Corporate Banking

By
Prof. Santosh Kumar
 Enough is enough
• This time agricultural farmers’ loan will be
waived...........populist or really
• NPA is all time high requiring massive
haircuts.....................what to do? No one
knows?..............conundrum
• Banks are not skilled enough in credit
evaluation.......all are fools........or only Govt.
one.........no idea...........stop credit...........stop
project finance..............stop
development.........OMG
 Learning Objectives
• The RBI’s regulatory aspects to expand, monitor,
supervise, and control the credit to corporate
sector
• The types of loans and advances and other credit
facilities being extended to the corporate sector
from the banking system
• The concept of consortium lending and
syndicated loans
• And to analyse a term loan proposal of a
corporate firm
 Cont.
• The working capital requirement of a firm
and its various approaches
• The concept of MSMEs and an assessment of
their financial requirements
• The corporate banking policies and process at
the bank level
 Regulatory policy and procedures
• RBI controls the flow of credit to corporate covering
the following areas.
1. Credit allocation ( Lead Bank circular)
2. Exposure limits and group approach
3. Interest regulations
4. Prudential norms for loans and advances ( industrial
loans, SME financing, agricultural loans, asset quality,
terms of repayment, indicators of performing and
non-performing assets)
5. Margin money requirement..
 Stop for a while
• 2.1.1.1 The exposure ceiling limits would be
15 percent of capital funds in case of a single
borrower and 40 percent of capital funds in
the case of a borrower group. The capital
funds for the purpose will comprise of Tier I
and Tier II capital as defined under capital
adequacy standards (please also refer to
paragraph 2.1.3.5 of this Master Circular).
 Credit allocation

Targets and
Helps in
Sub-targets
Credit achieving
for various
allocation financial
priority and
inclusion
other sectors
Exposure limits and group approach

Capital funds • Tier 1

• Tier 2

Exposure • Credit exposure (funded and non

funded)
• Investment exposure (underwriting
and other commitments)

• 15% for single borrower

Exposure limit • 40% of group exposure limit

• 25% exposure in oil companies for
single borrower (Party to oil bonds)
 Cont.
• 5% and 10% additional exposure permitted in
infrastructure sector for individual exposure
and group exposure respectively.
• Exposure of a bank to a single NBFC and NBFC-
AFC (asset finance company) should be less
than 10 and 15 % respectively. 5% additional
relaxation for infrastructure sector.
 One moment...........
• Capital funds: last day of the March of previous
year ( Tier 1 and tier 2)
• AFC............asset finance companies
• NBFC...........Non banking finance companies
• Tier 1 capital....shareholder’s equity and retained
earnings

• Tier 2 capital ..revaluation reserves, undisclosed

reserves, hybrid capital instruments, subordinate
debt
 Interest Regulations
RBI gives guidelines and the banks fix the
interest rate on their on

Arrive at base rate depending on the cost of deposit,

negative carry of CRR and SLR, Unallocable overhead
cost, average return on net worth ( assets-liabilities)

Banks will inform the max, min and the base

rate to RBI. It is reviewed quarterly.
 Cont.
• Interest is also subsidized by way of refinance
to the banks by the RBI or the other apex level
organizations.
• Sometimes interest cap is also fixed by RBI e.g
priority sectors, export finance
 Features of Bank Credit
• Maintaining healthy assets (quality and performance)
• Generation of income
• Risk control ( Mandatory reserves or provisions for
unforeseen situations)
• Managing liquidity ( adequate asset liability
management)
• Search for innovations
• Basis for credit creation (primary deposits are used)
• Driving force for economic growth ( Capital formation
and working capital requirements)
• Function to demand creation ( house, assets, business)
 Process of credit creation

Deposits in Cash reserve Remaining

banks deducted amount lent

Producers buy Suppliers And so on

machines and deposit in ......money
pay to supplier banks multiplies
 Principles of lending
Principles Desirables

Safety •Decentralized and diversification approach

•Reputation of borrower in the market
•Market value of securities
•Adequate interest on loan
Liquidity •Asset liability management
•Less gap between inflows and outflows pattern
•Scattered time schedule of repayment

Profitability Interest income and non-interest income should be sufficient

Purpose •More to production

•Less to consumption and
•No to speculative reasons
 cont.
Principles Desirables

Security Primary and Collateral security

Personal security

Marketability Freely marketable

Value Stability Security should have a stable price pattern

National Interest Credit must flow to agriculture, MSME, infrastructure, strategic

requirements, small borrowers, entrepreneurs, tribal
developments, export oriented industries
Process of lending to corporate sector

• Prepare loan policy document for corporate with detailed

procedures and lend for different needs and different time
1

• Close monitoring and follow up mechanism of loan

accounts to ensure the utilization of loan proceeds for the
2 known purposes and the project runs successfully.

• No resort to undue harassment for recovery reasons

3
 Retail banking vs. Corporate banking
Parameters of Retail Banking Corporate Banking
difference

Nature of Loan Consumer needs, personal Industrial and commercial loans

finance and small loans

Size of Negligible Large

exposure

Purpose Individual needs Project diversification or

expansion

Monitoring Pre sanction monitoring only Regular monitoring and end to

and follow up end fund utilization
by banks
 Retail banking vs. Corporate banking
cont.
Parameters of Retail Banking Corporate Banking
difference

Additional loan rare Often

requirement

Nature of Principal and borrower Principal and borrower along with

relationship commercial relationship

Credit simple Complicated

appraisal

Interest rates Decided by corporate office Lot of bargaining

 Retail banking vs. Corporate banking
cont.
Parameters of Retail Banking Corporate Banking
difference

Loan simple Mortgage and other legal

documentation formalities

RBI role less Exhaustive guidelines

Sanctioning Branch managers Higher level officials

authority

Bank’s expertise No specific skills Specialized skills in corporate

credit appraisal
 Loans vs. Advances
Loans Advances

Lump sum or in parts but after the Regular limit and can operate continuously
withdrawal of sanctioned amount no
further debits other than interest and
other charges
Long term Short term

Against security With or without security

Need not to carry enough cash as it is Banks has to carry enough cash as
one time disbursement customers can withdraw any time the
sanctioned limit.
 Loans vs. Advances
Loans Advances

Lower rate of Higher rate of interest

interest
Not frequent Periodic review and continuance depends on performance
review
Not too Banks have to comply the RBI guideline regarding maximum
much permissible bank finance, margin money, ceiling on the amounts of
restrictive credit for certain purposes
Advances without any security are clean advances e.g personal loan.
They are guaranteed on the basis of promissory note signed by the
borrower. Advances are also extended again tangible and marketable
securities which are pledged or hypothecated with the bank.
e.G cash credit
 So what is cash credit?
• Most common form of advances
• It is an arrangement under which banks allows
the borrower to raise funds up to a certain
limit against securities generally the
receivables or inventories.
• The banks sanction a particular limit and
borrower can withdraw and make other
transactions any number of times but within
the overall permitted limit.
 Then what is overdraft?
• Customer is permitted for a temporary period to
withdraw from the account exceeding the
permitted arrangement.
• Treated as loans and repayable with interest in a
short period.
• Overdrawn amount should be paid within time
otherwise legal action can be taken.
• Sometimes regular overdraft is also permitted
depending on the security or the financial worth
of the customer.
 Types of lending
Fund based lending ( most common, direct, prime
or collateral securities).......actual outflow of the
cash to the borrower

Non fund based lending (initially no fund outflow

but cash outflow if customer fails to fulfil the
obligations. ( letter of credit, bank guarantee

Asset based lending..........looks for future cash flows and

earning capacity of the asset being financed. Bank will
have limited or no recourse to the borrower. E.g
securitization or project finance
 Types of loans and advances
• Short term loans ( < than 3 years)
1. Financing working capital resulting from
temporary build up of inventories and
receivables
2. Seasonal lines of credit subjected to seasonal
sales cycle
3. Other term loans of repayment schedule
with less than 3 years
 Cont.
• Medium term loans
1. Purpose : creating or acquiring of assets
2. Repayment period: 3-7 years
 Cont.
• Long term loans ( 7-20 years)
1. Repayments = f( future CF arising out of asset
financed)
2. Purpose: Fixed assets acquisition, expansion,
modernisation and diversification
3. Substitute of equity or for financing permanent
working capital needs
4. Securities for the term loans are banks’ claim on
assets purchased from the term loan proceeds or
the collaterals obtained by the bank.
Other forms of loans and advances
• Clean advances
1. Loan without any security purely on personal
guarantee or third party guarantee.
2. Given to individuals or professionals with
salary account with sound financial health
and good history with banks.
3. Common parley ....personal loans ...will be
used for consumption, marriage any thing.
4. Repayable over short period
 Cont.
• Bills purchased or discounted
1. Banks discount genuine commercial or treasury
bills.
2. Loan amount constitutes the face value of the
bill minus the discount charges.
Discount constitutes the income earned by the
bank. Investment in these bills is generally
referred to as the third line of defence for the
banks.
3. The banker gets back the money lent on or
before the bill period.
 Cont.
• Consumer credit
It meets the personal and consumption
requirement like purchase of cars,
refrigerators, televisions, and other durable
articles.
Given to customers with good financial record
with banks and repayable by instalments in
the short medium duration.
If loan amounts are exceptionally high
• Loan syndication
• Consortium finance
Both are same or different. Let us see.

RBI also advises that the credits higher than 1.5% of

individual’s bank deposits should normally be
extended on a participation basis.
In case of working capital financed by many banks,
appraisal, follow-up and exchange of information
may be adopted
 Process under direct consortium
finance
• Several banks finance a single borrower with common
documentation, common appraisal, joint supervision
1 and follow –up exercises.

• Lead bank will take initiative and approach client and

collect all information. Client will fixes up the loan with
2 each participating bank. Lead bank will do follow up
and other jobs.

• Loans are disbursed through lead bank

• In case of disputes in recovery, lead bank will take the
3 legal action.
 Direct Consortium finance cont.
• The exposure to a single borrower < 25% of the net
worth of the banking system.
• The lead bank will charge suitable fee for the services
rendered within the RBI guidelines.
• Participating banks may offer different interest rates.
• Borrower of consortium finance should not avail any
other non fund based credit facility outside the
consortium.
• Share of participating bank should be minimum of 5 %
of the fund based credit limit or 1 crore whichever is
more.
 Advantages of direct consortium loan
• Risk is pro rata and diversified
• Credit appraisal becomes effective due to
expertise from various banks
• Smaller banks also get the benefit of
consortium finance
• Less competitive, less cost and more profits to
the bank
• Banks have pro rata right in the shares
 Indirect consortium loan
• Lead bank will directly grant loans to the
borrower and then splits the stocking credit
assets by way of share or repayment time.
Thus the lead bank transfer proportionate
credit assets to the other banks known as
assignee. Then, assignor and assignee form a
bank consortium to manage the entire loan
portfolio
 Now “ Loan Syndication” process

Lead manager Borrower

Borrower
prepares the
approaches a
information will inform
bank known as about the
memorandum and
lead manager to
share with loan
arrange credit and
participating
offers the credit
banks and fixes requirement
terms to lead bank
the T&C
 Cont.

Syndicate Fee consists of

members may arrangement fee,
consist of senior If any credit legal charges,
and junior deficit, it is to be underwriting
members. It is not borne by lead commissions,
essential for lead bank. participating fees,
bank to take facility fee, agency
credit share fee etc.
 Term Loan
• Loan for particular time period ( payments
may in lump sum or instalments)
• Mostly for acquiring movable or immovable
assets. Such assets are charged to the bank by
way of mortgage as prime securities.
• Drawdown may be lump sum or progress
linked ( construction linked)
• Appraisal = f (technical, economical and
financial, legal viability)
 Working Capital Assessment
• Capital required for day to day activities or
complete a working cycle of a product or
service.
1. Capital for inventory
2. Amount involved in receivables
3. Cash required to meet day to day expenses
• Net working capital or liquid surplus = CA-CL
 You may be aware of
• Current ratio...........2:1
• Quick ratio................1:1
• Operating cycle.............as low as possible
• Let us learn “ Maximum Permissible Bank
Finance ( Nov 1975)
• Tandon committee suggested 3 methods to
compute working capital requirement ( MPBF)
 Method 1 (Tandon Committee)
• Total current assets= 1850
• CL less bank borrowings= 750
• Working capital gap = 1850-750= 1100
• 25% margin from long term sources= 275
• Max permissible bank finance= WCG-margin=
1100-275= 825
• Bank borrowings= 1000
• Excess borrowings= 1000-825=175
• Current ratio = CA / ( 750 + MPBF) =
1850/(750+825)= 1.17
 Method 2
• Total current assets= 1850
• 25% from long term funds ( owned funds +term
borrowings)=462.5
• Working capital gap = 1850-462.5= 1387.5
• CL other BB= 750
• Max permissible bank finance= WCG-CL other than
bank borrowings= 1387.5 -750=637.5
• Bank borrowings= 1000
• Excess borrowings= 1000-637.5=362.5
• Current ratio = CA / ( 750 + MPBF) =
1850/(750+637.5)= 1.33
 Method 3
• CA= 1850
• Core assets from long term sources= 475
(assume)
• Real CA= 1850-475= 1325
• Then the entire process as method 2
 Cont.
• As per RBI directions, bank can use their own
method for MPBF
• Concluded
• Method 1= (CA-CL less BB)*0.75
• Method 2= 0.75*CA –CL less BB
• Method 3= 0.75* Core CA-CL less BB
 Turnover method
• Used in small scale industries
• Example
1. Estimated sales = 100
2. Min WC= 25% of 100= 25
3. Borrower’s contribution= 5% of estimated
sales= 5
4. Minimum bank finance for WC= 25-5=20 (
20% of estimated sales)
 Projected Balance Sheet Method
• F ( operating cycle, projected level of
operations, nature of projected current ratio,
profitability and liquidity
• Benchmark CA for liquidity: 1.33.......if lower
than this, it should be examined.
 Cash Budget Method
• Working capital limits = f ( cash gap projected
on monthly or quarterly basis)
• No strict norms for inventory or receivables
 Classification of WC
1. Permanent WC:
• Minimum amount of investments in CA required
to continue with operations of the firm.
• Met through long term sources
2. Fluctuating WC: to fulfil seasonal requirements
3. WC term loan: Usually for WC margin money in
the form of term loan.
4. WC margin through long term sources: WC
margin raised from equity and debt instruments.
 Working Capital and Commercial Bills
• RBI ....Bill rediscounting scheme in 1975 to promote
advances against discounting of commercial bills.
• Commercials bills are short term instrument and
known as bills of exchange.
• Usually supplier of goods draws the bill of exchange on
the buyer for the value of goods supplied. Buyer after
accepting the bill send to supplier.
• After supply of goods, supplier will approach bank by
endorsing on the documents like bills of exchange
along with shipment documents. Bank will give
advance against it. Bank will send it to buyer or the
other bank at buyer place.
 Cont.
• Buyer will receive transport documents
through bank and take the possession of
goods supplied. Buyer will make payment to
the bank which again remits to supplier bank.
• Here payment is received in advance rather
than waiting for credit period. The chances of
dishonour of the bills are minimized as the
banks become intermediary in the process.
• Cost of funds for the supplier is also lower.
 Types of commercial bills
• Foreign bill: Drawn on a person residing outside India
and may be payable outside India
• Inland bills: Drawn on person residing in India
• Demand bill: Payable on demand. No time mentioned.
• Usance bill: Specifies time duration for payment.
• Clean bill: Drawn on the party after supply the goods to
discharge the payment.
• Documentary bill: Drawn to claim the payment along
with documents like bill of lading, railway receipts,
lorry receipts,
 Commercial papers
• Short term negotiable instrument
• Corporate use it for raising resources from money market.
• Unsecured promissory note issued by corporate
• Issuing corporate should have min credit rating of P2 or equivalent.
Min tangible net worth 4 crore. Total WC issued including
commercial papers should be less than MPBF.
• Issued for 7 days to 360 days.
• Min size is Rs 5 Lakhs and multiple of 1 Lakh
• It can be transferred number of times till maturity by way of
endorsement and delivery
• On maturity, holder will receive the payment from the issuer.
• Issued at discount and redeemed at face value.
 Certificate of Deposit
• Short term instrument used to meet the requirement of
WC of corporate
• Secured instrument by Banks or FIs
• Issued at discount and redeemed at face value.
• Negotiable and traded in market by endorsement and
delivery.
• Individuals, corporate, companies, trust funds can invest in
this instrument
• Min size is Rs 1 Lakh and maximum multiple of Rs 1 Lakhs
• Time: 7 days to 360 days and in few cases 3 years.
• Issuing bank pays interest as per the market demand.
• Pre-mature of CD is not allowed.
 Benchmark financial ratios for SMEs
Ratios Desired
Current ratio 1:1
Debt equity ratio ( WC limits <Rs 5 lakh crore for micro and small 4:1
enterprises
Debt equity ratio ( WC limits > Rs 5 lakh crore for micro and small 3:1
enterprises

Debt equity ratio (medium enterprises) 3:1

Interest service coverage ratio 1.5

Debt service coverage ratio 1.25

 Please focus on
• Ability to meet short term obligations
• Debt load
• Debt bearing capacity
• Ability to convert the inputs into outputs
efficiently
• Market perception
• Savings for various stakeholders
 Rate of interest
• Varies with amount (directly proportional)
• Varies with risk (directly proportional)
• Varies with credit rating ( inversely
proportional)
• Priority sector has different norms
Types of services in Corporate Banking
• Exclusive corporate client services
• Forex business management
• Cash management services
• Customize business solutions
• Trade and channel finance
• Supply chain finance
• Trade finance
• Letter of credit
• Project finance and advisory services
• Lease finance
• Insurance services
• Consultancy services