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A Project Report on

MSME CREDIT OPERATIONS & OVERVIEW OF FOREIGN EXCHANGE


Submitted to the Mumbai University In partial fulfillment of the requirements for the award of the Degree of

MASTERS of MANAGEMENT STUDIES ( M.M.S.)


Submitted by: SUSHILKUMAR SHANKAR GUPTA (Roll No.10)

Project Guide:

Prof. Amit Raut

IBSAR Institute of Management Studies, Karjat

May-June 2011

DECLARATION

I hereby declare that the Project Report on MSME Credit operations & Overview of Foreign Exchange submitted for the Masters of Management Studies (M.M.S.) Degree at Mumbai Universitys IBSAR Institute of Management Studies, Karjat, is my original work and the dissertation has not formed the basis for the award of any degree, associate ship, fellowship or any other similar titles.

Place: Karjat

Date:

Signature of the Student

Certificate
This is to certify that the Project Report entitled MSME Credit operations & Overview of Foreign Exchange is the bonafide Project work carried out by Mr. SUSHILKUMAR SHANKAR GUPTA student of MMS, at IBSAR Institute of Management Studies, Karjat during the year 2010 -2012, in partial fulfillment of the requirements for the award of the Degree of Master of Management Studies and that the dissertation has not formed the basis for the award previously of any degree, diploma, associateship, fellowship or any other similar title.

(Dr. Jayanti Gokhale Dy. Director IBSAR Institute of Management Studies, Karjat)

(Dr. M.L.Monga, Director, IBSAR Institute of Management Studies, Karjat)

Place: Karjat

Date:

KHAND BAZAR MUMBAI Branch 109, Kazi Sayed Street, Khand Bazar, Mumbai, Maharashtra 400003 Tel No: 022-23422390 Ref. No.: KBZ/506/2011 Date: 30/06/2011

TO WHOMSOEVER IT MAY CONCERN

This is to state that Mr. Sushilkumar Shankar Gupta of IBSAR Institute of Management Studies, Karjat has undergone training at our Khand Bazar Branch, Union Bank of India (UBI) from May 2, 2011 to June 30, 2011 on MSME Credit Operations & Overview of Foreign Exchange.

The trainee has a sound knowledge, good aptitude to learn & has successfully completed the 2 months internship at our Khand Bazar Branch, UBI.

Mr. S.K. Jain (Asst. Gen. Manager Khand Bazar Branch, UBI)

Certificate from Summer Project Guides


This is to certify that Mr. Sushilkumar Shankar Gupta, a student of the Masters of Management Studies, has worked under our guidance and supervision. This Summer Project Report has the requisite standard and to the best of our knowledge no part of it has been reproduced from any other summer project, monograph, report or book.

Faculty Guide Designation Advances) IBSAR Institute of Management Studies, Karjat Date -

Organizational Guide - Mr. Amarnath Mishra Designation - Sr. Manager (Loans & Organization UBI Address Khand Bazar Date 30.06.2011

Organizational Guide Mr. Sanjeev Kulkarni Designation Manager (Foreign Exchange) Organization - UBI Address Khand Bazar Date-30.06.2011

ACKNOWLEDGEMENTS

I would like to express my sincere thanks to Prof. Amit Raut, IBSAR Institute of Management Studies, Karjat for guiding me during the course of my internship at UBI. Without her help it would have been impossible for me to complete the project.

I would like to extend my sincere thanks to the Asst. Gen. Manager of UBI, Khand Bazar branch, Mr. S.K.Jain for allowing me to have a learning experience in foreign exchange and Advances department of Khand Bazar Branch of UBI. Also I am thankful to him, for all the co-operation and support, he provided to me during the internship. I would like to thank Mr. Amarnath Mishra and Mr. Gautam Sharma for providing me with practical knowledge and a great learning experience at Union Bank, Khand bazaar branch, in the loans & advances department. I

would also like to thank Mr. Sanjeev Kulkarni, for giving me learning opportunity and all needed assistance in understanding the functioning of foreign exchange department at UBI. Also, I am thankful to all the staff and non-staff members of UBI Khand Bazar Branch, for their helpful and kind approach. I would be failing in my duty if I do not acknowledge with a deep sense of gratitude the sacrifices made by my parents and thus have helped me in completing the project work successfully.

Place: Karjat

Date:

Signature of the student.

TABLE OF CONTENTS

Chapter No A B C D E 1 LIST OF TABLES LIST OF FIGURES

Title

Page No 9 9 10 11 12 12 13 13 14 17 19 19 20 22 22 22 25

LIST OF ABBREVIATIONS EXECUTIVE SUMMARY Objective of the Study RESEARCH METHODOLOGY INTRODUCTION 1.1 Indian Banking Industry a brief overview 1.2 Introduction to MSME

1.3 UBI- Brief Introduction TYPES OF CREDIT 2.1 Fund Based 2.2 Non-Fund Based

CREDIT APPRAISAL PROCESS 3.1 Credit Appraisal 3.2 Credit Appraisal process METHODS FOR DETERMINING THE CREDIT LIMIT

5 6

4.1 Turnover Method 25 Maximum Permissible Bank Finance Method 4.2 (MPBF) 26 TYPES OF SECURITIES PROVIDED AGAINST ADVANCES 28 CREDIT RATING 6.1 Rate of Interest 6.2 CIBIL 30 33 34
7

TABLE OF CONTENTS (Contd) Page No 35 37 53 54 54 55 56 57 57 58 59 60 63 63 65 66 67 68 70 70 70 70 72 73

Chapter No 7

Title CASE STUDY: M/S ABC CHEMICALS

7.1 Preparation of the Proposal 7.2 Documentation Process 7.3 Disbursement of credit 7.4 Follow-Up/Monitoring 8 9 10 INTRODUCTION TO FOREIGN EXCHANGE ROLE OF BANKS IN FOREIGN EXCHANGE TRANSACTIONS EXPORT FINANCE 10.1 Pre-Shipment Finance 10.2 Post-Shipment Finance FDBP (Foreign Document Bill Purchased) & PC 10.3 (Packing Credit) 10.4 ECGC 11 IMPORT FINANCE 11.1 Letter of Credit 11.2 L/C Mechanism Uniform Customs and Practices for Documentary 11.3 Credit (UCPDC) 11.4 Types of Documentary Credit 11.5 Risks associated with Opening Import L/C 12 REMITTANCES 12.1 Inward remittances 12.2 Outward remittances 12.3 SWIFT 13 14 CONCLUSION BIBLIOGRAPHY

A. LIST OF TABLES
Table 1 Table 2 Table 3 Classification of MSME for Manufacturing & Service Sector Credit Rating Break up of Balance Sheet 15 33 37-38

B. LIST OF FIGURES

Figure1 Figure 2 Figure 3 Figure 4 Figure 5

Types of credit Credit Appraisal Process Types of security provided Credit Rating Modules LC Mechanism

19 22 28 30 65

C LIST OF ABBREVIATIONS

CAGR MSME CRISIL NPA LC LIBOR FBF CMA FDR CIBIL BR BPLR QPR ECGC CC CID DP/DA RO LSR CPA DP SOD FEMA UCPDC ICC DGFT FDBP PC SWIFT AD ICRA MPBF UBI RBI FOREX DOP

Compounded Annual Growth Rate Micro, Small & Medium Enterprise Credit Rating Information Services of India Limited Non Performance Asset Letter of Credit London Inter-Bank Offered Rate Flexible Bank Finance Credit Monitoring Analysis Data Fixed Deposit Receipt Credit Information Bureau India Limited Based Rate Benchmark Prime Lending Rate Quarterly Performance Report Export Credit Guarantee Corporation of India Ltd Cash credit Credit Information Department Document Purchase / Document Acceptance Regional office Legal Search Report Credit Process Audit Demand Promissory Note Secured Overdraft Foreign Exchange Management Act Uniform customs & practices of documentary credit International Chamber of Commerce Director General of Foreign Trade Foreign Document Bill Purchase Packing Credit Society World Wide for Inter-bank Financial Telecommunication Authorized Dealer Investment Information and Credit Rating Agency of India Limited Maximum Permissible Bank finance Union Bank Of India Reserve Bank of India Foreign Exchange Delegation Of Power

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D. EXECUTIVE SUMMARY

The Indian banking sector has been an integral part of the overall economy growing with and supporting the growth of other sectors. The sector has withstood the global financial turmoil with little disruption and continued to grow at a healthy pace. The RBI has been actively encouraging financial inclusion. Only 40% of the Indias total population has been connected to banking system. Hence, there is vast scope for banking industry to grow, and explore the unexplored. The banking system in India primarily consists of state-owned banks (PSBs), private banks & foreign banks. Union bank of India also known as UBI is one of India's largest state-owned banks (the government owns 55.43% of its share capital). This report does an in depth study and analysis of the various credit facilities for working capital requirements of MSME facilitated by UBI. This report also gives brief insights about the operations of foreign exchange at UBI which would further help in understanding the credit provided by UBI. There two major topics covered in this project viz. Credit appraisal of MSME working capital credit and a brief overview of foreign exchange operations at Union bank, Khand Bazar branch. This branch is located at Masjid Bunder, Mumbai, which is famous market of whole sellers, stockiest and traders of various goods. At Khand Bazar branch, most of the customers are business customers, more specifically chemical traders. This report contains a case study of a chemical trading firm, seeking working capital credit for foreign trade. Also, report explains the various factors to be considered while appraising the credit to a business customer, like credit rating, determining credit limit, types of credits, etc. The another section i.e. an overview of foreign exchange, provides an idea, as how a foreign trade takes place between an importer and exporter, and roles of banks in it. It throws a light on the three major aspects of foreign exchange functions viz. Export finance, import finance and remittances (inward & outward).

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OBJECTIVES
1. Learn about the various Credit facilities provided by Union Bank. 2. Analyse Balance Sheet of the clients, calculation of credit rating and verify their creditworthiness. 3. Gain knowledge about the methods used for limit calculation & the various ratios used in the banks. 4. Learn about the basic operations of foreign exchange department.

E.RESEARCH METHODOLOGY
Primary data: This data was collected purely on the basis of interaction with the branch manager, and associates at Union bank of India. Secondary data: The sources of secondary data were a combination of information from the Internet, periodicals and newspapers.

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1.0 INTRODUCTION
1.1 Indian Banking Industry a brief overview The Indian banking sector has been an integral part of the overall economy growing with and supporting the growth of other sectors. The sector has withstood the global financial turmoil with little disruption and continued to grow at a healthy pace.

The RBI has been actively encouraging financial inclusion. There are around 72,315 villages, with a population of over 2000 (as per the 2001 census), that are yet unbanked and which need to be brought under the banking net. Only 40% of the Indias total population has been connected to banking system. Hence, there is vast scope for banking industry to grow.

The banking sector business has grown at a CAGR of around 23% between FY05 to FY10. On account of lower capital expenditure by the industry, coupled with the apprehension of the banking sector to issue credit the sector witnessed a slightly modest growth in FY10 y-o-y of around 16.7%. However, the same has witnessed a pickup in the current financial year, with a growth of around 20% y-o-y as of October 2010. With the overall economy expected to grow at around 8.8% for FY11, and services and industry expected to grow at a faster pace of around 10.3% and 9.5% respectively, bank credit is expected to continue at a healthy pace.

New trends in Banking Consolidation the way forward for the banking sectors; would help banks finance larger transactions. Eg: ICICI & The Sangli Bank, ICICI & bank of Rajasthan, etc. Mobile technology to drive the next leg of the banking sector growth; would also support financial inclusion. Core banking to solution to speed up the transactions and customer orientation. Investments in commercial papers to rise given the shift to the base rate system. 13

1.2 Introduction to MSME Worldwide, the micro small and medium enterprises (MSMEs) have been accepted as the engine of economic growth and for promoting equitable development. The major advantage of the sector is its employment potential at low capital cost. The labour intensity of the MSME sector is much higher than that of the large enterprises. In India, the MSMEs play a pivotal role in the overall industrial economy of the country. In recent years the MSME sector has consistently registered higher growth rate compared to the overall industrial sector. It is estimated that in terms of value, MSME sector accounts for about 45% of the manufacturing output and around 40% of the total export of the country.

As per MSMED Act 2006 the MSME segment has broadly been classified into Manufacturing Enterprises & Service Enterprises. i) A Manufacturing Sector Enterprise is one, which is engaged in the manufacturing or production, processing or preservation of goods. Investment in plant & machinery is the criterion for classifying a manufacturing enterprise into Micro, Small and Medium Manufacturing Sector Enterprise. ii) A Service Sector Enterprise is one, which is engaged in providing or rendering of services. Investment in equipments is the criterion for classifying a service enterprise into Micro, Small and Medium Service Sector Enterprise.

The following table reflects the investment ceilings for classifying Micro, Small and Medium sector enterprises: Micro and small enterprises are to be treated as priority sectors as per the rules of Reserve bank of India. It means 18% of the net bank credit (NBC) of the bank should be advanced to the micro and small enterprises i.e. priority sector. Investments made by the banks in special bonds issued by the specified institutions could be reckoned as part of priority sector advances. These institutions are National Housing Corporation, NABARD, SIDBI, etc.

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Classification

Manufacturing Sector (Investment in P & M)

Service Sector (Investment in Equipments)

Micro Enterprise Upto Rs 25.00 Lacs Upto Rs 10.00 Lacs

Priority Sector

Small Enterprise

More than Rs 25.00 Lacs upto Rs 5.00 Crores. More than Rs. 5.00 crores upto Rs. 10.00 crores

More than Rs 10.00 Lacs upto Rs 2.00 Crores More than Rs. 2.00 crores upto Rs. 5.00 crores

Medium Enterprise

Table 1: Classification of MSME for Manufacturing & Services Industry Following activities are also falling under Service Enterprises:

Consultancy Services including Management Services Composite Broker Services in Risk and Insurance Management Third Party Administration (TPA) Services for Medical Insurance Claims of Policy Holders

Seed Grading Services Training-cum-Incubator Center Educational Institutions Training Institutes Retail Trade Practice of Law i.e. legal services Trading in medical instruments (brand new) Placement and Management Consultancy Services Advertising agency and Training centers

Benefits of MSME RegistrationMSME Registration is pre-requisite for several schemes of Government of India. MSME Registration provides following benefits to the company-

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Credit Linked capital subsidy scheme for Technology Upgradation The scheme was launched at facilitating technology upgradation of micro and small enterprises by providing 15% capital subsidy (12% prior to

2005) on institutional finance availed by them for induction of well established and improved technology in approved sub-sector/products. The admissible capital subsidy under the revised scheme is calculated with reference to purchase price of Plant & Machinery. Maximum limit of eligible loan for calculation of subsidy under the revised scheme is also been raised from Rs. 40 lakh to Rs. 100 lakh.

Credit Guarantee schemeThe credit Guarantee Fund Scheme for Micro & Small Enterprises (CGMSE) was launched by the Government of India to make available collateral-free credit to the micro & small enterprise sector. Both the existing and the new enterprises are eligible to be covered under the scheme. The collateral free loan can be availed by micro & small enterprises.

Performance and Credit Rating scheme for MSMEsGovernment of India provides subsidy for the rating of micro & small enterprises on the basis of their MSME Registration. The subsidy is up to 75% of the total rating fees. MSMEs can avail the rating from Rating Agency CRISIL Ltd.

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1.3 UBI- Brief Introduction Union Bank of India was established on Nov 11, 1919 and is head quartered in Mumbai. The registered Office of the Bank was inaugurated by Mahatma Gandhi, father of the Nation in the year 1921.

After Independence, UBI accelerated its growth and by the time the government nationalized it, along with 13 other banks in 1969, it had grown to 240 branches in 28 states. Shortly after nationalization, Belgaum Bank, a private sector bank merged in UBI. Then in 1985 UBI merged in Miraj State Bank. In the year 1999, UBI acquired Sikkim Bank on the request of Reserve Bank of India.

UBI began its international expansion in 2007 with the opening of representative offices in Abu Dhabi, United Arab Emirates, and Shanghai, Peoples Republic of China. The next year, UBI established a branch in Hong Kong, its first branch outside India. In 2009, UBI opened a representative office in Sydney, Australia.

VISION:

To become the Bank of first choice in our chosen area by building beneficial & lasting relationship with customers through the process of continuous improvement.

MISSION: Corporate mission to gain market recognition in chosen area by building effective strategies. Bank has a network of more than 3100 service outlets which includes specialized branches for MSME (SME SARALS), corporate credit, Union Loan points for Retail Products etc. Union Bank is the first large bank to achieve 100% CBS roll out.

Through its large network of authorized branches, the bank caters to the foreign exchange needs of its clientele engaged in export and import trade and the Treasury provides rates for conversion of all major world currencies like U S Dollar, Sterling Pounds, Euro, Swiss Francs, Japanese Yen and other currencies. The services to the customers of the Bank include hedging of 17

foreign currency risks by providing forward covers and various derivative products.

Union bank has been performing well since its inception, as per its financials. The bank showed a Y-o-Y growth in net profits of 0.34%, 20.15% & 24.51% for the FY-2011, FY-2010 & FY-2009 respectively. The actual net profit stood at Rs.20.82 billion, Rs.20.75 billion & Rs.17.27 billion for the FY-2011, FY2010 & FY-2009 respectively.

The net NPA has been consistently increasing for the bank from 0.34% in FY2009 to 0.84% in FY-2010 to 1.19% in FY-2011. Although, the net NPA for FY-2011 is quite acceptable, still bank needs to take certain measures to bring this indicator down in the subsequent years.

The bank had a capital adequacy ratio of 12.95% as on March 31 as against 12.51% previous year & deposits as on March 31, 2011 were at Rs 2.02 trillion, more than the Rs 1.70 trillion a year earlier.

The major competitors of Union Bank of India:

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2.0 TYPES OF CREDIT


To meet the working capital requirements of the firm, banks provide two types of credit facilities.

Figure 1: types of Credit Fund based limit also includes term loan which is required by the borrower/company for meeting long-term requirements. 2.1 Fund Based Credit Fund Based credit is a facility in which the company/borrower gets funds from banks to meet its business requirements.
2.1.1

Cash Credit
Cash credit is short-term working capital provided by the bank to the borrower, to carry out its day-to-day functioning of his business activities. This credit facility is sanctioned by the bank for 1 year which needs to be renewed after that every year. This facility is provided by the bank against hypothecation of stock and book debts by the borrower. It runs like a current account except that the money that can be withdrawn from this account will depend on the drawing power sanctioned by the bank. This calculation of drawing capacity or power of the borrower will be explained in the subsequent section.

2.1.2

Overdraft

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The word overdraft means the act of overdrawing from a bank account. An overdraft occurs when withdrawals from a bank account exceeds the available balance. In this situation a client is said to be "overdrawn". If there is a prior agreement with the bank for an overdraft protection plan, and the amount overdrawn is within this authorized overdraft limit, then interest is normally charged at the agreed rate. OD account holder is allowed to exceed 10% of the total OD limit sanctioned provided it is approved by the competent authority of the bank, for the period not more than 3 months. If the balance exceeds the agreed terms, then higher interest rates will be applicable. Eg SOD (secured over-draft), TOD (temporary over-draft), clean overdrafts. Clean overdrafts are granted against the perceived worth of an individual.

Difference between Cash credit & Overdraft


The difference is very subtle and relates to the operation of the account. In the case of Cash Credit, a proper limit is sanctioned which normally is a certain percentage of the value of the inventories/book-debts hypothecated by the account holder with the Bank. Overdraft, on the other hand, is allowed against a host of other securities including financial instruments like shares, units of mutual funds, surrender value of LIC policy and debentures, FD etc.

2.1.3

Export Credit
Export Credit consists of a) Pre-shipment Credit (Packing Credit) b) Post-Shipment Credit These are available to the exporters, for financing purchase, processing, manufacturing or packing of goods prior to shipment & after shipment of goods to the importer.

2.2 Non-fund Based Credit Non-fund based credit is a facility given by the banks where actual bank funds are not involved. Generally, banks stand as a guarantor instead of giving money as in the case of fund -based credit to the borrower.
2.2.1

Letter Of Credit
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A letter of credit (L/C) can be defined as an arrangement where in a bank guarantees, on behalf of its importer, to make payment to the exporter upon presentation of documents specified in the credit. In other words, it is an undertaking by a bank to pay or accept bills provided the beneficiary of the credit fulfils the terms and conditions set forth in the L/C document.
2.2.2

Bank Guarantee
A guarantee is provided by a lending institution ensuring that the liabilities of a company/institution would be met. In other words, if the debtor fails to settle a debt, the bank will cover it.

2.2.3

Buyers Credit
Exporter prefers to sell merchandise on sight terms or a maximum usance period of 90/180 days from date of shipment. However, importers prefer to buy on a usance terms and at times, beyond 90/180 days depending on the cash flow position. This cash flow mismatch need can be taken care by the banks through an import buyers credit offering. The local bank through their offshore offices arranges foreign currency financing to pay off the exporter on due date of the transaction. Buyers credit is the credit availed by an Importer (Buyer) from overseas Lenders i.e. Banks and Financial Institutions for payment of his Imports on due date. The overseas Banks usually lend the Importer (Buyer) based on the letter of Credit (a Bank Guarantee) issued by the Importers (Buyers) Bank. In fact the Importers Bank brokers between the Importer and the overseas lender for arranging buyers credit by issuing its Letter of Comfort for a fee. Buyers credit helps local importers access to cheaper foreign funds close to LIBOR rates as against local sources of funding which are costly compared to LIBOR rates. Maximum allowed rate of interest on buyers credit is (LIBOR + 2) %, as per RBI guidelines.

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3.0 CREDIT APPRAISAL PROCESS


3.1 Credit Appraisal Before going to credit appraisal process, first let us see what credit appraisal is. Credit appraisal is the step which decides if the applicant can avail the credit or not. Credit Appraisal is the process by which a lender appraises the creditworthiness of the prospective borrower. It is a very important step in determining the eligibility of a loan borrower for a loan. Every potential borrower has to go through the various stages of a credit appraisal process of the bank, which might include an interview with the bank officials. However, just like every bank charges different rates for different loans from different customers based on the credit rating mechanism, in the same way, each bank has its own set criteria that one must satisfy to qualify as a certified borrower of money/assets from the bank. All banks have their own rules to decide the credit worthiness of their borrowers. Credit appraisal process refers to the steps that the loan application goes through in order to get it converted into loan approval letter. Following is the process of the credit appraisal that contains six basic steps, starting from loan application till disbursement of the credit. 3.2 Credit Appraisal Process

Figure 2: Credit Appraisal Process 22

Step 1. Application
In this first step for credit appraisal or extension process, an applicant applies for loan as per his needs and requirements. He is asked to submit various necessary documents like: Address proof, identity proof, balance sheet of the firm, personal balance sheet of the individual proprietor or partners or directors as the case may be, Income tax return, CMA data etc. Depending upon the information gathered from the party, by all verbal and non verbal communication, credit appraisal officer fills the client information form along with his own comments.

Step 2. Analysis
This is very crucial step in the entire credit appraisal process. In this step, the credit appraisal officer scrutinizes and critically evaluates the documents furnished by the party.

Step 3. Processing
After the critical evaluation of the financial statements and other documents, credit appraisal office calculates important ratios like current ratio, debt-equity ratio (with and without quasi capital), etc and prepares a proper proposal for further sanctioning by higher authority like AGM of a branch. The details of processing will be explained in detail in upcoming chapters of the project.

Step 4. Sanctioning
The bank keeps the following things in mind while discussing/sanctioning the request namely: The kind of person being dealt with, the business, the industry and economic conditions in general. A complete analysis of the strengths and weaknesses of an advance as a whole should be made. The Bank should not commit itself without adequately examining all the aspects of the advance including banking and legal points of view. The Bank should make certain that at each stage of discussion with the borrower all the facts are correctly put. As far as possible dealings should be straightforward leaving little room or no room for misinterpretation, whether the advance is granted or rejected.

Step 5. Documentation
Once the loan is sanctioned by the higher authority then next step of documentation starts. In this step various documents have to be prepared by 23

the branch Viz. agreement, terms and conditions, necessary legal documents, proposal duly signed and accepted by the party, documents pertaining to mortgage or hypothecation of the property documents, etc .

Step 6. Disbursement
Now, the last step in credit appraisal is disbursement. After completing all the documentation formality the bank remits the funds to the clients account or issues the pay order as per the request made by the client.

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4.0 METHODS FOR DETERMINING THE CREDIT LIMIT

A unit needs working capital funds mainly to carry its day-to-day operations. Inadequate levels of Working Capital may result in under-utilization of capacity and serious financial difficulties. Similarly, excessive levels may lead to unproductive use of credit and unnecessary interest burden on the unit. With the withdrawal of the mandatory requirement on the MPBF method by the Tandon Committee in 1997, RBI has given freedom to the Banks to assess the Working capital needs of their Borrower, however under certain prudential guidelines and norms. 4.1 Turnover Method Under this method, the working capital limit shall be computed at 20% of the projected sales turnover accepted by the bank. In the case of MSME borrower seeking fund based working capital up to Rs. 500.00 lacs, the limits shall be assessed on the basis of turnover method. The Turnover method shall be applied for sanction of fund based working capital limit to the non-MSME borrowers requiring working capital facility upto Rs. 100.00 Lacs from the banking system. This system shall be made applicable to the traders, merchants, exporters who are not having a predetermined manufacturing/ trading cycle. Under this method, branches shall ensure maintenance of a minimum margin on the projected annual sales turnover. In other words, 25% of the estimated sales turnover value shall be considered as working capital limit, of which, at least 20% shall be provided by the bank and the balance 5% shall be by way of promoters contribution towards margin money. However, if the available net working capital is more,

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the same shall be reckoned for assessing the extent to which the bank will finance the borrower and the lower limit would be considered.

Calculation of credit limit under turnover method Particulars A) Net Sales B) 25% of Net Sales C) 5% of Net Sales D) Net Working Capital (CA-CL) E) Net Eligibility (B Higher of C and D) Amount XXX XXX XXX XXX

XXX

4.2 Maximum Permissible Bank Finance Method (MPBF) In 1974, Reserve bank of India appointed a study group with Shr P. L. Tandon, then chairman Punjab National bank as the chairman for framing Guidelines for the follow up of the bank credit. A working Group to review the system in April 1979 under the chairmanship of Mr. K. B. Chore Chief officer DBCOD, Reserve Bank of India. RBI had appointed Tandon committee and Chore committee, which recommended that businesses should try to improve their liquidity position and firstly they should try to improve their current ratio to the level of 1.33:1 and thereafter should try to achieve a current ratio of 2:1 The desired current ratio suggested by Tandon and Chore committee was never attainable by business, practically. Now the desired current ratio for businesses is 1.80:1.

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Second method i.e. 0.75 CA-CL is generally used all over for determining the Maximum Permissible Bank Finance (MPBF) Instead of using the MPBF method to determine the eligibility of the borrower, Union Bank of India uses Flexible Banking Finance (FBF) method. FBF method is an extension of MPBF method, with customer friendly approach in as much as the scope of the current assets is made broad based and for evaluating projected liquidity, acceptable level of current ratio is taken at 1.17:1 against benchmark level of 1.33:1. FBF method is applicable for account with credit limit of above Rs. 1.00 crore for other advances and above Rs. 5.00 crore for MSME advances. Under the FBF system, a uniform classification for current assets and current liabilities shall be adopted on the terms given in CMA data format. The assessment of credit requirement of a party shall be made based on the projected study of the borrowers business operations via-a-via the production/processing cycle of the industry. The projected level of inventory and receivables shall be examined in relation to the past trend, market developments and industry trend. Calculation of eligibility under FBF method Particulars A. B. C. D. E. Total current assets Current Liabilities Excluding Bank Borrowings Net Working Capital Gap (A-B) Net Working Capital (CA-CL) Flexible Bank Finance (C-D) Amount XXX XXX XXX XXX XXX

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5.0 TYPES OF SECURITIES PROVIDED AGAINST ADVANCES


After the bank decides on granting an advance to a borrower, whether in the form of a Cash Credit, or Overdraft, they keep in mind against what security the funds will be granted. This is very important aspect in granting or refusing any advance, as for the bank, that security will be the only means to recover any dues from the borrower at the time of default. At time of over-draft facility of secured nature, the bank provides credit to the borrower against fixed deposit receipt (FDR). A right to lien for FDR is created in a secured over draft facility. A lien is a right to retain property till the debt is repaid. It is a legal claim on the securities which come in to the hands of the bank in the ordinary course of business. In the case of a cash credit facility given to the company to meet its working capital requirements, the firm needs to provide the following:

Figure 3 Types of Security As the name suggests, the primary security is the basis on which the cash credit is being given to the firm. The primary security is generally the hypothecation of stocks & book debts. Hypothecation is the pledge provided by the borrower in the form of movable property just like stocks & book debts. In hypothecation, possession of the movable property remains in the hands of the borrower. The calculation of the drawing limit for the cash credit is based on the amount of hypothecation of stocks & book debts 28

(sundry debtors). Banks calculate the drawing limit every month based on the stock & book debts statements submitted by the firm. In other words, the margin to be provided is also based on stock & book debts. In general, the margin required is 25% of stocks 40% of book debts

The margin may be reduced at the discretion of the bank depending upon the financial stability of the borrower. The firm needs to submit the stock & book debts statements before the 15th of next month. Ex: for month of June, the stock & book debts statements should be submitted before 15th of July. Also, the stock & book debts should be insured by 110% of the total value of the security. Collateral security or secondary security is the additional protection provided by the borrower in case, borrower fails to pay back the amount & interest under the term of the cash credit facility. The collateral security can be in the form of mortgaged house property (immovable property), pledging of shares, lien of FDR, assignment of LIC policy etc. In banking terms, the above mentioned examples are termed as charge creation. In case of house

property (immovable property) given as collateral, it needs to be valued by a valuation-firm which is authorized by the bank. The valuation-firm will provide the market value & distress market value of the property. The valuation of the house property is done in every 3 years which is as per RBI guidelines.

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6.0 CREDIT RATING


Union bank of India, for credit appraisal, has its own credit rating models, in order to determine the creditworthiness of the applicant. Once the applicant has applied for the loan, and has submitted all the above mentioned necessary documents, processing officer undertakes the deep study of the financial statements, bio data of the company and owner or partners or directors as the case may be, and other essential documents which are submitted by the applicant. After studying the documents, he has to do credit rating as per appropriate UBI model. UBI has four credit rating models depending upon the total credit requirement of the applicant i.e. both fund based and non fund based. Those are as under:

2 Lacs to 10 Lacs

Credit Rating Model

10 Lacs to 100 Lacs

1
Credit Rating Model 4

Credit Rating Model2 Credit Rating Model

1000 lacs and above

100 Lacs to 1000 Lacs

Figure 4 Credit Rating Models

As mentioned in the above diagram, considering the credit need of the applicant, an appropriate credit rating model is used by the processing officer and applicants total score is calculated. In all the above mentioned four models, credit rating is done on four parameters, what differs in these models is the weight given to each parameter. Total score of each model is 100. Four broad parameters are as under: 30

I.

Rating of the borrower Rating of the borrower is the first and foremost segment in the credit rating model of UBI. Under rating of the borrower, UBI has three subsegments viz. financial risk, management risk and Market or industry risk. a) Financial aspects In financial risk analysis, assessment of Financial Standing should be on the basis of "Soundness" of the company. The general parameters, which are pertinent from the banking point of view, are quantum of owned funds, policy followed by the company in retaining part/full of the profits, debt equity ratio, funded debt equity ratio (TOL/TNW) and more importantly current ratio. Capacity of the company for raising resources (including margin contribution) for expansion/modernization is also to be counted, while judging this aspect. In case of fund based and non fund based limits are more than Rs.1000 lacs, additional sub-parameter of Cash Flow Related Parameters is included under rating of the borrower. b) Management risk On the other hand in management risk segment, bank examines the Company's management set up, the composition of the Board and the Chief Executive in charge of day-to-day operations. Ascertain whether the company is well versed in all functional areas of purchase, production, marketing, finance and personnel administration. Take an overall view on the "Management" of the unit, its reputation and allocate the marks accordingly. c) Market / industry risk In market risk the processing officer, studies the market conditions or industry prospects in order to check the external risk factors. Under this head, officer, checks details of following: Demand and supply situation Geographical spread of the business and customers 31

Competitive situation, number of competitors, nature of market, etc. Availability of the raw materials and their costs Location issues like, availability of infrastructure facilities, proximity to the market place Technology: not to be changed in immediate future, availability of R&D facilities, etc. Manufacturing capacity utilization: more than 90% is good, 75%90% is satisfactory, 50%-75% is average, and below 50% is considered as below average.

II.

Rating of the facility A company can start functioning only after completing statutory obligations laid down by the governing authority. Such statutory obligation involves obtaining licenses, permits for ensuring smooth operations. Preparation and submission of financial statements, stock statements in the standard format within the given time schedule. Presently, the entire facility rating is treated as NOT APPLICABLE for new borrowers.

III.

Risk mitigators Risk mitigators refer to the availability of the collateral security and the quality of the collateral. Availability of the guarantor, proprietor or partners or directors as the case may be, is to be taken into consideration along with the personal means of the guarantor.

IV.

Business aspects The length of the relationship with bank enables the lender to assess the previous performance of the account holder. A good track record acts in the favour of the borrower; however underperformance makes the lender more vigilant. The income value to the bank is also considered. Based on the points obtained by the borrower under the four different heads mentioned above, the total score is calculated out of 100. Depending on the percentage of total score obtained, the borrower is classified into 9 different categories. Also, depending on the rating of the borrower, bank decides the lending rate of interest

32

Credit Quality Lowest Risk Minimal Risk Moderate Risk Satisfactory Risk Acceptable Risk Watch List Risk Prone High Risk Sub-standard Doubtful Loss

Rating Numeric CR-1 CR-2 CR-3 CR-4 CR-5 CR-6 CR-7 CR-8 CR-9 CR-10 CR-11

Table 2 Credit Rating Minimum Credit Rating required for considering a new proposal is CR-5 and for takeover proposal is CR-4 at present. The cut-off point is changed from time to time depending on banks requirements by the management. In addition to the UBI credit rating model, if the credit limit given by the bank is more than 1 crore i.e. for all credit facility greater than rating model-III of UBI an additional rating needs to be done. The additional rating model could be of CRISIL, ICRA, Moody etc.

6.1 Rate of Interest


Interest on any type of advance is applied on daily debit balances standing at the close of the day. The rate of interest applicable to the borrower is based on the credit rating obtained. Banks may charge the borrowers at their own discretion. At UBI, the rate applicable is Base Rate (BR) + Additional rate according to credit rating of the borrower Thus, the minimum rate of interest at UBI is the base rate. The current base rate (BR) is 10%. Also, the rate of interest may vary according to the collateral (greater than 75%) provided by the borrower & industry in which the borrower operates. The rate of interest may change if the business of the borrower belongs to the priority sector.

33

6.2 CIBIL
Credit Information Bureau (India) Limited (CIBIL) was incorporated in 2000. The establishment of CIBIL is an effort made by the Government of India and the Reserve Bank of India to improve the functionality and stability of the Indian financial system by containing NPAs while improving credit grantors portfolio quality. CIBIL provides a vital service, which allows its Members to make informed, objective and faster credit decisions. The CIBIL gives a score to every borrower on a total score of 1100. Before granting any credit facility to the borrower, the bank needs to review the score. Although, Union bank doesnt advocates a minimum score requirement in the CIBIL report but generally a score in the range of 800 is considered good.

34

7.0 CASE STUDY: M/S ABC CHEMICALS


I, have completed an internship with Union Bank of India, Khand Bazar branch, Mumbai, Masjid 400 003. I got to work practically on a proposal of M/s ABC Chemicals, which is a proprietorship firm. Following are the details of the case: M/s ABC Chemicals is a sole proprietorship firm which is controlled by Mr. DEF. He is having a rich experience of around 25 years in the same field of chemical industry. Prior starting his own firm he worked as a commission agent which helped him to gain knowledge about the different functionality of chemical industry. He also takes assistance of intermediaries, who constantly keep him informed & updated about the new products & changing market conditions. Mr. DEF, Owner of M/s ABC chemicals has applied for following limits: Particulars Fund Based (Cash Credit ) Non Fund Based (L/C limit) Total Limit Amount Rs. 1 crore Rs. 2 crore Rs. 3 Crore

Mr. DEF has submitted following documents on behalf M/s ABC Chemicals Personal Bio data of both the firm and proprietor himself Audited balance-sheets of 2008, 09 & 10 and provisional B/S (2011) and projected B/S of 2012. CMA data (if the limit is above Rs. 1.00 crore.) Credit Information Form of the firm & proprietor duly filed in and signed by the proprietor List of sundry creditors and debtors along with break-up of debtors (below and above 180 days) Details of collateral, sister concerns, if any. Etc.

35

Following will be the working of the processing of the working capital application Balance sheet break-up as per Union bank model Current assets: Assets if satisfies following two conditions, it will be treated as current asset: a. It should be business related. b. It should be convertible in cash within 1 year. For sundry debtors, the break-up needs to be done for less than 180 days & greater than 180 days. Sundry debtors below 180 days are treated as is taken into current assets & above 180 days are taken into miscellaneous assets. Examples: Cash and bank balance, sundry debtors (below 180 days), stock, loans & advances & deposits. Loans & advances & deposits should be related to business activity. Current liabilities: Liabilities that need to be paid off with in 1 year. Examples: Other bank borrowings, sundry creditors, outstanding liabilities, etc. Fixed Assets: Fixed assets are the assets of the company which are held for long term purpose and not liquidated within 1 year. Examples: Land and building, plant & machinery, equipment etc. Long Term Liabilities: It includes secured and unsecured liabilities, quasi capital, etc. Quasi capital is the capital which is contributed by the friends, relatives and family members of the proprietor. Miscellaneous Assets: Assets not included in current assets are included in miscellaneous assets. Examples: sundry debtors more than 180 days, advances given to friends, etc. Net Worth: It is the personal capital contributed by the proprietor. Examples: Paid up capital, general reserve, retained profits of the previous years, etc.

36

7.1 Preparation of the Proposal


BREAK-UP OF BALANCE SHEET: M/s ABC Chemicals As at 31st March CURRENT ASSETS Cash & bank balance margin money on LC Book Debts Inventory a) Raw Materials b) Work in progress c) Finished Goods d) Consumables stores & Spares Taxes paid in advance advance to suppliers Other Current Assets TOTAL CURRENT ASSETS CURRENT LIABILITIES: Bank Borrowings (Short Term) Bank Borrowings (Short Term) -other bank Sundry Creditors Expenses Loans from others Sundry Creditors Intt./Other ch.accrued but not due for payment Provision for taxation Other Provisions Installments due in 12 months on Term Loans Other Current Liabilities Advance from Customers Deposit against sales TOTAL CURRENT LIABILITIES: CURRENT RATIO FIXED ASSETS: Land Building Plant and Machinery Other Fixed Assets Furniture and Fixtures Constn.waiting for completion OTHERS TOTAL FIXED ASSETS; LONG TERM LIABILITIES: Deferred Tax Liability Redeemable Pref.Shares Term Loan - car loan from HDFC bank Term Loan Others Term Loan - UNION BANK Other Term Liabilities Unsecured Loans from FRIENDS & RELATIVES Rs. In Lacs 2008 Aud 0.74 376.57 86.71 2009 Aud 33.20 402.23 118.95 2010 Aud. 24.07 711.12 108.58 2011 Prov. 43.93 727.83 260.04 2012 Proj. 54.90 1056.91 275.00

1.66 465.68

1.49 1.08 556.95

1.08 844.85

6.31 1038.11

7.55 1394.36 50

6.40 3.00 373.74 0.62

7.77 1.50 458.64

13.16 689.38 3.82

13.00 878.33 1196.37

0.13 6.54 390.43 1.19:1

1.58 0.08 469.57 1.18:1

1.24

1.18

5.25

707.60 1.19:1

892.51 1.16:1

1251.62 1.11:1

2.26

1.84

1.80

0.70

0.38

2.26

1.84

1.80

0.70

0.38

29.00

34.50

53.20

19.84

20

24.00

24.70

31.85

59.52

60

37

TOTAL LONG TERM LIABILITIES: MISCELLANEOUS ASSETS: Deferred Tax Assets Bals/Dep with P.Trust/Customs Other Loans & Advances Unquoted Investments Non.Consumable Stores/Spares Other Miscellaneous Assets-deposits Book Debts older than 6 months SecuritY DEPOSITS TOTAL MISCELLANEOUS ASSETS: NET WORTH: Paid Up Capital Prop. Current account General reserves & Surplus Other Reserves- subsidy Balance of Profit TOTAL NET WORTH TOTAL ASSETS: TOTAL LIABILITIES:

53.00

59.20

85.05

79.36

80.00

0.02 8.01 8.03 32.54

0.03 11.53 11.56 41.58

0.02 14.25 14.27 68.27

22.51 22.51 89.45

32.69 32.69 95.81

32.54 475.97 475.97

41.58 570.35 570.35

68.27 860.92 860.92

89.45 1061.32 1061.32

95.81 1427.43 1427.43

Table 3 Break up Balance sheet

From the above break up, credit rating of the borrower is conducted by the bank, as per the latest audited balance-sheet, i.e. 2010 in this case. As per the credit rating model of UBI, M/s ABC chemicals gets the CR4 rating which is satisfactory for further processing of the application. After the breakup of balance sheet, credit rating, now the proposal is made and forwarded to the Regional office for the approval and sanction.

38

PROPOSAL of the M/s ABC Chemical UNION BANK OF INDIA MEMORANDUM TO THE COMPETENT AUTHORITY FOR APPROVAL PROPOSAL FOR SANCTION GROUP BANKING MONTH OF REVIEW ASSET CLASSIFICATION INTEREST RATING STATUS OF ACCOUNT (Please tick appropriate box) Sole New Account Standard CR-4 (Aud. 2010) Regular Early Alert Special System Mention Account

a) NAME OF THE ACCOUNT

M/s ABC Chemicals

b) BRANCH / ZONE

Khand Bazar Branch

c) BORROWER CREDIT RATING CR-4 (Aud. 2010)

d) DATE OF ESTABLISHMENT

2005-06 (Proprietorship/Partnership/Company)

CONSTITUTION ADDRESS REGD. AND ADM. OFFICE

Sole Proprietorship

XXXX

39

Proprietor NAME OF
4

Means as of (31/3/2010)

PROPRIETOR & HIS MEANS

Mr. DEF

103.72 lacs

The business is managed by Mr. DEF. He is well


5

BACKGROUND OF PROMOTERS

known in trade circles and is reported to be experienced businessman with satisfactory dealings.

CAPITAL STRUCTURE
6

(Applicable in case of a company)

N.A (Proprietorship Firm)

6a

SHAREHOLDING PATTERN No. Of shares IN CASE OF PARTNERSHIP FIRM

N.A. Face value -

Holding % -

INDICATE CAPITAL CONTRIBUTED BY EACH PARTNER SEPARATELY

NA

LINE OF ACTIVITY
8

(Description of the business)

Traders & Dealers in chemicals & Solvents

(Reference with the existing parties which have


9

DUE DILIGENCE

availed credit facilities by the bank is required given by the borrower)

40

COMMENTS ON LATEST
10 CREDIT / SEARCH

(CID is the Credit Information department of the bank which would give brief history & information about the firm. CID report is required for limit greater than Rs. 1 Crore)

REPORT

A) DEALING WITH
11

BANK SINCE B) CREDIT FACILITIES SINCE WHETHER A/C. IS TAKEN / TO BE

September 2006

2007

(This is applicable in situation where the borrower has credit facilities with other banks. Credit report by the other bank is required in this case.) N.A.

12

TAKEN OVER. IF SO NORMS FOR TAKE OVER ARE FULFILLED

13 FINANCIAL INDICATORS:

(Rs. In lacs) Year Ending Paid up Capital Reserves & Surplus Tangible Net Worth Long Term Liabilities Capital Employed Net Block Investments Non Current Assets Net Working Capital Current Assets Current Liabilities 31/03/08 31/03/09 31/03/10 31/03/11 31/03/12 (Aud.) 32.54 32.54 53.00 85.54 2.26 8.03 75.25 465.68 390.43 (Aud.) 41.58 41.58 59.20 100.78 1.84 11.56 87.38 556.95 469.57 ( Aud.) 68.27 68.27 85.05 153.32 1.80 14.27 137.25 844.85 707.60 ( Prov.) 89.45 89.45 79.36 168.81 0.70 22.51 145.60 1038.11 892.51 (Proj.) 95.81 95.81 80.00 175.81 0.38 32.69 142.74 1394.36 1251.62 41

Current Ratio DER DER with quasi capital TOL/TNW TOL/TNW with Quasi Capital Net Sales Net Profit Before Tax Provision for Tax Net Profit After Tax Depreciation Cash Accruals

1.19 1.63 0.51 13.63 7.42 1330.69 9.53 9.53 0.51 10.04

1.19 1.42 0.52 12.72 7.61 1849.70 15.11 15.11 0.42 15.53

1.19 1.25 0.53 11.61 7.60 2913.03 48.63 48.63 0.42 49.05

1.16 0.88 0.13 10.86 6.12 3384.11 42.86 42.86 0.54 43.4

1.11 0.83 0.13 13.90 8.16 4230.00 52.95 52.95 0.34 53.29

COMMENTS ON FINANCIAL INDICATORS Based on Audited financial statements as of 31/03/2010: Capital/TNW Total net worth of the M/s Veer chemicals has been rising since last 3 years. Capital/TNW improved from `41.58 lacs in 2008-09 to `68.27 lacs in 2009-10 due to induction of additional capital by the proprietor and plough back of the entire profit. As per the provisional balance sheet as of March 2011 the capital is increased to `89.45 lacs & `95.81 lacs as of March 2012. Current Ratio Current Ratio is constant for both the F.Y 2009 & 2010 i.e. at 1.19. It was marginally above the acceptable level of 1.17. In 2010-11 (Prov.), the same is at 1.16 due to increase in sundry creditors and increase in non-current assets (Debtors older than 180 days). In the year 2011-12 the same is estimated at 1.11. DER ( TL/TNW) The DER (Debt-to-Equity Ratio) is reduced from 1.42:1 as of March 2009 to 1.25:1 as of March 2010, due to increase in the capital. It further reduced to 0.88:1 as of March 2011(Prov.), which is due to increase in capital. It is further reduced to 0.83:1 as of March 2012. However, considering the unsecured loan as quasi capital the DER is of 0.52:1, 0.53:1, 0.13:1 as of March 2009, March 2010 & March 2011 respectively, which is reasonable. 42

TOL/TNW. TOL/TNW (Total Outstanding Liability/Total Net Worth) of the firm reduced from 12.72:1 as of March 2009 to 11.61:1 as of March 2010, due to increase in capital. It is further reduced to 10.86:1 as of March 2011(Prov.) followed by increase to 13.90:1 as of March 2012. However by considering the quasi capital the ratio will be 7.61:1, 7.60:1 & 6.12:1 as of March 2009, March 2010 & March 2011(Prov.) respectively, As on 30/05/2011 the party has further introduced under quasi capital from `59.20 lacs to `86.91 lacs which has reduced TOL/TNW in quasi capital to 5.17:1.

Sales: Net sales have been consistently increasing from the year 2007-08. The performance of the firm in the year 2009-10 is encouraging. The firm has recorded a growth of 57.48% over the last year 2008-09 from `1849.70 lacs to `2913.03 lacs. In the year 2010-11(Prov.), it grew by 16.17%. The projected growth of the sales for the year 2011-12 has been pegged at 25% and value of the net sales expected to be `4230.00 lacs. Profitability: FY 2008-09 FY 2009-10 FY 2010-11 FY 2011-12 PBT Sales PBT/Sales (%) 15.11 1849.70 0.82 48.63 2913.03 1.67 42.86 3384.11 1.27 52.95 4230.00 1.25

The profit of the firm has increased `15.11 lacs to `48.63 lacs as of March 2010. It is marginally reduced to `42.86 lacs as of March 2011(Prov.). For the year 2011-12 it is estimated to `52.95 lacs. Overall financial statement of the firm is satisfactory. NO

AUDIT NOTES IN BALANCE SHEET (IF ANY, TO BE SPECIFIED) COMMENTS ON FINANCIAL INDICATORS ON CASH BASIS

The firm has earned the cash accruals of `25.53 lacs as of March 2009, `49.05lacs as of March 2010 and `43.40 lacs as of March 2011 respectively.

43

14. EVALUATION OF MANAGEMENT M/s ABC Chemicals is a sole proprietorship firm which is controlled by Mr. DEF. He is having a rich experience of around 25 years in the same field of chemical industry. Prior starting his own firm he worked as a commission agent which helped him to gain knowledge about the different functionality of chemical industry. He also took assistance of intermediaries, who constantly keep him informed & updated about the new products & changing market conditions. 15. EVALUATION OF INDUSTRY The chemical industry is highly versatile segment in the overall industrial economy of India. It has a linkage of almost every other industrial activity, textiles, rubber etc. There is in fact hardly any segment where chemicals do not feature. The industry has remained amongst the fastest growing sector except for slow-down witnessed in the early 90s which was attributed primarily to the economic liberalization policies ushered in the early 90s. 16. EVALUATION OF BUSINESS RISK There are a number of competitors in the chemical market. The firm mainly deals with established & reputed companies. Hence, the risk in payment default is minimal. In 2010-11, the demand for chemicals is likely by 6-8% on account of improvement in demand from end user segments. Margins of players in the chemical industry are sensitive to raw material as it constitutes nearly 65-70% of the total cost. In the year 2011-12, we expect margins to shrink on account of higher in the feed-stock prices (in line with the anticipated rise in crude oil prices) as compared to product prices. As per the union budget 2010-11, the excise & custom duty remains unchanged except carbon black which in our case the firm doesnt import. 17A. CONDUCT OF THE ACCOUNT a) Regularity in submission of: Stock Statements / Book Debt statement New Account QPR statements / Half Yearly statement New Account Financial Statements Submitted CMA Data Submitted 44

(QPR stands for Quarterly Performance report. CMA stands for Credit monitoring analysis report. All the above statements have to be submitted in case of limit more than Rs.1 Crore) 17B. COMMENTS ON OPERATIONS/ OVERDUES: New Account

18. COMPLIANCE TO TERMS OF SANCTION: New Account Completion of Mortgage formalities

a)

New Account (ROC stands for Registrar of

b)

Registration of Charges with ROC

Companies) (Applicable in case of company) NA

c)

Whether documents valid and in force Whether all other terms and conditions complied with Compliance of RBI guidelines Whether consortium meetings held at prescribed periodic intervals where the Bank is the leader DATES OF INSPECTION

New Account

d)

New Account

e)

New Account (Consortium is applicable when a group of banks in collaboration are providing the credit facility to the borrower) NA (Inspection to be done by bank officials) Done by the bank.

f)

19a

DURING THE FINANCIAL YEAR

19b Nature / Description of collateral security indicating area and location of property

NATURE & VALUE OF COLLATERAL SECURITY Date of Value (in lacs) valuation along with name of valuer Insurance Amt and Date of Expiry Remarks

45

PQR flats Ghatkopar (E) Mumbai 400077 LIC Policy FDR TOTAL 5.00 10.00 165.00 150.00

Valuation done by Yardi Prabhu Consultants Dtd 30/04/2011

(Valuation is to be done by the recognized company dealing in valuation of the real estate property. The valuation should include the market value & distress value.) (FDR stands for fixed deposit receipt) OUR ASSESSMENT: (Verification needs to be as to whether the property given as collateral has already been mortgaged.) Deducting twice the outstanding amount from the valuation, we are left with 80.00 lacs which the party has proposed to add as collateral for the proposed credit facility. Thus, the total collateral coverage for the total limit of 175.00 lacs becomes 54.28%.

(fig in lacs)

19c)

PERSONAL GUARANTEE OF Name PROPRIETOR & FAMILY (WITH MEANS) Mr. DEF Wife of Mr. DEF Total

Means as on 31/03/2010 (fig in lacs) 103.72 24.86 128.58

20 a)

b)

WHETHER THE NAME OF THE COMPANY / DIRECTORS FIGURES IN RBI DEFAULTERS No / CAUTION LIST / WILFUL DEFAULTERS / ECGC. IF YES PLEASE FURNISH DETAILS WHETHER DIRECTOR / PARTNER / PROPRIETOR IS A No DIRECTOR IN OUR / OTHER BANK OR IS RELATED TO THEM IF YES ANY LITIGATION IN FORCE AGAINST THE FIRM / No COMPANY OR AGAINST THE PARTNERS / DIRECTORS IF SO, MENTION DETAILS & PRESENT POSITION 46

c)

21)

22)

AUDIT OBSERVATIONS a) Internal b) Concurrent c) Statutory d) RBI Inspection e) Stock Audit ANY IRREGULAR FEATURE OBSERVED IN THE MONITORING REPORT Limits Existing

(Done by bank auditors) New Account (Done by external auditors) (Done by external auditors) (Done by bank auditors) NA

23a)

EXPOSURE DETAILS FROM OUR BANK Limits Recommended 50.00 -50.00 125.00 (50.00) 125.00 Nil Nil 175.00 D.P O/s. as on Value Of Securities -

Nature of facility

A) FUND BASED LIMITS CC ( HYP. ) New SOD FDR 9.50 Sub Total [A] 9.50 B) NON FUND BASED LIMIT Imp./Inl./ L/C New W/w Buyers Credit Sub Total [B] C) TERM LOAN/ DPGL LIMITS Other term loans New Sub Total [C] GRAND TOTAL [A+B+C] 9.50

(SOD FDR stands for Secured over-draft against the fixed deposit receipt.) (The borrower is already enjoying the SOD against FDR.) 23. b) DETAILS OF EXCESSES ALLOWED DURING THE YEAR No. of occasions excesses allowed Nil Maximum Excess allowed Nil

(Excesses are allowed in the case where the borrower is given credit above the limit which has been sanctioned by the bank.) 23.c OTHER EXPOSURE , IF ANY, NO INCLUDING INVESTMENTS 23.d OTHER LIABILITIES OF NO DIRECTORS / PARTNERS (IN THEIR INDIVIDUAL CAPACITY) 47

24.a EXPOSURE DETAILS FROM BANKING SYSTEM (INCL. OUR BANK)

Name of the Bank

Fund Based Non-Fund Based Comments on the conduct of the account % Amt. % share Amt. Share UBI(SOD/FDR) 100 9.50 Nil Nil Satisfactory Total 100 9.50 (100% share means bank has solely funded the SOD amount. In case of consortium, the bank has to specify the percentage of amount it has funded.) 24. b) CONDUCT OF THE ACCOUNT & EXPOSURE DETAILS FROM FINANCIAL INSTITUTIONS 24. c) VALUE OF ACCOUNT ( Applicable in the case of existing account.) New Account. (Since, this is a new account it is not applicable in this case.) i) Advances 01/04/2009 to 31/03/10 01/04/10 to 31/03/2011 - Interest Income - Fee based Income ii) Retail / Consumer / Finance (to employees associates) iii) Deposits Own & family members Amount Tenor & due date : Satisfactory

DETAILS OF THE FOREIGN CURRENCY 24.d) EXPOSURE COMMITMENTS & NA

UNHEDGED PORTION IF ANY OPERATIONAL 25.a) REGARD CONCERNS COMMENTS ON OTHER BANKS / NA TO EXPERIENCE SISTER / WITH ALLIED NA

25.b) CREDIT REPORT ON SISTER CONCERN (Applicable in the case where the borrower has a sister concerned company.) 48

26 PRUDENTIALEXPOSURE NORMS COMMENTS ON ASSESSMENT OF LIMITS a) PROJECTED LEVEL OF SALES (Rs. in lacs) PERIOD 07-08 (Aud) Sales % growth 1330.69 -08-09 (Aud) 1849.70 39

Within the prudential risk exposure ceiling of the bank

27

09-10 (Aud) 2913.03 57.48

10-11 (Prov.) 3384.11 16.17

11-12 (Proj.) 4230.00 25

b) COMMENTS ON INVENTORY RECEIVABLE (Rs. in lacs) Particulars Mar. 09 (Aud.) Finished goods (Months cost of sales) Receivables (Months sales) Other currents assets Sundry Creditors (Months purchases) Advance from customers 118.95 (0.78) 402.23 (2.61) 33.77 458.64 (3.02) 0.08 Mar. 10 (Aud.) 108.58 (0.47) 711.12 (2.93) 25.15 689.38 (2.96) Mar. 11 (Prov.) 260.04 (0.91) 727.83 (2.58) 50.26 878.33 (3.07) Mar. 12 (Proj.) 275.00 (0.80) 1056.91 (3.00) 62.45 1196.37 (3.48) -

Finished Goods: As per Aud B/S of 2009 stock of finished goods is at 0.78 month cost of sales and it is reduced to 0.47 months as of March 2010. It is increased to 0.91 months in 2011 (Prov) and projected at 0.80 months cost of sales as of March 2012, which is reasonable and acceptable. Receivables: As per Aud B/S of 2009 the credit given to customers was 2.61 months sales and it is marginally increased to 2.93 months as of March 2010. It is reduced to 2.58 months sales in 2011 (Prov) and projected at 3.00 months as of March 2012, which is in line with past trend hence acceptable. Sundry Creditors: As per Aud B/S 2009 the credit available from the supplier is for 3.02 months and it is at 2.96 months credit in 2010. It is increased to 3.07 months purchase as of March 2011 (Prov) and projected at 3.48 months as of March 2012, which is in line with past trend and reasonable and hence acceptable. 49

c) WORKING CAPITAL ASSESSMENT Based on the built up of current assets and current liabilities and its accepted levels, working capital assessment for F.Y 2011-12 is arrived as:

(Amount in Lacs) PARTICULARS (Aud.) 2009-10 (Prov.) 2010-11 (Est.) 2011-12

A. Net Sales 2913.03 3384.11 4230.00 B. 25% of Net Sales 728.25 960.275 1057.5 C. Margin 5% of Net sales 145.65 192.055 211.5 D. Net Working Capital 137.25 145.60 142.74 E. Net Eligibility 528.6 768.22 846.00 The working capital assessment is being done by the turnover method. COMMENTS ON ASSESSMENT Based on the projected sales, the assessment of Working capital limit, the firm is eligible for Cash Credit limit of Rs. 50.00 lacs.

d) TERM LOAN: NA (Applicable in the case where the borrower has applied for any term loan related to business activity) e) NON FUND BASED LIMIT The company is engaged in import of chemicals for which they have requested for Imp L/C (DP/DA upto 120 days) limit of 125.00 lacs. The assessment of L/C limit is as under (Rs. in lacs) A B C D E F G H Projected Total Purchases Projected Import Purchases ( 2011-12) Less: Custom Duty 20% Net Import Purchases Average L/C Period Lead Period L/C requirement on Usance Terms (780 x 120/365) Total L/C requirement 975.00 195.00 780.00 90 days 30 days 256.44 256.44

COMMENTS ON ASSESSMENT Import L/C limit is assessed at Rs. 125.00 lacs as above. 50

BUYERS CREDIT The firm has also requested for the buyers credit limit of 50.00 lacs as sub limit of L/C (DP/DA upto 120 days) limit of 125.00 lacs. The total period of buyers credit and L/C usance period should not be more than 120 days. 28. CREDIT RATING Year Total Score obtained Grade Parameters Borrower Rating Facility Rating Risk Mitigators Business Aspects Total Marks Grade Current Year 31/3/2010 73.44% CR-4 Marks obtained F.Y. 2009-10 44/57 N.A 2/5 47/64 73.44%

RECOMMENDATIONS In view of satisfactory financials of the firm we recommend sanction of credit facility as under: Nature of facility FUND BASED CC( Hyp.) Stock & Book Debt NONFUND BASED L/C (DP/DA upto 120 days) W/w Buyers Credit TOTAL Limits Existing Limits Reco-mend Margin Int / Com Security (Rs. in lacs)

New

50.00

St-25% Bd-40%

BR + 6.25 =16.25

Hypothecation of stock & book debts duly insured with the bank clause DA= Hyp. of goods received under L/C duly insured with usual bank clause & BDs created out of sell of such goods plus pledge of deposits receipt.

New

125.00 10+15=25% Usual (50.00)

New

175.00

(The margin for the fund based limit i.e. CC limit are as follows: 51

1) Stock 25% 2) Book debts 40% The above mentioned margin requirement is at the discretion of the bank & varies as per bank requirement. The margin has to be calculated every month based on stock & book debts value as submitted by the borrower. The rationale behind the stock & book debts value is that it gives us a proper indication of the business done by the firm in the month. The drawing power during a period cannot be greater than the total credit limit sanctioned by the bank. The margin for the Non-fund based limit i.e. L/C limit are as follows: 1) For sight L/C, the margin to be provided is 10% of the total value of sight L/C. The margin to be provided is required in the form of FDR. 2) For usance L/C, the margin to be provided is 25% of the total value of usance L/C. As stated above, the margin needs to be provided in the form of FDR.) Again, the margin requirement at the discretion of the bank. (As this proposal is greater than Rs. 50 lacs, the proposal is required to be submitted at the credit grid of RO, Branch along with all the necessary documents for their approval.) Branch power for sanctioning credit limit Particulars Fund Based Non Fund Based Amount Rs. 4.50 crore Rs. 1.50 crore

For limits under the Branch DOP (Delegation of Power) is appraised & sanctioned in the Branch. Also, the limits under the Branch DOP are sent for grid approval department for further verification provided the amount is greater than Rs.50 lacs. If limits to be appraised & sanctioned are above the mentioned limits in the above table i.e. above the branch DOP, the branch doesnt have the power to sanction the proposal. The branch needs to submit all the relevant documents to the Regional office which will further process the application of the borrower. After such preparation of the proposal, the proposal is sent to Grid department at RO. Grid then verifies the proposal, and then sends it back to the branch with or without its recommendations. If Grid approves the proposal, branch then prepares the sanction advice in duplicate. One copy is handed over to the applicant & another one is retained by the bank. 52

Borrower, if agrees and accepts the sanction advice, bank then goes ahead with procedure of documentation. Applicant has to borne documentation charges and processing charges.

7.2

Documentation Process
The documentation process will vary & change as per the limit sanctioned for the borrower/firm. After the proposal for the working capital credit has been sanctioned by the branch heads/regional branch and sanction advice accepted by the borrower than the documentation process start, the following documents are required before the final disbursement 1.) DP (Demand promissory) note The DP note needs to be separately submitted for all the different limits which the applicant has applied for. 2.) Letter of Continuity (AD-09) Similar to the DP note, the Letter of continuity needs to be separately submitted for different limits. Generally, the number of DP note should be equal to Letter of continuity. 3.) Hypothecation of Stocks & Book-debts (SD-06) The borrower needs to submit the document. The value of this letter is generally 0.2% of the limit sanctioned by the bank. (These above mentioned documents are mandatory documents for any borrower.) 4.) Declaration of Partnership (AD-07) Applicable in the case of partnership firms. 5.) Letter of undertaking not to alienate Hypothecated goods (AD-12) The borrower needs to submit a letter of undertaking stating that they wont isolate their hypothecated goods 6.) Letter of guarantee (SD-01) The applicant needs to submit a letter of guarantee to the bank. The value of this letter is generally 0.2% of the limit sanctioned by the bank. 7.) LSR report This is the legal search report of the property which is being conducted to know the complete details of the property which is being mortgaged. 8.) Memorandum of Title deeds 9.) Declaration & Affidavit - The borrower needs to submit a declaration that he is availing a credit facility. Also, affidavit needs to be submitted which is 53

generally done 1 day after the Declaration by the borrower. Also, declaration & affidavit needs to be notarized. Finally, Vetting of the documents needs to be done by the lawyer. Also, a Credit Process audit (CPA) is required by the internal bank official who will check into the complete credit process done by the bank for the borrower. If any irregularities are found by the bank official, then it needs to be reported to higher authorities. CPA is the process followed by UBI which may vary from bank to bank. The above two process of vetting & CPA will be applicable only when the credit application process is above 10 lacs & 1 Cr respectively.

7.3

Disbursement of credit
Once the documentation process is done then bank disburses the credit. Under this disbursement stage, bank provides the limit raised for the borrower as per the agreement. In case of non-fund based credit, L/C limit is created by the bank, and for fund based credit, the amount is credited in the borrowers bank account. Interest is chargeable only for that portion of the limit, which is actually being used by the borrower. Borrowers, if has availed short-term limit, it needs to be renewed every year. For such renewal of the short-term limit, bank every year has to calculate credit rating and again has to renew the short-term limit, after inspecting the stock and book debts of the borrower of the projected year.

7.4 Follow-Up/Monitoring Bank has to undertake regular follow-up/monitoring steps, to check, if the party is properly utilizing the limit i.e. it checks whether the party has utilized the sanctioned limit & it should be used for the business purposes. If within 3 months of the sanctioned credit limit, the borrower/company doesnt avail complete the process then the bank has the right to reject the sanction limit. Party, each month has to submit the statements of stock and book debts, before 15th of next month.

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8.0 INTRODUCTION TO FOREIGN EXCHANGE


Foreign trade takes place between different sovereign countries having different monetary units, different rules and regulations governing foreign trade, different legal system. Hence, exporters and importers participating in trade have their own compulsions. Thus, the exporters want money for the goods exported or services provided in the currency of the country he resides, the importer on the other hand can pay for the goods imported in the currency of the country .This is where foreign exchange comes into play and helps convert one currency into another and smoothen the flow of international trade and monetary resources. Foreign exchange is a mechanism by which the currency of one country is converted into currency of another country. Forex operation is a very critical and important for a country so the government has developed a systematic process for its operation & regulation. The regulatory authority for the Indian forex market is RBI whereas FEMA [Foreign Exchange Management Act] is the law which regulates the forex market. RBI issues Guidelines/regulations/instructions from time to time which govern the functioning of the market .Only A.Ds (Authorised Dealers) licensed by the RBI can participate directly in the forex market. These are usually the commercial banks which operate in India. Foreign exchange operations can be regulated and controlled by following guidelines: 1. Trade & Exchange Management- This is managed by the ministry of finance with the help of the DGFT Import & Export, Foreign trade policy of the government, RBI & authorized dealers. 2. UCPDC UCPDC stands for Uniform customs & practices of documentary credit. It is managed by International Chambers of Commerce (ICC) which defines set of rules governing Letter of Credit (L/C). 3. ECGC ECGC stands for Exchange credit Guarantee Corporation of India Ltd. ECGC is controlled by the ministry of Commerce through board of directors representing Government, banking, trade & industry. 4. Bank Policies Bank policies includes service charge, internal documentation, margin required etc. These policies vary from bank to

bank as banks are at their own discretion to decide matters related to service charge, margin requirement etc. 55

9.0 ROLE OF BANKS IN FOREIGN EXCHANGE TRANSACTIONS


Banks also play a vital role in forex operations .They perform many functions but the most important one is that they are the intermediaries through whom documents are exchanged for money between exporters and importers. Banks also assist RBI in the administration of FEMA. Every commercial bank deals in foreign exchange since it is an activity with good potential for profits. But, broadly we would classify the functions into: 1. Finance of exports 2. Finance of import, letters of credits 3. Remittances and other miscellaneous services like travelers cheque, currency encashment, credit card transactions, etc. Accounts Used By Banks in FOREX To facilitate dealings in foreign exchange, a bank in India maintains accounts with banks abroad to facilitate the foreign transaction. Similarly, some foreign banks may maintain accounts with bank of India. In banking terminology these are known as Nostro account & Vostro account. a. Nostro Account: An account that bank in our case Union bank of India holds with a foreign bank. Nostro accounts are always in the legal currency of the foreign country. This helps the banks in better cash management as there is no need to convert the currency. e.g.: Union Bank of India maintains an account with Bank of China or Bank of New York. b. Vostro Account: The account opened by a foreign bank in Indian rupee with an Indian bank would be referred by all correspondence by Indian banks as vostro account, meaning foreign bank account with our bank. e.g.: Bank of China having its account in domestic currency with our Union Bank.

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10.0 EXPORT FINANCE


Export finance is a short term, working capital finance allowed to an exporter. An exporter may avail financial assistance from any bank provided following two requirements are satisfied. 1) Timely availability of credit: Funds should be available to the exporter at the required time to ensure the availability of the funds to eligible borrowers. 2) Cost of fund should be affordable: In order to compete in the international market, exporter requires funding at cheaper cost. Export financing is loan made for the shipping of products outside a country. As the name suggests, export finance is divided into financing activities and other export related activities. The financing activities are further sub-divided into a. Pre-shipment finance & b. Post-shipment finance EXPORT FINANCE

Pre-shipment Finance

Post-shipment finance

10.1 Pre-Shipment Finance Pre-shipment is also referred as packing credit. It is working capital finance provided by commercial banks to the exporter prior to shipment of goods. The finance required to meet various expenses before shipment of goods is called pre-shipment finance or packing credit. The exporter requires finance for procuring of raw material, manufacturing and packaging of goods. Forms or Methods of Pre-Shipment Finance a) Cash Packing Credit Loan: In this type of credit, the bank normally grants packing credit advantage initially on unsecured basis. Subsequently, the bank will always ask for security. 57

b) Advance Against Hypothecation Packing credit is given to process the goods for export. The advance is given against security and the security remains in the possession of the exporter. The exporter is required to execute the hypothecation deed in favour of the bank.

c) Advance Against Pledge The bank provides packing credit against security. The security remains in the possession of the bank. On collection of export proceeds, the bank makes necessary entries in the packing credit account of the exporter. d) Advance Against Exports Through Export Houses Manufacturer, who exports through export houses or other agencies can obtain packing credit, provided such manufacturer submits an undertaking from the export houses that they have not or will not avail of packing credit against the same transaction. e) Advance Against Duty Draw Back (DBK) DBK means refund of customs duties paid on the import of raw materials, components, parts and packing materials used in the export production. It also includes a refund of central excise duties paid on indigenous materials. Banks offer pre-shipment as well as post-shipment advance against claims for DBK. 10.2 Post-Shipment Finance Post shipment finance is provided to meet working capital requirements after the actual shipment of goods. It bridges the financial gap between the date of shipment and actual receipt of payment from overseas buyer thereof. Whereas the finance provided after shipment of goods is called post-shipment finance. Forms/Methods of Post Shipment Finance a) Export bills negotiated under L/C The exporter can claim post-shipment finance by drawing bills or drafts under L/C. The bank insists on necessary documents as stated in the L/C. If all documents are in order, the bank negotiates the bill and advance is granted to the exporter.

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b) Purchase of export bills drawn under confirmed contracts: The banks may sanction advance against purchase or discount of export bills drawn under confirmed contracts. If the L/C is not available as security, the bank insists on ECGC cover to be obtained by the exporter. c) Advance against bills under collection: In this case, the advance is granted against bills drawn under confirmed export order L/C and which are sent for collection. They are not purchased or discounted by the bank. However, this form is not as popular as compared to advance purchase or discounting of bills. d) Advance against claims of Duty Drawback (DBK): DBK means refund of customs duties paid on the import of raw materials, components, parts and packing materials used in the export production. It also includes a refund of central excise duties paid on indigenous materials. Banks offer pre-shipment as well as post-shipment advance against claims for DBK. e) Advance against goods sent on Consignment basis: The bank may grant post-shipment finance against goods sent on consignment basis. f) Advance against Undrawn Balance of Bills: Importer normally does not make the entire payment at a time. He retains a part of it, and releases the same after confirming the quality of the goods supplied by the exporter. So, such bills, which are due but against which payment is yet to receive, are called undrawn bills. And bank may provide advance to the exporter against such bills. 10.3 FDBP (Foreign Document Bill Purchased) & PC (Packing

Credit)
FDBP is type of Post shipment finance offered by the bank to the exporter. Under the mechanism of FDBP, exporters bank provides the facility of purchasing the bills of the exporter. This will help the exporter to have the funds available in hand immediately after the shipment of goods. This facility provides exporter with the immediate availability and liquidity of funds to carry on the further export or inland order processing. Also, after availing the FDBP facility, exporter parts with the risk of non-payment by the importer, or any other uncertain event. Bank, for this facility charges some commission to the 59

exporter. FDBP can be availed by the exporter provided a L/C is present or not i.e. it can availed even if the exporter has the export order for shipment of the goods to the importer. Packing credit (PC) is a pre-shipment working capital finance made available to the exporter. This credit limit is usually included in FDBP limit. Bank provides the packing credit to the exporter to fund his initial production, processing or packing activities, for export order. An exporter who has availed the packing credit has to present his export bill to the bank. Eg: Exporter A has availed the FDBP limit of Rs. 15 lacs, within which packing credit of Rs. 5 lacs. Exporter A has used packing credit of Rs. 3 lacs for his export order of Rs. 10 lacs. After availing the packing credit, he undertakes the production of goods as per export order, and finally ships the consignment for delivery to the importer. Now, he has with him the Bill of Rs. 10 lacs. Since, he has availed packing credit the Bank will buy the export bill of the exporter. Bank purchases his bill of Rs. 10 lacs. Exporter actually gets Rs. 10 lacs minus some commission charges of the bank & packing credit he has already availed (Rs. 3 lacs in this case). This means, bank first gets its loan recovered along with its commission charges for bill purchase, from the bill amount and then credits the exporters account by the remaining amount. Now, the Packing credit limit of exporter is again Rs. 5 lacs, but FDBP limit reduces to Rs. 5 Lacs. Finally, when the Bank actually receives the payment from the importer on behalf of the bill purchased the FDBP limit will be re-instated to Rs.15 lacs. 10.4 ECGC Export Credit Guarantee Corporation of India Ltd (ECGC), was established in the year 1957 by the government of India to strengthen the export promotion drive by covering the risk of exporting on credit. Being essentially an export promotion organization, it functions under the administrative control of the Ministry of Commerce & Industry, Department of Commerce, Government of India. It is managed by a Board of Directors comprising representatives of the Government, RBI, banking, insurance & exporting community. ECGC is the 5 th largest credit insurer of the world in terms of coverage of national exports. 60

ECGC Cover is issued to the exporter and guarantees are issued to the Bank (Exporters Bank). It is a type of insurance policy but it covers only the losses. ECGC guarantees protect the bank from losses on account of their lending to exporters. These guarantees have been designed to encourage banks to give adequate credit & other facilities for exporters both at pre-shipment & postshipment stages. Bank provides the funds to the exporter to carry out his export order, but for that bank asks for ECGC cover obtained by the exporter in order to reduce the risk. In ECGC cover if either importer or his bank or both decline to make any payment to the exporter, then in this case the ECGC makes payment to the ultimate beneficiary, provided he has complied with all the necessary requirements and has paid the regular premiums. When L/C is obtained by the exporter, it is not mandatory for the exporter to procure ECGC cover also. But in case L/C is not obtained or it does not cover pre-shipment guarantee, then exporters bank before providing any financial assistance to the exporter insists upon ECGC cover that is to be obtained by the exporter. Eg. When L/C is issued by the importer which would reach the exporter after he has started with the production as per the specifications of the importer, then to start with such production activities he needs funds to be supplied by the banker. Banker without any L/C in the possession of the exporter will not part with funds to provide assistance to the exporter. For this bank will seek ECGC cover to be taken by the exporter for his banker. In case, if the goods produced for the export purpose are unable to be exported due to reasons like unstable political conditions, weather conditions, etc that are beyond the control of the exporter, then ECGC will compensate the exporters bank who has already provided advances to the exporter.

Eg. An exporter of perishable goods like onions etc from India enters into contract for exporting onions to an importer in the foreign country. Exporter has obtained the ECGC cover. Exporter as per specific requirements of the importer has shipped the onions. Due to unfavourable weather conditions, onions were not in consumable conditions. Importer therefore refuses to accept the goods and also, denied to make the payment. ECGC thereby, makes the payment to the exporters bank, as the loss of quality of onions was 61

due to the unfavourable weather conditions.

Such importer parties which

refuse to pay for the goods are then black-listed by the ECGC & future trades with these parties is restricted. Trade with these parties in future will be curtailed. As per the mechanism of ECGC, exporter obtained such insurance cover to protect his banker from any unpredicted financial loss due to export trade. The payment of the insurance premium is to be borne by the exporter. Difference between ECGC cover & insurance cover The difference between a regular insurance policy and an ECGC policy is that, under ECGC if the payment later realized by the exporter, then such an exporters bank which has already recovered the same from ECGC, has to remit back the funds to the ECGC, which is not so in case of regular insurance policy.

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11.0 IMPORT FINANCE


The import department does all the banking activities pertaining to the import of goods to India. This includes opening of import letter of credit, retirement of bills under letter of credit and collection bills. IMPORT FINANCE

Letter of Credit

Inward collection bill

Other import related services: 1. Guarantees 2. Import loans etc

11.1 Letter of Credit A letter of credit (L/C) can be defined as an arrangement where in a bank guarantees, on behalf of its customers, to make payment to the beneficiary upon presentation of documents specified in the credit. In other words it is an undertaking by a bank to pay or accept bills provided the beneficiary of the credit fulfils the terms and conditions set forth in the L/C document. Parties involved in a L/C
1.

Applicant (Opener): Applicant which is also referred to as account party is normally a buyer or customer of the goods, who has to make payment to beneficiary. L/C is initiated and issued at his request and on the basis of his instructions.

2.

Issuing Bank (Opening Bank): The issuing bank is the one which create a letter of credit and takes the responsibility to make the payments on receipt of the documents from the beneficiary or through their banker. The payment has to be made to the beneficiary within seven working days from the date of receipt of documents at their end in case of sight L/C, provided the documents are in accordance with the terms and conditions of the letter of credit. If the documents are discrepant one, the rejection thereof to be communicated within seven working days from the date of receipt of documents at their end. 63

3.

Beneficiary: Beneficiary is normally stands for a seller of the goods, who has to receive payment from the applicant. A credit is issued in his favour to enable him or his agent to obtain payment on surrender of stipulated document and comply with the term and conditions of the L/C.

4.

Advising Bank: An Advising Bank provides L/C advice to the beneficiary which provides the authenticity to the document. Advising bank is normally located in the country of the beneficiary.

5.

Confirming Bank: Confirming bank adds its guarantee to the credit opened by another bank, thereby undertaking the responsibility of payment/negotiation acceptance under the credit, in additional to that of the issuing bank. Confirming bank is liable to make the necessary payment to the exporter in case both importer and issuing bank fail to make the payment.

6.

Negotiating Bank: The Negotiating Bank is the bank who negotiates the documents submitted to them by the beneficiary under the credit either advised through them or restricted to them for negotiation. On negotiation of the documents they will claim the reimbursement under the credit and makes the payment to the beneficiary provided the documents submitted are in accordance with the terms and conditions of the letters of credit.

7.

Reimbursing Bank: Reimbursing Bank is the bank authorized to honour the reimbursement claim in settlement of negotiation/acceptance/payment lodged with it by the negotiating bank. It is normally the bank with which issuing bank has an account from which payment has to be made.

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11.2 L/C Mechanism 1. Export contract

5. Export Goods

6. Document

11. Payment

Exporters Bank (advising & negotiating Bank)

3. L/C 7. Document 10. Payment Figure 5 L/C Mechanism Buyers Bank (Issuing Bank)

Explanation of L/C Mechanism: 1. Contract between exporter & importer. 2. Buyer applies for issue of L/C. 3. Buyers bank issues L/C. 4. Issuing bank communicates issue of L/C to the advising and negotiating bank. 5. Advising & negotiating bank communicate issue of L/C to beneficiary. 6. Advising bank adds its own confirmation, if required. 7. Beneficiary receives L/C. 8. Seller exports the goods. 9. Presentation of documents to negotiating bank. 10. Scrutiny of documents. 11. Discrepancies in documents. 12. Dispatch of documents to issuing bank 13. Presentation of the documents to the applicant and acceptance of the same by him. 65

8. Document

9. Payment

2. Request to issue L/C

4. L/C

14. Delivery of documents to the applicant by the issuing bank. 15. Payment by the buyer to the issuing bank. 16. Negotiating bank receives the payment & pays the money to the seller along with the commission to the bank. 11.3 Uniform Customs and Practices for Documentary Credit

(UCPDC)
The Uniform Customs and Practices for Documentary Credit (UCPDC) were evolved by the International Chamber of Commerce to define a set of rules governing letters of credit which can be universally accepted by all the participating countries. In a purchase and sale transaction, the essence of the agreement is the confidence and trust that seller must have vis--vis the buyer. A business deal is usually completed in following steps Buyer places he order for the goods with the seller after negotiating the price and terms. Seller executes the order and supplies the goods ordered. The buyer effects the payment to the seller after being satisfied that the goods that he has received are the ones that he had ordered. This cycle is complete once the seller receives his payment from the buyer. In a sale and purchase transaction in international business, geographical distances separate the seller and the buyer, and it is really difficult for the buyer & seller to have complete confidence in each other. To avoid these uncertainties the bank steps into the picture by providing a guarantee for this trade. In short a Documentary Credit is an undertaking issued by a bank, on behalf of the buyers (importers), to seller(exporter), to pay goods and /or services, provided that the seller presents documents which comply fully with the terms and conditions of the credit. These are advantages to both the buyer and seller when settlement is arranged by documentary letter of credit. Firstly, the buyer knows that payment will only be made if the documents received comply strictly with the terms and conditions of the credit as stipulated by the buyer. Secondly, the seller knows that payment will be received provided the terms and conditions of the credit are strictly complied with. 66

The main aims of the International Chamber of Commerce in adopting a universal standard for documentary credit were to: Reduce misinterpretations Reduce the number of articles by clubbing them and deleting the repetitive ones. Define the articles in much clearer and simplified language Take advantage of technology.

11.4 Types of Documentary Credit


a) Revocable letter of credit A revocable credit is one, which can be amended or cancelled at any time without prior notice or warning to the seller. It involves risks to the beneficiary, as the credit may be amended or cancelled while the goods are in transit and before correct documents are presented. The seller of goods would face the problem of obtaining payment directly from the buyer. A revocable credit gives the buyer maximum flexibility ,as it can be amended or cancelled without prior notice to the seller up to the moment of presentation of documents to the bank at which the issuing bank has made the credit available for payment. b) Irrevocable letter of credit: An irrevocable credit cannot be amended or cancelled without the agreement of the issuing bank, the confirming bank (if the credit is confirmed) and the seller (beneficiary).An irrevocable credit gives the seller great comfort of payment but is really only dependent upon undertaking of bank abroad. c) Unconfirmed letter of credit: Advising Bank has no engagement or responsibility as regard payment, even conforming document are presented. The Advising Bank will make a decision on ability to effect payment at the time of presentation of documents. The beneficiary will need to assess the country risk concerned before continuing with handling of the credit .It should always be remembered that whilst a bank has issued credit it might not be able to secure the foreign exchange in order to meet its obligation d) Confirmed letter of credit: 67

The confirmation constitutes the undertaking of that bank in addition to that of the issuing bank, to effect payment upon presentation at its counter of conforming documents. Therefore, in the event the issuing bank to effect payment upon presentation at its counter of conforming documents. Therefore, in the events of the issuing bank not being in a position to honour its obligation, the confirming bank will effect payment to beneficiary as prescribed in the credit terms. e) Sight Credit: A credit available by sight payment usually allows the nominated bank to debit account of the issuing bank on the presentation of the conforming document. A draft payable sight may be called for, drawn on the nominated bank. In the case of a confirmed credit, the nominated bank is nearly always the confirming bank. f) Usance credit: It calls for drawing of drafts at a stated usance period requiring acceptance and /or payment by drawee at the end of such usance period. This type of credit is also referred as term credit. In other words, the buyer is given a time-period over which he has to make the payment of the goods that he has bought from the exporter.

11.5 Risks associated with Opening Import L/C


The basic risk associated with an issuing bank while opening an import L/C are: 1. The financial standing of the importer - As the bank is responsible to pay the money on the behalf of the importer, thereby the bank should make sure that it has the proper funds to pay. 2. The goods - Bankers need to do a detailed analysis against the risks associated with perishability of the goods, possible obsolescence, import regulations packing and storage, etc. Price risk is another crucial factor associated with all modes of international trade. 3. Exporter Risk - There is always the risk of exporting inferior quality goods. Banks need to be protective by finding out as much possible about the exporter using status report and other confidential information. 4. Country Risk - These types of risks are mainly associated with the political and economic scenario of a country. To solve this issue, most 68

banks have specialized unit which control the level of exposure that that the bank will assumes for each country. 5. Foreign exchange risk - Foreign exchange risk is another most sensitive risk associated with the banks. As the transaction is done in foreign currency, the traders depend a lot on exchange rate fluctuations.

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12.0 REMITTANCES
Remittances department would deal with the issuance and payment of foreign currency, telegraphic transfers, mail transfers, issuance and encashment of travellers cheque, sale and encashment of foreign currency notes, maintaining non-resident accounts, etc. Remittances are of two types: Inward remittances. Outward remittances.

12.1 Inward remittances: Inward remittances may arise out of: Export from India. Remittances into India by non residents for investment. Foreign travellers/tourists spending their exchange in India.

12.2 Outward remittances: Outward remittances may arise out of: Imports. Travel of residents outside India. Remittances by foreigners employed/settled in India. Other remittances like gift, medical expenses, subscription to magazines, examination fees etc.

12.3 SWIFT: The SWIFT system of transmitting messages is widely used throughout the world. SWIFT stands for Society World Wide for Inter-bank Financial Telecommunication is a co-operative society registered in Brussels. The transmission of messages takes place in seconds therefore this method is economical and time saving. The greatest advantage is that SWIFT message has is that the communications are sent using pre-defined

structured format, hence there is no ambiguity of any sort, since these formats are used all over the world on a standardized basis for conducting all types of banking transactions. 70

For communication between banks, each bank has its own swift code. The standardized format used for nomenclature the bank consists of 11 alphabets. The break-up of these alphabets is as follows The first 4 alphabets are used for the banks name. The next 2 alphabets are used for the origin country of the bank. The next 2 alphabets are used for the specific city of the branch. The final 3 alphabets are used for the appropriate branch name.

Eg. The SWIFT code for the UBI Bank at Khand Bazar which is located in Mumbai is UBIN-IN-BB-KBZ.

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13.0 CONCLUSION
This report highlights the importance and the impact of working capital finance to any Company/borrower. After all, working capital finance is a segment of finance which deals with the decisions taken by the different corporations & borrowers.

The report discusses about the different types of credit facilities provided by the bank and the complete process involved in the bank for granting capital to the

borrower. It also studies and analyses the tools & methods that are mandatory in arriving at such decisions of giving capital.

The report also gives a brief introduction about the foreign exchange in reference to the various types of facilities provided both to the firm where they may be exporter/importer. This report describes about the various ways in which banks are involved & the roles played by banks in the foreign exchange transactions of the importer & exporter.

Banks by providing all these facilities to the company/borrower earn money in the form of either interest on cash credit, overdraft & guarantees & commission on facilities extended to the importer/exporter. Thus, the final objective of this study is to help in the maximization of firms value & assist them in the wealth creation process by providing the much required assistance to meet their day-to-day credit requirement in the business & to help them in conducting their foreign exchange transactions in an efficient & effective manner by acting as the much needed facilitator.

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14.0 BIBLIOGRAPHY
www.rbi.org.in www.unionbankofindia.co.in www.ecgc.in www.statebankofindia.com www.fedai.org.in www.iibf.org.in www.investopedia.com www.bankofbaroda.com

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