 0.40 2.00
Interest on TL 0.16 0.27 0.22 0.16 0.11 0.05 0.97
Sub Total (B) 0.16 0.67 0.62 0.56 0.51 0.45 2.97
DSCR (Gross) 5.13 2.04 2.11 2.34 2.65 3.04
Net DSCR - 2.75 2.73 2.88 3.10 3.30
Average Gross 2.54
DSCR
Average Net 3.28
DSCR

Break-even and sensitivity analysis and whether acceptable:(Rs. in crores)


Break even analysis 31/03/09 31-Mar-10 31-Mar-11 30-Mar-12 31-Mar-13 31-Mar-14
Capacity Utilization 70% 80% 83% 85% 88% 90%
Net Sales (A) 9.26 19.77 20.58 21.09 21.82 22.34
Variable costs
Raw material 8.74 17.13 17.77 18.20 18.84 19.27
Consumable spares 0.00 0.00 0.00 0.00 0.00 0.00
Power and Fuel 0.26 0.47 0.50 0.53 0.56 0.59
Other operating Exp. 0.09 0.13 0.15 0.16 0.17 0.18
Stock Changes 0.73 0.39 0.06 0.03 0.04 0.04
Total Variable Cost(B) 8.36 17.34 18.36 18.86 19.53 20.00
Fixed Costs
Direct Labour 0.08 0.13 0.14 0.15 0.16 0.17
Selling, Admin. & General
Expenses 0.06 0.10 0.11 0.12 0.13 0.14
Interest Expenses 0.40 0.55 0.48 0.42 0.35 0.29
Depreciation 0.37 0.32 0.30 0.33 0.37 0.44
Total Fixed Cost ( C) 0.91 1.10 1.03 1.02 1.01 1.04
Contribution (D=A-B) 0.90 2.43 2.22 2.23 2.29 2.34
Contribution ratio (E=D/A) 0.10 0.12 0.11 0.11 0.10 0.10
BE sales (F=C/E) 9.10 9.17 9.36 9.27 10.10 10.40
BE sales as % of Net
Sales 98.27 46.38 45.48 43.95 46.29 46.55
Interfirm Comparison: (To be given only where data from comparable units is available.)

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CREDIT APPRAISAL IN BANKING SECTOR

(Amt in Cr)

Name of Company FBL NFBL Year Sales PBT / TOL / CR


Sales TNW
%

Ahmedabad Packaging 3.30 1.20 2007 23.11 2.16 1.47 1.16


Industries Ltd.

Singhal Industries Pvt. Ltd 6.70 -- 2010 15.19 6.52 2.90


1.90
Asia Woven Sacks Pvt. 7.44 1.00 2008 22.98 4.53 3.14
Ltd. 1.08

Akshat Polymers 4.25 -- 2010 19.77 5.92 2.50


1.52

Raw material – The major raw material for this plant is HDPP in the form of granules. This raw
material is available locally by sales & distribution network of the major suppliers as under:

• Reliance Industries Limited


• Nand Agencies
• Labdhi International
• Hadlia petrochemicals Ltd.
• Sharada Polymers
• IPCL

The raw materials are purchased from the suppliers against the advance payment only and cash
discounts are offered resulting in the increase n profitability. Any variation in the cost of raw
material is proposed to be passed on to the finished products and will not affect the profitability.

Analysis:-

• The firm is into manufacturing of HDPP woven sacks which are widely used as
packaging material in cement, fertilizer, etc.

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CREDIT APPRAISAL IN BANKING SECTOR

• As per ICRA report, grading and research services (2006) Flexible packaging sector is
expected to grow at the rate of 12.40%.

• The promoters have sufficient experience in the line of activity. The promoters had
already made negotiations of the some of the industries as detailed under for selling the
HDPP woven sacks:

• Indian Farmers Fertilizer Co. Ltd


• Birala cement
• Sanghi cement
• Ambuja cement
• Various grain & Food Export Unit of Gujarat

• The orders worth Rs.2.50 crores is expected to be finalized by end of Agust, 2008 and
before commissioning of the plant as advised.

• The company’s borrower rating is SB-6 based on projected financials as on 31.03.2010


(the first full year of operations).

• Projected financials are in line with the financials of the some of the unit in similar line of
activity and production level.

• The promoters are having experience of more than 15 years in the line of the activity.

• The affairs of the firm are expected to be managed on professional lines based on their
past experience.

• The conduct of accounts of associate with the existing bankers has been satisfactory.

• The short and medium term outlook for the industry is stable

• Availability of collateral security reflected in collateral coverage of 50.566%.

• Gross average DSCR of 2.54.

• Average security margin of 48%.

• The company has adequate management skills and production/marketing infrastructure in


place to achieve the projected trajectory. There is steady demand for the product.

Chapter-9
Findings

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CREDIT APPRAISAL IN BANKING SECTOR

• Credit appraisal is done to check the commercial, financial & technical viability of the
project proposed its funding pattern & further checks the primary or collateral security
cover available for the recovery of such funds

• SBI loan policy contains various norms for sanction of different types of loans

• These all norms does not apply to each & every case

• SBI norms for providing loans are flexible & it may differ from case to case

• The CRA models adopted by the bank take into account all possible factors which go into
appraising the risk associated with a loan

• These have been categorized broadly into financial, business, industrial, management
risks & are rated separately

• The assessment of financial risk involves appraisal of the financial strength of the
borrower based on performance & financial indicators

• After case study we found that in some cases, loan is sanctioned due to strong financial
parameters

• From the case study analysis it was also found that in some cases, financial performance
of the firm was poor, even though loan was sanctioned due to some other strong
parameters such as the the unit has got confirm order, the unit was an existing profit
making unit & letter of authority was received for direct payment to the bank from
ONGC which is public sector

• Different appraisal scheme has been introduced by the bank to cater different industries
such as:-

Doctor plus scheme for doctors


Transport plus scheme for transport
School, collages & educational institutions
Trader’s easy loan
Warehouse receipt financing for commodity traders
(agriculture related stock, cotton ginning, etc.)

• In the business world risk arises out of:-

Deficiencies / lapses on the part of the management

Uncertainties in the business environment

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CREDIT APPRAISAL IN BANKING SECTOR

Uncertainties in the industrial environment

Weakness in the financial position

• Credit is the core activity of the banks & important source of their earnings which go to
pay interest to depositors, salaries to employees & dividend to shareholders

• Credit & risk go hand in hand

• Bank’s main function is to lend funds/ provide finance but it appears that norms are taken
as guidelines not as a decision making

• A banker’s task is to indentify/assess the risk factors/parameters & manage/mitigate them


on continuous basis

BIBLIOGRAPHY
BOOKS:-

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CREDIT APPRAISAL IN BANKING SECTOR

1) Vaidhyanathan, T.S., “Credit Management”

Internal Circular of SBI, State Bank Staff Collage Hyderabad

JOURNALS:-

1) Agarwala, R.G., “Banking Finance” A Leading Monthly of Banking & Finance


Published by Sashi Publications,
Vol. XXII No.1 January, 2008
ISSN-0971-4498

2) Agarwala, R.G., “Banking Finance” A Leading Monthly of Banking & Finance


Published by Sushil Kumar Agarwala,
Vol. XII No.12 December, 2008
ISSN-0971-4498

WEBSITES:-

http://www.rbi.org.in
http://www.sbi.co.in
http://www.indianbankassociation.com
http://www.bankersindia.com
http://www.wikipedia.com

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