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A Report




Chiranjit Basu



A Report



Chiranjit Basu
Enrollment No. 09BSHYD0234


A report Submitted in partial fulfillment of
The requirements of
MBA Program of
IBS Hyderabad

Company Guide:
Faculty Guide:
Mr. P. K. Misra
Prof. L. Sridharan
Senior Manager
ICFAI Business School
Indian Bank, Ganesh Chandra Avenue Branch

Date of submission: 21st May, 2010


This is to certify that Mr. Chiranjit Basu, Enrollment No. 09BSHYD0234 has
done his summer internship in Indian Bank, 1, Ganesh Chandra Avenue,
Kolkata and has submitted this project report entitled “The Corporate Credit
Monitoring and Follow-Up Practices of Indian Bank” towards partial fulfillment
of the requirements for the award of the Post Graduate in Management
2009-2011. This Report is the result of his own work and to the best of my
knowledge no part of it has earlier been comprised in any other report,
monograph, dissertation or book. This project is carried out under my overall

Mr. P. K. Misra KOLKATA

Senior Manager May 21, 2010
Indian Bank, G. C. Avenue


A journey is easier when we travel together. Interdependence is certainly

more important than independence. It will always be my pleasures to thank
those who have helped me in making this project a lifetime experience for

I would like to express my heartiest gratitude to Indian Bank, Ganesh

Chandra Avenue Branch, Kolkata for giving me an opportunity to work with
its Department of Loans and Advances, my Institute and important persons
associated with this project as without their guidance and hard work I would
have never ever got a chance to have real life experience of working with a
Public Sector Bank of such a great repute and learn practically about the
Credit Appraisal and monitoring practices of Indian Bank.

I would also like to extend my gratitude to Mrs. Sikha Majumdar (Chief

Manager, G. C. Avenue Branch) for giving me an opportunity to join her to
know and learn various aspects of the Loans and Advances in the

It is my privilege to thank Mr. P. K. Misra (Industry Guide & Chief Mentor)

whose guidance has made me learn and understand the finer and
complicated aspects of banking, in general and of Credit Monitoring of Indian
Bank, in particular. The help and guidance which he has extended to me has
made me feel as being an integral part of the organization.

I would like to pay my heartiest regards to Mr. K. P. Bose, the Concurrent

Auditor to the branch. His meticulous technical expertise and above all
kindness to share it with others need special mention. Without his inspiration
and advices throughout the project period, this thesis would not have been

Throughout the time I have gained wonderful guidance and tremendous

support from my internal guide, Mr. L. Sridharan, a tireless champion. It has
been a great pleasure to be associated with him and I feel almost lucky to
have him as my mentor. I forward my heartfelt thanks to him.

I would like to thank all the staff members of Indian Bank, G. C. Avenue
Branch for providing me with necessary information and for their
affectionate care, valuable time and their patience for making this project a
worth. I would especially thank Mrs. Shyamali, Mr. Partho, Mr. Deben, Mr.
Samitabha, Mr. Rajesh Prasad, Mr. Keshab, Mr. Pradyut, Mr. Bidhan and Mr.
Sridam for their constant help.

The greatest credit goes to the blessings bestowed upon me by Almighty
Lord Krishna without whose causeless mercy, I could not have even moved a
step forward and to my parents who are always a constant source of
inspiration in all my endeavors.

Chiranjit Basu































5.2.2 RATIO


5.2.4 BREAK EVEN ANALYSIS……………………………………………………..





































10. RECOMMENDATIONS……………………………………………………

11. REFERENCES………………………………………………………………










The project mainly concerns itself with the study of corporate credit
monitoring practices of Indian bank, G. C. avenue branch, Kolkata with
regards to large borrowal accounts with sanctioned credit limit of Rs. 1 Crore
and above. As the first step, the project involves in depth analysis of the
important returns /statements in the monitoring of working capital
advances such as, MSODs, inspection of stocks, CMO monthly report,
operations in the account, Quarterly information system (QIS) statements,
annual audited accounts, review/renewal of advance, asset classification
under IRAC and other norms, credit rating under RAM model, stock audit,
concurrent auditor’s report and unit inspection report. The pre sanction
appraisal involves the preparation of Credit Reports and careful study of
the borrower’s character, capacity and capital (the 3 C’s). The internal and
external credit ratings accorded to the company are studied. Track
records of repayment / cash flow projections for capacity to repay are
checked. The Key Ratios are studied to understand and evaluate Key Risk
Indicators of the relevant industry. The compliance of terms and conditions
by the borrower is studied and any deviation thereto is reported. Pre-
release Audit is done in this regard. Legal audit reports are studied to
understand the nature of the securities (stocks, equitable mortgages, land,
residences etc.) entrusted with the bank. As the next step of follow-up,
documentation of necessary formats and documents which are to be
issued to the borrower on sanction of a renewal/ enhancement is done to
create a charge on the security. Drawing Limits of various borrowal
accounts are calculated on a monthly basis. As post sanction monitoring,
stock and book debt audit are done to check adequate availability of primary
security, its nature and quantity. Regular monitoring of the operations in the
borrowal account is done to keep a tab on the fluctuations in the account.
Few review/ renewal proposals are taken up to study the nature of an
ongoing borrower and performances (financial, production, credit rating etc.)
of the company are checked. Apart from the above steps, few activities are
concurrent as the project advances, such as the unit inspection with the
bank officials to cross verify the stock statement. The year end balance
sheets and P & L statements submitted by the borrowers (FY 2009-2010) are
studied and comparisons made on the projections with actuals
especially on sales and profit. To understand the working capital assessment
better, various structured products (such as, IND SME secure) of the
bank are studied. Finally, a study on the bank’s NPA accounts is carried out
to understand the nature of the non-remunerative borrowers and suggest
possible remedial measures to prevent slippage of an account into
substandard category.


Banking is both an art and science, which cannot be guided by merely a set
of rules. It is to be guided by general principles only. Even then there is no
rigidity in the application of the set of principles in banking. As a
consequence of post liberalization of the economy and on account of reforms
in financial sector, the Banking Industry has witnessed phenomenal changes
during the last decade. In view of such liberalization, the Credit
Administration also needs to be re-looked, taking into account the variety of
credit products unveiled in the industry and the competition faced from the
new generation banks in luring the potential customers to strengthen their
asset portfolio. There has been thrust for lending under structured retail
banking products which are built on the basic platform of the Conventional
Advances category (O&M Division, Head Office, 2006, manual of Instructions
on Conventional Advances. Chennai: Indian Bank).

Adequately managing credit risk in financial institutions (FIs) is critical for

the survival and growth of the FIs. In the case of banks, the issue of credit
risk is even of greater concern because of the higher levels of perceived
risks resulting from some of the characteristics of clients and business
conditions that they find themselves in. Banks are in the business of
safeguarding money and other valuables for their clients. They also provide
loans, credit and payment services such as checking accounts, money orders
and cashier’s checks. Banks also may offer investment and insurance
products and a wide whole range of other financial services (Takang Felix
Achou, Ntui Claudine Tenguh, 2008, Bank Performance And Credit Risk
Management, University of Skovde).

Credit creation is the main income generating activity for the banks. But this
activity involves huge risks to both the lender and the borrower. The risk of a
trading partner not fulfilling his or her obligation as per the contract on due
date or anytime thereafter can greatly jeopardize the smooth functioning of
a bank’s business. On the other hand, a bank with high credit risk has high
bankruptcy risk that puts the depositors in jeopardy. Among the risk that
face banks, credit risk is one of great concern to most bank authorities and
banking regulators. This is because credit risk is that risk that can easily and
most likely prompts bank failure.

Credit management is a structured approach to managing uncertainties

through risk assessment, developing strategies to manage it, and mitigation
of risk using managerial resources. The strategies include transferring to
another party, avoiding the risk, reducing the negative effects of the risk,
and accepting some or all of the consequences of a particular risk. (Available
from: tips on credit management [accessed 15th April,

This thesis takes a fast look on Banking and Credit management and further
probes into bank risk exposure, borrower’s assessment, effective post-
sanction management and control. An attempt will be made to unfold the
use of some credit management, evaluation and assessment tools, models,
and techniques.


The very nature of the banking business is so sensitive because more than
85% of their liability is deposits from depositors (Saunders, Cornett, 2005).
Banks use these deposits to generate credit for their borrowers, which in fact
is a revenue generating activity for most banks. This credit creation process
exposes the banks to high default risk which might lead to financial distress
including bankruptcy. All the same, beside other services, banks must create
credit for their clients to make some money, grow and survive stiff
competition at the market place.

Banks forward credit to various types of business entities with a view to help
them in carrying out various activities related to their business. Creating
such borrowal accounts does not only involve assessment of the operations

of the account, but also timely following up with the borrower to ensure the
health of the credit and the proper end use of the fund.

The principal concern of this thesis is to ascertain to what extent banks

can manage their large corporate credits, what tools or techniques
are at their disposal to appraise, disburse and follow up with the
borrowers and to what extent their performance can be augmented
by analyzing and suggesting possible remedial measures to identify
early warning signals in the quality of the asset.


 To study the corporate credit monitoring practices of the bank

extending credits to several manufacturing and trading firms having
large borrowal accounts.

 To suggest possible measures (if any) to identify early warning

signals to prevent slippage of accounts in NPA category.

 To appreciate the essential features of a legally binding contract.

 To understand the issues involved in pursuing slow payers and

debtor recovery.

 To understand the Legal Processes in the Collection of Debts.


This study is divided into ten sections; the first section cuts across a general
introduction, statement of problem, objective of the study, and layout of the
Section two is on a brief introduction on the profile of Indian bank in which
organization the thesis work is done.

Section three elucidates the review of literature related to the work done in this
Section four is on the methodology adopted to carry out the thesis work.
Section five describes the Credit Risk Assessment in the Bank.
Section six describes a comprehensive practical case study on the credit
appraisal process of a borrower seeking term loan and working capital finance
from the bank.
Section seven is on a detailed study that is made in relation to the non-
performing assets (bad debts) of the Bank.
Section eight relates to the conclusions reached after the careful study of the
findings of the research.
Section nine describes the inherent limitations of the study
Section ten elucidates few recommendations related to various issues involved
in credit monitoring and NPA control.
Section eleven is on the references used for the present work.


Indian bank is a premier bank owned by government of India. It was

established on 15th august, 1907 as part of the Swadeshi Movement and has
been serving the nation since then with a current team of over 22000
dedicated staff. Total Business crossed Rs.1, 24,413 Crores as on
31.03.2009. Its Operating Profit increased to Rs. 2228.83 Crores as on
31.03.2009 and the net profit stands at Rs. 1245.32 Crores. Indian Bank
follows the Core Banking Solution (CBS) in all 1750 branches making its
efficiency commendable. It has international presence in Singapore and
Colombo including a Foreign Currency Banking Unit at Colombo. It is a fully
diversified banking firm with three subsidiary companies, Indbank Merchant
Banking services Ltd., Indbank Housing Ltd., IndFund management Ltd.
Indian bank is also a frontrunner in specialized banking services. It has 90
Forex Authorized branches inclusive of 1 Specialized Overseas Branch at
Chennai exclusively for handling forex transactions arising out of Export,
Import, Remittances and Non Resident Indian business. The bank has played
several leadership roles in rural development. It pioneered in introducing Self
Help Groups and Financial Inclusion Project in the country. It has won many
accolades for its achievements. It is an Award winner for Excellence in
Agricultural Lending from Honorable Union Minister for Finance. It is the
winner of Best Performer Award for Micro-Finance activities in Tamil Nadu
and Union Territory of Pondicherry from NABARD.

IMAGE which is the acronym for Indian bank Management Academy for
Growth and Excellence is the prestigious Training Academy of Indian Bank.
The academy stands at a quiet and peaceful locality of Chennai, India in a
sprawling complex, with modern amenities like air-conditioned Class Rooms,
Seminar Halls, indoor recreational facilities and a state-of-the-art Auditorium.

The Academy caters to the training needs of Indian Bank, its Subsidiaries
and other members of the banking fraternity. The Academy also undertakes
Training of Middle and Senior Management Personnel of Government, Public
Sector and Corporate companies. The Infrastructure facilities are also
available on payment of stipulated fees to select group of corporate
companies and other bodies (Available from: http//
[accessed 15th April].


How can bank managers, investors, bank regulators and other stakeholders
know whether a bank is a good monitor? This question has gained in
importance since the onset of the recent financial crisis, during which a large
number of banks around the world have shown to be insufficiently attentive
to risks within their portfolios. In this paper we study various methods for
analyzing the ability of a bank to monitor its commercial loans.

The credit appraisal practices (both individual and corporate) of the bank,
and in turn its effect on the overall profitability and loss assets of the bank
has remained an active topic of banking finance research. Although there
has been extensive study done on the banks’ ability to forecast the client’s
repaying capability and its own risk taking ability through pre-sanction
appraisal, there is not much research done on Post-sanction follow up on
similar topic.

Although non-financial corporate debt (bond issues and privately issued
debt) has become more common in the past 10-20 years, bank loans are still
the prime source of business finance, especially for small and medium size
enterprises (SME’s). As a consequence, banks’ ex-ante assessment of the
riskiness of loan applicants, the resulting decision to grant credit or not at
some risk-adjusted interest rate, and the way in which monitoring of granted
loans takes place, are of great importance for most businesses.

Bank regulators also depend increasingly on the risk assessments made by

banks. In the new Basel II Accord (Basel Committee on Banking Supervision,
(2004), International Convergence of Capital Measurement and Capital
Standards: a Revised Framework, June 2004, Basel, Switzerland), internal
risk ratings produced by banks have been given a prominent role and the
size of the required buffer capital will be made contingent on banks’
appraisal of ex-ante individual borrower risk. It will be up to the banks to
characterize the riskiness of the borrowers and loans in their portfolios by
means of a limited number of risk categories or ’rating classes’(Basel
Committee on Banking Supervision, (2003), Quantitative Impact Study 3:
Overview of Global Results, May 2003, Basel, Switzerland, available from:
http:// [accessed 18th May, 2010]

Assessing borrower risk is generally considered one of the banking industry

´s core activities. Banks’ role as an intermediary is commonly explained by
their supposedly superior ability to collect and assess information with
respect to borrower risk. Research has been extensive in this area, since
Diamond formalized the concept of a delegated monitor (Diamond, Douglas,
(1984), Financial Intermediation and Delegated Monitoring, Review of
Financial Studies, no. 51, pp.393-414).

When a borrower suffers unexpected losses its probability of bankruptcy

rises and by a familiar moral hazard mechanism its incentives to invest
optimally falls. A lender who monitors the borrower’s account and is able to
detect such losses may be able to create incentives for the borrower to take
actions that improve expected return. In particular, the lender may strive to
ensure that the operating loan extended by the bank finances operations
and not unexpected equity losses. It is thus an important advantage to a
lender to be able to detect changes in normal seasonal borrowing needs,
that is, flows of inventory and accounts receivable.

Although much of the literature cites a bank’s ability to monitor borrowers as
one of its special talents, the literature rarely describes what gives the bank
its monitoring advantage over other types of lenders. A bank loan officer has
access to fine-grained information about a borrower’s activities through its
operating account, as he or she can observe checks on an item-by-item basis
and compare them to the borrower’s pro forma business plan (Loretta J.
Mester, Leonard I. Nakamura, Micheline Renault, 2001, Checking Accounts
and Bank Monitoring, Federal Reserve Bank of Philadelphia and The Wharton
School, University of Pennsylvania (online). Available from: [accessed 20 May, 2010).

If banks collect private information about the borrowers they monitor, as

economic theory tells us, in addition to the public information that a credit
bureau possesses, and if credit ratings summarize the information included
in them, then bank credit ratings should be able to forecast future changes
in credit bureau ratings. On the other hand, credit bureau ratings should not
be able to predict changes bank ratings (Treacy, William and Mark Carey,
(2000), Credit risk rating systems at large U.S. banks, Journal of Banking and
Finance, No. 24, pp. 167-201).

Banks’ internal credit ratings summarize the risk properties of the bank loan
portfolio and are used by banks to manage their risk. One usually thinks of
these ratings as monotonic transforms of the probability of default, although
Loffler and Altman and Rijken have argued that credit ratings may have
more complex functions (Loffler, Gunter, (2004), Ratings versus Market-
based Measures of Default Risk in Portfolio Governance, Journal of Banking
and Finance 28, pp. 2715-2746).

Internal ratings can also be considered to contain evidence of the private

information that banks possess, and distinguishes them from ratings
produced by credit bureaus (Loretta J. Mester, Leonard I. Nakamura ,
Micheline Renault,2001, Checking Accounts and Bank Monitoring, Federal
Reserve Bank of Philadelphia and The Wharton School, University of
Pennsylvania (online). Available from: [accessed 20
May, 2010).

Another strand of literature has studied what conditions may weaken banks’
or other investors’ monitoring efforts. Recent work has also shown that
screening and monitoring quality by financial intermediaries dropped
substantially in the wake of the current financial crisis (Keys, Benjamin J.,
Tanmoy Mukherjee, Amit Seru, Vikrant Vig, 2009, Financial Regulation and
Securitization: Evidence From Subprime Loans, Journal of Monetary
Economics, 56 (5) (July, 2009), pp700-720). However, the general notion that
financial intermediaries are superior monitors relative to, for example, public
alternatives and other investors, remains empirically unchallenged. In
particular, the informational superiority of bank credit ratings over public
alternatives has not been demonstrated empirically.

The ability of a bank to collect private information and thereby produce a

superior judgment of borrowers’ expected performance is of relevance not
only for regulators and banks, but potentially also for the industrial
organization of borrowers and for business cycle theory. Dell’Ariccia and
Marquez (2004), for example, have pointed out that informational
asymmetries among lenders affect banks’ ability to extract monopolistic
rents by charging high interest rates. As a result, banks finance borrowers of
relatively lower quality in markets characterized by greater information
asymmetries (Dell’Ariccia, Giovanni, and Robert Marquez, 2004, "Information
and bank credit allocation", Journal of Financial Economics 72, pp185—214).

When forced to curtail lending, they reallocate their loan portfolio towards
more creditworthy, more captured borrowers. Povel, Singh and Winton
(2007) investigate the relation between the cost of monitoring, and reporting
fraud incentives for companies across the business cycle. Their work has
implications for how carefully financial institutions should scrutinize firms in
which they invest and for the gains from increased informativeness of
publicly available information (Povel, Paul, Rajdeep Singh and Andrew
Winton, 2007, "Booms, Busts, and Fraud", Review of Financial Studies 20 (4),
pp. 1219-1254).

Profitability and Viability of Development Financial Institutions are directly

affected by quality and performance of advances. The basic element of
Sound NPA Management System is quick identification of Non- Performing
advances, their containment at minimum levels and ensuring that their
impingement on the financials is minimum. Excessive Reliance on Collaterals
has led Institutions to long drawn litigations and hence it should not be sole
criteria for sanction. Banks should manage their exposure limit to few
borrower(s) and linkage should be placed with net owned funds for
developing control over high leverages of borrower level. Exchange of credit
information among banks would be immense help to them to avoid possible
NPAs. Management Information system and Market intelligence should be
utilized to their full potential (Joshi, Dr. Amitabh, Analysis of Non-Performing
Assets of IFCI Ltd (2003).


The methodology followed in this project is in accordance with the guidelines

for post sanction follow up and monitoring by Indian Bank. The HO is quite
specific about the steps that are to be taken to follow up with the borrowal
accounts and reporting the same. The whole project is studied with the help
of few large borrowal accounts of different trading and manufacturing
companies in and around Kolkata. The project is divided into three main

1. Pre sanction appraisal

2. Disbursement

3. Post-sanction Monitoring and Analysis


The main methods of credit appraisal are done according to the Indian bank’s
Loan Policy (2009-2010) as per RBI’s Guidelines. This is framed by the
Head Office’s Credit Division. The methods by which a credit proposal is
appraised are as follows:

4.1.1 Assessment of the profile of the borrower:

Purpose or need for credit: The banker should be very clear as to why the
credit is required by the borrower and the sources wherefrom the borrower
is expected to replay back the loan. If the advance is for hoarding stocks or
for speculation, it should be discouraged. Again, if the money required is for
liquidation of prior borrowings or to make good the loss incurred or for
unproductive expenditure, then the banker should cautiously appraise the

The borrower may require stop-gap finance till the money from other
sources flows in (for example, issuing of share capital/debentures likely to be
subscribed to by the public). Such proposals may be favorably considered for
good parties depending upon merits of each case and subject to RBI
guidelines from time to time.

Also, with emphasis by government on export growth, the banks have been
instructed to allocate at least 12% of their total credit to export sector. The
bank has to finance new classes of people namely professionals, self
employed persons, retail traders, agriculturists and transport operators for
productive purposes and generation of employment.

Types of facilities required: while appraising a credit proposal, the bank

has to evaluate and decide different types of credit that the borrower

Integrity and reputation of borrower: the next step in appraisal process

is to check the market reputation and the integrity of the prospective
borrower. This is to ensure the proper end use of funds and timely service of
the installment and interest.

Borrower’s business expertise, status of his economic activity: the

bank has to ensure the efficiency with which the prospective borrower runs
his business, his experience and expertise in the business concerned and the
short and long term economic viability of the business.

Current risk profile and its sensitivity to changes: the bank has to
enumerate the risk profile of the prospective borrower, check whether it fits
for the advance and also evaluate the future chances of the borrower’s
account being sensitive in terms of risk.

Internal and external credit rating: a very important next step is to

accord suitable credit rating to the prospective borrower. A credit rating
estimates the credit worthiness of an individual or corporation. It is an
evaluation made by credit bureaus of a borrower’s overall credit history.
Typically, a credit rating tells a lender or investor the probability of the
subject being able to pay back a loan. Internal credit rating is done by the
bank itself whereas the external ratings are given by professional credit
rating agencies.

Adequacy and enforceability of the tangible securities/ guarantees

under various scenarios: the securities charged to the bank should be
free from all encumbrances and they should be legally enforceable at all
times under all circumstances.

4.1.2 Standards for financial norms:

The next step is to check the Key Ratios of the business of the borrower,
such as, Current ratio, Debt equity ratio, TOL/TNW, Interest Coverage ratio,
Security Coverage ratio etc. The standard financial norms for considering
credit proposals are given below:

S. Key Ratios Bench Mark (Minimum)


1. Current i. 1.33(without inclusion of annual maturing term

Ratio liabilities as current liability)

ii. 1.17(with inclusion of annual maturing term

liabilities as current liability)

iii. 1.00(including annual maturing term liabilities in

exceptional cases like sugar industry)

2 Debt Equity i. 2:1 for medium and large scale industries

ii. 4:1 for infrastructure projects

3 TOL/TNW 3:1 for all borrowers with exception to the following


5:1 for infrastructure project

9:1 for contractors (including guarantees-NFB)

otherwise 3:1

4 DSCR 1.5 to 2- average; any year shall not be lower than 1.25
during the repayment period

5 Interest 1.5 times


6 Security i. 1.25 times of advance value for WC limits

Ratio ii. 1.20 for term loans

7 FACR 1.20

*Debt Equity ratio- normally promoter’s contribution should be brought

front end. However, in big projects involving a construction period of more
than a year or where a part of such funds are expected to be funded through
internal generation or proposed public/ private offering of equity, bringing
the promoters’ contribution up-front may not be feasible. In such
circumstances it should be ensured that at the minimum ‘the pro rata level’
of promoters’ contribution is infused before releasing the loan.

4.1.3 Exposure to Defaulters/ Willful defaulters:

While evaluating the proposal for credit, it has to be kept in view whether
the names of the borrower entity/ guarantors/ directors/ partners/ trustees of
the borrowing entity are listed in the caution list/ defaulter’s list circulated by
RBI/ CIBIL/ECGC. As per RBI directives, no additional facilities shall be
granted to the willful defaulters whose names appear in the RBI willful
defaulters’’ list.

4.1.4 Preparation of IDO Report:

Techno economic viability forms an integral part of credit appraisal for

manufacturing companies and other projects. All the credit proposals for the
manufacturing sector for limits of more than Rs. 1 Crore shall be
accompanied by Industrial Development Officer’s (IDO) report on the
Technical viability of the proposal.

4.2 Monitoring of implementation of project:

In project financing, one of the major risks is the implementation risk which
leads to revision in estimation of outlays, time limits and consequent
deterioration in credit quality.

The implementation period is arrived at, taking into account, the various
implementation risks perceived. As per the RBI guidelines, the asset is
downgraded in case the commercial operation date (COD) extends beyond a
period of six months from the original date of COD as documented at the
time of financial closure.

Monitoring of the project acquires importance to ensure proper/ timely

implementation of the project. Hence, progress report on implementation of
the project duly counter signed by the lender’s Engineer/ Chartered
Accountant shall be obtained and forwarded to the sanctioning authority on
quarterly basis. An example of Project Implementation Progress Report is
given as per Annexure 1.

Generally, the borrowers require credit facilities either for meeting their
working capital purposes or for purchase of fixed assets, construction of
factory buildings or office buildings etc.

4.3 Credit facilities for Working Capital:

A borrower may require finance for pre-sale transactions i.e. for the purpose
of production. During the process of production he may have to hold raw
materials, work-in process and finished goods at different levels. The actual
holding of such inventory depends on factors like nature of industry, size of
the unit, volume of production and sales, availability of raw material,
capacity utilization, etc. Banks are extending OCC/KCC/LC limits for financing
against stocks and inventories. The borrower may require finance for
meeting post-sales transactions i.e. credit sales through bills. Banks extend
credit facilities for post-sales transactions by way of Bill Finance (Bill
purchase and discount limits, Bills Negotiated under LC).

4.3.1 Application for Credit facility: The pre-sanction includes obtention

of application form from the prospective borrower, analysis of the financial
statements, projections, etc., compilation of a Credit Report and
determination of the eligible quantum of advance, type of advance,

securities to be obtained etc. At the time of receiving the credit proposal,
branches should obtain a declaration from the borrowers about their
relatives, if any, employed in the Bank or in any other bank / financial
institution. Besides, facilities availed in other banks/branches should also be
furnished by them separately. The details of legal heirs of the
borrower/guarantor (Name, Age, Relationship, Address etc.,) should be
obtained in the loan application. These details should be obtained for the
borrower and guarantor separately. The information should be updated on
an ongoing basis, even after filing suit against the borrower. A separate
Credit Proposal Received Register is maintained in the branch to record
information relating to all applications received for sanction of advances.

4.3.2-Analysis of collected information: a critical and careful analysis of

the information collected from the applicant and from other sources is
undertaken in this project. After analyzing the data, the Credit report/s of the
borrower / guarantors is prepared and the applicant's request is presented in
the form of a credit proposal to the sanctioning authority. If the applicant is
already a customer of the bank (which is the case in this project) a scrutiny
of the operations in the account will reveal the trends, connections, nature of
business dealings etc. As far as possible, before sanctioning a credit facility,
the borrower's place of business should be visited.

4.3.3-Preparation of Credit reports: Credit Report is the basic document

on the basis of which assessment of the borrower's character, capital and
capacity (normally referred to as three C's) is made by a banker. In
preparing credit reports, the branch should be careful about the following:
i. Inclusion of assets not standing in the applicant's name
ii. Inclusion of other's share of property
iii. Suppression of encumbrances on the property
iv. Overvaluation of assets
v. Suppression of liabilities.

Credit reports are compiled only after individual verification by a Chartered

accountant of the information relating to the assets and liabilities furnished
by them.

4.3.4-Calculation of Tangible Net Worth in Credit Reports:

The tangible net worth shall be arrived at as under:

i. For individuals/ Proprietorship concerns

a. Movable assets such as Bank deposits, gold ornaments/
jewellery, etc.
b. Personal immovable properties (self acquired properties of an
individual and also any share in the ancestral properties acquired
on the division of the Joint Hindu Family)

Loans taken against any of the above assets in individual name or
offered as third party security

ii. For partnership / Joint Hindu Family firms

a. Capital invested in the business
b. Undivided profits/ deduct accumulated losses, if any
c. Total worth of individual partners

iii Limited companies

Paid up capital and Free Reserves
Accumulated balance of loss, balance of deferred revenue
expenditure and also intangible assets in all the above cases.

The renewal proposal should invariably be accompanied by the Credit

Report. Reasons for increase or decrease in net worth should be indicated in
the report. Reduction in net worth due to disposal of fixed assets or incurring
of loss is a danger signal. If there is any increase in fixed assets, source of
acquiring them should be ascertained or it should be verified whether it is
due to any revaluation of the assets.

When the borrower's/ guarantor's declared Net worth exceeds Rs.50 lakhs,
the following documents should be obtained

i. Certificate from a Chartered Accountant

ii. Photocopy of the title deeds in case of immovable properties
iii. A declaration that any disposal of properties will be intimated to the Bank
iv. A declaration that additional liability assumed will be intimated to the

In the event of the prospective borrower enjoying credit facilities with other
banks, confidential report should be obtained from such banks and a
certified true copy of the same should be sent to the appropriate sanctioning
authority along with the proposal

4.3.5-Assessment of quantum of credit required: The next process

involved in the pre-sanction stage is assessment of the credit requirements
of the applicant. While carrying out this process, branches have to keep in
view the purpose, the period for which the advance is required, type of
facility, security offered, additional benefits that may accrue to the Bank etc.
The assessment of Working Capital shall be made, taking into account
reasonable projected level of activity, so as to avoid frequent sanction of
adhoc limits and excess drawings. There are three main aspects that are to
be considered here:
i. Assessment of the level of current assets required to be held
for a given level of production,
ii. Determination of credit other than bank finance available
to the borrower
iii.Calculation of bank finance required

The following methods are adopted for assessment purposes:

A. Turnover method

B. Short Term Bank Credit(STBC) method

A. Turnover Method: the limit will be arrived at on the

following basis-

i. 20% of the projected annual turnover

ii. The actual working capital needs as assessed by

STBC method, whichever is higher

iii. The Bank Finance is intended only to support the

need based requirements of the borrower. In order to
ascertain the extent of assistance, the marginal
contribution by way of Net long surplus viz., Networking
Capital (NWC) should be reckoned. If it is more than 5% of
the turnover, the limit (being 20% of the turnover) shall
accordingly be reduced. For instance, if NWC is 8% (3% in
excess of the prescribed 5%), then the limit will be
computed as 17% (20% minus 3%) of the turnover. Thus,
the aggregate of the limits plus NWC shall not exceed
25% of the turnover.

iv. While applying the above simple formula of 20%, it

has to be ensured that the borrower’s financial health is
satisfactory as revealed by the following:
1. Borrower’s operations result in net profit every
2. Borrower’s Current Ratio as per the latest Audited
Balance Sheet is not less than 1.20. (Current Assets
around 33.33% of sales and Net Working Capital
around 5 to 6 % of sales).
3. Borrower’s Total Outside Liabilities (TOL) do not
exceed 3 times of the equity (equity would include
quasi-equity represented by subordinate debt, owed
to owners of the business).

B. Short Term Bank Credit (STBC) Method: The Short

Term Bank Credit Methodology of working capital
assessment should be made applicable to all industrial
advances in excess of Rs. 2 Crores. The computation of
working capital under this method is primarily concerned
about the level of Current Assets and the Net Working

i. Level of Current Assets: The level of Current Assets is

expressed as a percentage of Gross Sales projected.
However, it is necessary to ensure that no individual
item of Current Assets is held for unduly longer periods.
Banker has to use his judgment and experience in
appraising inventory. There should not be any excessive
inventory with speculative interest to make profits. If
excessive raw material is due to poor working capital
management and inefficient distribution channel, Bank
should not encourage this.

ii. Net working capital: The minimum level of Net working

Capital (NWC) will be the highest of the following:
 25% of the assessed level of current assets
less Annual maturing term liabilities
 16.66% of assessed level of current assets
 Actual projection as per Balance Sheet

An example of Assessment of bank credit through STBC method for a

borrower having limits of 1 Crore and above is shown in the Practical Case
Study Section.

4.3.6-Compilation of Credit Proposal: a fresh/renewal proposal should

contain the following essential particulars:
i. Name, address of the borrower/guarantor along with Asset
Classification assigned to the borrower.
ii. Net Worth of the borrower/guarantor along with the Assets and
liabilities statements and credit reports.
iii. Quantum of credit requirements of the borrower
iv. Margin proposed, sources from which the borrower would bring
in such margins.
v. Nature and value of security offered, its title, the mode of
charging such security
vi. The renewal proposals should also carry the particulars
such as
a. Date of inspection
b. Name and designation of the officer who inspected the
c. Brief remarks with observation made during the
inspection by the branch regarding value of stocks and
other securities including adverse features, if any.
vii. While assessing the credit requirements of a party, the party's
financial requirements for the next 12 months should be taken
into consideration. This will avoid referring to the sanctioning
authority very often for additional/adhoc facilities. However, for
reasons unexpected, if temporary increase in limits or additional
facilities are required and recommended, the reason for such
increase or additional facility and the period for which they are
required must be clearly stated.

For appraising a credit proposal, lot of information are supposed to be

meticulously checked to ensure safety of the funds. The ways through which
the banker would get these necessary informations are as follows:

i. Application for advance: the application tendered by the

prospective borrower is a primary source of information available
to the banker.

ii. Market reports through friends or competitors of similar trade or

business: All such reports sometimes though contradictory to
each other have to be weighed independently and a balanced
opinion has to be formed about the 'three Cs' of the borrower.

iii. Mode of living: While preparing a credit report, the applicant's

mode/style/status of living has to be ascertained to assess
whether he is normal/moderate/lavish in his lifestyle.

iv. Borrower's bank accounts: the bank accounts of the borrower

lying with other banks are studied side by side. Income-tax
assessment order/returns are studied to ascertain the various
sources of income and the investments declared.

v. Analysis of Assets and Liabilities statements.

4.3.7-Analysis of Assets and Liabilities Statement: these are

very crucial sources of informations as it gives a clear picture about
the net worth of the borrower. The Assets and Liabilities Statements
should be obtained separately for each applicant and guarantor. They
should bear the latest date as far as possible and should be obtained
within a reasonable time, say, not more than 3 months from the date
of such statements. The statement shall contain complete details
regarding the assets and liabilities of the borrowers and guarantors. It
must be accurate by collecting documentary evidences regarding all
movable and immovable assets of the firm/person to whom the
statement is related to. Similarly, all liabilities must also be recorded to
arrive at the actual worth. If the property of a guarantor has already
been offered as a security to the assessing Bank or other
Bank/Financial Institution, the value of the same has to be excluded
while arriving at the net worth of that guarantor. It is necessary to
obtain contingent liabilities of a borrower/guarantor along with the
Assets and Liabilities Statement. Even though the contingent liabilities
need not be taken into account for the purpose of arriving at the net
worth, a footnote should be given in the Credit Report.

For Sole Proprietorship Concerns, the assets and liabilities of

the firm and that of the proprietor should be merged to have a clear
picture of the net worth. Alternatively, in the personal assets and
liabilities statement, the capital employed in the sole proprietorship
concern should be shown as Investment in Business.
For Partnership Firms, for compiling the individual net worth of
the partners, Assets and Liabilities statements from individual partners
showing all their private assets and liabilities should be obtained and
credit report prepared. The capital employed by a partner in the firm
should be ignored in the individual credit reports of the partners, as
these investments form part of the firm’s Net Worth.

In case of Limited companies, their audited Balance Sheets and

Profit & Loss accounts for three years should be obtained and an
analysis and interpretation of the financial statements shall be done.

List of documents to be verified and valued while analyzing A & L


i. In case of immovable properties(land and building)

 Verification of charges in the register of charges

maintained by the company
 Registration of charges with Registrar of Companies in
case of Limited companies
 Search report on the searches made in the office of the
Registrar of Assurances
 Municipal tax receipt, ground rent receipt
 Wealth tax assessment order
 Sale deed and other title deeds, patta, etc

 Non encumbrance certificate.

ii. In case of machinery:

 Original sale invoices of plant and machinery should be verified.

iii. In case of Cash and Bank Balances:

 Pass Book or Statement of account

 Balance sheet

iv. Realizable Book Debts:

 Making enquiries as to the long pending
 Search at the office of the Registrar of Companies (in case
of limited companies)
 Test check of prospective borrower's account books
 Bazaar reports

An example of A & L statement is given in the Practical Case Study

section for the partners of a partnership firm with limits of Rs. 1 Crore
and above.


It is necessary that the terms and conditions contemplated are discussed

with the borrower beforehand to judge the feasibility of including them in the
sanction ticket. After such discussion and firming up, these terms and
conditions should be mentioned in the final recommendations made to the
sanctioning authority along with the reasons for instituting them.

Special conditions applicable to the respective loan/product depending on

various factors like the type of facility, type of security, period of repayment,
method of charging interest, percentage of margin, etc., could also be
specified in the sanctions in addition to these general terms and conditions.

The sanction should be informed to the borrower in writing mentioning

therein the terms and conditions to be complied with. The sanction

communication should clearly divide the terms and conditions into Pre-
disbursement conditions and Post-disbursement conditions. The advance will
be released only upon completion of documentation in all respects as per
Bank's rules. Processing fee and other charges like equitable Mortgage
charges are collected before disbursement of credit. All fund based/non-fund
based /fee based transactions shall be routed only through the account with
the Bank. For working capital facilities against stock etc, monthly stock
statement with break up of stocks as required by the Bank is to be

4.4.1 Documentation:

Documentation is done before disbursement of credit. This step is a must

because the bank may not be able to enforce its rights in a court of law for
recovery of the money due unless the documents executed by the borrowers
and guarantors are complete in all respects and are in order (and kept alive).
The documents are useful in:
i. Identification of the borrower,
ii. Identification of the security,
iii. Creation of a charge on the security,
iv. Settlement of the terms and conditions of a
v. Proving the transaction (like interest to be paid and
repayment terms),
vi. Prevention of fresh charge on the security,
vii. Deciding the period of limitation,
viii. Settlement of the rights and remedies of the lending
banker against the borrower and
ix. Filing suits and enforcing the claim.

The documents should be current and legally enforceable. It should have the
description of securities, the amount of loan/facility, interest and overdue
interest, the date of execution, should give terms of repayment, major and
important terms and conditions mutually agreed upon, the place of
execution etc.

The sanction is scrutinized, documents appropriate to the advance with

reference to the terms and conditions are listed out, procured, the blanks are
filled in correctly without overwriting, cutting, erasing, etc. Advances should
not be released except when all the relevant documents are obtained from
the parties concerned duly executed by them. The documents should be
duly filled in and properly stamped before obtaining the signature of the
borrowers. Formats of documents: The Bank has printed standard forms of

documents to be executed for various products/services normally handled by
the branches. These forms have been drafted by the Bank's Legal Advisers in
the (technical) language commonly adopted and judiciously interpreted by
the Courts with preamble and consideration clauses, obligations, privileges
and reservations and thus provide necessary legal safeguards to protect the
Bank's interests.

In this context, a live case of documentation is given in Annexure 2 for a

trading company.

4.4.2 Pre-release Audit:

On being satisfied that complete documentation / security creation/

compliance of terms and conditions are completed, pre-release audit is to be
conducted for applicable advances.

Pre release Audit is stipulated in respect of advances with limits of Rs.10

lakhs and above in order to bring in discipline with regard to compliance of
terms and conditions of credit sanctions, zero error documentation and
conduct of accounts.

Pre-release Audit shall cover only pre-disbursement conditions and

completeness in documentation.

A live case showing the Pre Release Audit report is given in Annexure 3.


While a qualitative credit appraisal indicates the viability and bankability of a

credit proposal, post sanction measures such as timely disbursement, proper
documentation, monitoring and follow-up play a crucial role in ensuring that
the account continues to be a performing asset.

This plays the most crucial role as it ensures that the account continues to
be a performing asset and the project continues to run in terms of the
projections made. Monitoring also includes anticipation of problems in
advance and taking suitable corrective measure in consultation with the

No industry becomes sick overnight and a careful watch over the working of
the unit would help in tracking and averting sickness in the incipient stage
itself. Close monitoring is of paramount importance particularly in the light of
the fact that once a unit slips into sickness, it becomes difficult for the Bank
to recover its advance in full or even part of it, at times.

The post sanction appraisal depends largely on the pre sanction appraisal.
The requirements of post sanction follow up are:

4.5.1 Security Monitoring:

Banks borrowings must be adequately secured by core current assets. To

ensure this, margins are prescribed on each of core current assets.
Irregularity in the cash credit account arises when bank borrowings exceed
the Drawing Power and the security position is adversely affected. If assets,
existing or to be created out of bank borrowings, are taken as security,
following things should be ensured:

 The security conforms to the terms of sanction, is adequate, in good

condition and readily enforceable.

 All the legal formalities have been complied with and a valid charge on
the security in the bank’s favor has been created.

 While arriving at drawing limits on stocks/book debts, sundry creditors

for goods (including those under supplier’s credit, co-acceptance
liability under DA/LC) should be deducted from the values of such
stocks/book debts.

A Practical example of calculation of adequacy of drawing power is given in

Annexure 7.

4.5.2 Collection and analysis of data:

Various statements and returns need to be studied carefully for proper
monitoring of the borrowal accounts. These are:

i. Monthly stock statement and monthly data on production and sales

(Monthly Select operational data/MSODs),

ii. Inspection of stocks,

iii. CMO monthly report,

iv. Operations in the account,

v. Quarterly information system (QIS) statements,

vi. Annual audited accounts,

vii. Review/renewal of advance,

viii. Asset classification under IRAC and other norms,

ix. Credit rating under RAM model,

x. stock audit and concurrent auditor’s report

xi. Unit inspection report.

4.5.3 Stock statements:

Borrowers should submit a stock statement showing the quantity and value
of stocks hypothecated to the bank. The stock statement should clearly show
the value of unpaid stock, stocks under DA/LC etc.

Regular submission of stock statements from the OCC borrowers should be

ensured. The stock statement received should be properly made use of by
entering the advance value, insurance in force, verification of declaration in
the statement, entering the relevant details in the appropriate registers,
cross verification of particulars with borrower's books and physical
verification of stocks during inspection etc.

Stocks - quantity and value should be reconciled from month to month

showing opening stock, receipts, issues and closing stock. Wherever book
debts are financed, the book debts upto the tenor accepted in the CMA only
should be recognized. In case no specific tenor is fixed by the sanctioning

authority, only book debts up to 180 days are to be taken cognizance for
arrival of Drawing Power.

A review of stock statements (at least once in 6 months) shall reveal the
degree of movement of inventory, raw material, finished goods, etc., and
indicate the non-moving items and the degree of obsolescence of inventory.
For this purpose, borrower should give break up of large value items under
raw materials, stock in progress and finished goods. Such observations shall
be confined only to high value items constituting substantial monetary value
of inventory. (Stock-in-process, for instance, would remain the same if
production is more or uniform every month).

4.5.4 Inspection of stocks: Stock inspection is usually done on a monthly basis with an element

of surprise maintained at the time of inspection. Such inspections are
besides Stock Audit exercise for fund based and non-fund based working
Capital limit of Rs.1 Crore and above. Where there are large volumes of stocks, thorough stock inspection
should be taken up on a small portion in quantity but significant in value. All the establishments of the borrower in the same city like factory,
go-down and office should be inspected on each inspection. Stocks shown in the stock statement shall be cross verified with
those in the books of accounts and the records maintained for the purpose of
excise and other statutory authorities. Valuation rates adopted for stocks with market rates/cost shall be
verified to ascertain whether the company follows the same basis of
valuation as disclosed in the audited Balance Sheet. The supplementary data on consumption, production, sales etc., shall

also be verified with the books of accounts of the borrower.

39 Insurance on stocks shall be examined for its adequacy and coverage
and to ensure that all the policies are in force.

4.5.5-Other factors of relevance at the time of inspection General working and tempo of activity Power supply, alternate of power supply if any. Utilization of power

shall be verified from meter reading. If through alternate supply the fuel
consumption etc., shall be cross checked. No. of shifts worked and labor statements Purchase/sales returns, quality control, scrap/wastage management Maintenance of Account Books and Records Slow-moving/old stocks and book debts Statutory liability/pressing creditors Difficulties, if any, experienced in carrying out inspections. Wherever shortfall in stocks/book debts is noticed, the matter should

be reported to controlling office. While the borrower would be asked to
regularize the accounts, the financial position of the company has to be
examined in detail. For Book Debts, books of accounts and records of the borrower
must be verified and it should be ensured that periodical confirmation from
debtors has been obtained by the company. Internal Reports of the company as to age and quality of book

debts, sales returns of finished goods may also be scrutinized. Consignment stocks in and out to be supported by proper records.

40 Wherever any additional construction/other capital expenditure is
noticed/incurred during unit inspection, it should be cross checked for source
of funds to finance such activities.

4.5.6-Scope of periodical inspection:

Over a period of time, the system of physical verification/ inspection of

stocks within the unit are not given the importance it deserves. It does not
merely involve assessing the quality, quantity and valuation of stocks but
also involves,

1. A look at the tempo of activity

2. A look at the books held at the unit, other relevant records including
copies of returns/ statements submitted by them to the bank and to
the statutory authorities.

3. Meeting and holding discussions with the borrower and key

personnel and also the auditors of the unit.

4. Inspection officials satisfying themselves that the borrower is agile

and committed to his responsibilities.

5. Supplementing and constantly updating bank’s knowledge about the

operations of the borrower in particular and the industry in general.


1. It helps in ascertaining the extent to which the operations of the unit

are conforming to the various norms/ assumptions, on the basis of
which the advance is sanctioned.

2. It reveals several aspects which the financial data generally do not


An example of a Stock inspection for a trading company is shown in

Annexure 4.

4.5.8 Stock Audit:
Stock Audit is an effective credit-monitoring tool, which offers an opportunity
for making a qualitative assessment of the advances. The scope of stock
audit is to go in for a detailed study on the adequate availability of primary
security, its nature and quantity.

Stock Audit is a supplement to the system of inspection. It helps in

identifying irregularities, thereby prompting for initiation of suitable and
timely remedial measure which is crucial in improving the quality of loan
assets of the Bank

The stock audit shall be carried out by an agency appointed by the Bank, the
charges of which are to be borne by the borrower. Stock Audit has to be
conducted once in a year for accounts with fund based and non-fund based
working capital limit of Rs.1.00 crore and above.

For accounts identified by the Monitoring Committee for slippage/showing

signs of slippage and for accounts specifically directed by the Sanctioning
Authority, Stock Audit has to be conducted at Quarterly / Half yearly
intervals as directed.

Coverage of stock audit: Stock audit should cover Book Debts, Pledge stocks,
fixed assets (charged to Bank either as primary or as collateral security) and
goods covered under LCs.

The stock audit report should cover the following:

i. Physical verification of the quantity of stock declared in the stock

statement by visiting the places of storage;
ii. Reconciliation with the stock statement lodged with the bank;
iii. Correctness of valuation of stock by scrutinizing invoices, valuation of raw
material, stock-in-process, finished goods, age, quality etc.;
iv. Valuation of obsolete / slow moving stock;
v. Recovery of obsolete / non-moving stock;
vi. Major customers of the borrower;
vii.System for maintenance of stock and stock records, movement of stock
from stores, policy of procurement, management of stocks;
viii.Age-wise break-up of receivables and their realizability in normal course;

An example of the analysis of Stock and Book Debt audit is given in
Annexure 5.

4.5.9 Periodical inspection of units and verification of

Periodical inspection of goods secured under KCC/OCC should be done.
Periodical inspection and verification may also be undertaken of machineries
and immovable properties taken as security for term loans. It is to be noted
that the purpose of inspection is not only to ensure the availability of
sufficient security cover for the advance but also to have a first hand
knowledge about the borrower's current business position, his problems,
bottle necks faced etc. so that necessary corrective measures can be taken

Inspection of the units financed / securities charged on a regular basis

constitutes a vital tool in effective credit administration. Besides, the signals
forewarning the onset of any problems could also be detected during such

The inspection of units should be done on a monthly basis unless or

otherwise the periodicity of the same is specified quarterly / half-yearly etc.,
in the sanction.

The order of priority for inspecting the Units is as follows:

i. Accounts which do not show healthy signs of operation and wherein the
submission of stock statements and other financial data is irregular
ii. Accounts with healthy operations
iii.Consortium advances

4.6 Monitoring the operations in the account:

The operations in the cash credit accounts should be verified to check the
health of the account, that is, if there are healthy fluctuations in the account
depending on the sales etc. It should also be checked if there are any
drawings for the purposes other than that for which the advance has been
Following aspects should be meticulously checked in terms of an account

1. Unusual debit/ credit entry

2. Return of Bills Receivables/ Cheques unpaid

3. Repeated requests for additional funds which may indicate decline in

sales, low realization of debtors or payment to pressing creditors,
diversion of funds, cash loss etc.

4. Decline in level of operations in the account.

5. Large return of inward bills

6. Default in payment of Term Loan installments/interest

7. Devolvement of LCs, invocation of guarantees or excessive extension.

8. Notice of demand from PF/Tax assessment, law suits or other legal
action against the borrowers.

4.6.1 Quarterly Information system (QIS):

For borrowal accounts having aggregate working capital limit of Rs.1 Crore
and above, statements under Quarterly Information System (QIS) should be
obtained as per time schedule prescribed and scrutinized. QIS can be used
as a tool for checking the purpose of the drawals. The projections made in
the QIS will enable the banker to know whether the drawal is to meet the
working capital requirements or not.


Compare the information with projections for the whole year. Any variation
over 10% should be scrutinized.


1. Production and Sales shall be compared with earlier projections; so

also current assets and current liabilities. Any variation over 10% on
either side should be enquired to initiate corrective steps.

2. Variation in NWC compared with the actuals of previous quarters shall
be analyzed for possible diversion.

3. Actual sale and inventories of two quarters shall be compared with

figures given in half-yearly statement. Cumulative sales for four
quarters shall be compared with the audited accounts of the
corresponding year.


1. Sales, cost of goods sold and other expenses and operating profit shall
be studied to understand the trend. Any negative trend should be
noted down.
2. Variation over 10% between estimates and actuals shall be studied
and analyzed.
3. Relationship between insured value of stock/security and value
declared shall be studied. Any inadequacy has to be corrected.

A practical example of QIS-I and QIS-II for a trading company is given in

Annexure 6.

4.6.2 Funds flow statement:

1. Variation in excess of 10% between estimates and actuals shall be

analyzed to know how deficit was covered or excess was utilized.
2. Increase in bank borrowing without corresponding increase in
inventory and receivables shall indicate that such borrowings were
used for other purposes. Borrower should be advised to take steps to
repay the amount so diverted.

4.6.3 Review/Renewal of advances:

Review/renewal of advances is an important post sanction exercise. Review

helps to identify the state of health of an advance and is an opportunity to
evaluate the performance of borrowers and to adopt remedial measures to
safeguard our Bank's interest.

Review/ renewal is also one of the many parameters on which the RBI
evaluates a bank’s performance. So, all the borrowal accounts are subject to
periodical review or renewal.

Review/renewal of advances involves collection and analysis of individual

account data like
i. Account behavior
ii. Financial performance
iii. Market reports of the borrowers
iv. Production performance
v. Overall change in credit rating

The review exercise pays more attention to future performance of the

company, apart from detailing account operations, profitability and security.
The review covers the market risks and management risks (for example,
there may be change in the management or in the quality of management).

The financial performance analysis has to give importance to the underlying

reasons for the variance in actual performance vis-a-vis projections and
management action required to correct the situation.

Proposals for increased working capital assistance shall be based on increase

in sales projection. Any increase in demand for Working Capital without
considerable improvement in sales calls for deeper study of the
circumstances. Such a trend shall indicate that the company is using current
surplus towards liquidation of term loan dues or acquisition of capital asset.

This process gives the banker an opportunity to evaluate the borrower's

operational performance both quantitatively and qualitatively, to reassess
his credit requirements, to check up afresh the continuity or otherwise of his
financial solvency, to review the rating of his credit worthiness etc. These
aspects help him decide his recommendations as to whether the limits
should be renewed or reduced or cancelled.

While considering the application of renewal/enhancement/ additional/ fresh

limits, it should be checked as to whether the names of the
proprietor/partners/Directors find a place in the list of defaulters under
various categories like RBI, CIBIL etc. All renewal proposals should be
accompanied by a Credit report of the borrower as a review form.

Irregular features that have been detected during the course of
operational/security/financial follow up, should be specifically mentioned in
review proposal.

While submitting the review proposal, any steep fall in the security value, fall
in Net Worth of the borrower/guarantor, fall in production/sales etc should be
brought into notice.

Renewal proposals should also contain following additional particulars:

 Interest income derived
 Commission earned from non-fund based facilities
 Share of export business passed on to the bank
 Other financial benefits accrued/accruing to the Bank. of Balance Sheets and other financial statements:

The balance sheet and other financial documents submitted by the borrower
are extra sources of informations to the bank. These documents should be
properly studied and commented upon on the liquidity, solvency, profitability
and turnover of assets. Symptoms such as over-trading, decline in profits,
decline in sales (in terms of quantity and/or price) decline in net
worth/negative net worth, deterioration of current ratio, decline in gross
profit and/or operating profit margin, mounting external debt, poor inventory
turnover, diversion of funds outside the business, diversion of short term
funds for long term uses etc. should be checked.

4.7 Identification of willful defaulters’ accounts:

Banks and FIs will report all cases of willful defaults which occurred or
detected after 31st March, 1999 on a quarterly basis - (then and there
without any delay) to RBI. A willful default would be deemed to have
occurred, if any of the following events is noticed

 The unit has defaulted in meeting its payment / repayment

obligations to the lender even when it has the capacity to
honor the said obligations.

 The unit has defaulted in meeting its payment / repayment

obligations to the lender and has not utilized the finance from

the lender for the specific purposes for which the finance was
availed of but has diverted the funds for other purposes.

 The unit has defaulted in meeting its payment / repayment

obligations to the lender and has siphoned off the funds so that
the funds have not been utilized for the specific purpose for
which the finance was availed of nor are the funds available
with the unit in the form of other assets.

For accomplishing this, the willful defaulters’ list in the website should be checked to identify names of the borrowers,
directors, promoters or proprietors. In case, a similar name happens to occur
in the list, the concerned party should be asked to give justification.


In today’s deregulated financial regime, risk perception in respect of a
borrowing unit is considerably influenced by internal as well as external
factors. If these factors are not favorable, a performing unit may suffer with
adverse risk situations. Each Bank has to develop its own Internal Rating
System to rate its Borrowers. All exposures have to be brought under Credit
Rating Framework (CRF). For the purpose of internal rating, the Bank has
developed the Risk Assessment Model (RAM).

A credit rating estimates the credit worthiness of an individual, corporation

or even a country. It is an evaluation made by credit bureaus of a borrower’s
overall credit history. Credit ratings are calculated from financial history and
current asset and liabilities. Typically, a credit rating tells a lender or
investor the probability of the subject being able to pay back a loan.
However, in recent years, credit ratings have also been used to adjust
insurance premiums, determine employment eligibility and establish the
amount of a utility or leasing deposit.

A poor credit rating indicates a high risk of defaulting on a loan and leads to
high interest rate, or the refusal of a loan by the creditor.

An individual’s credit score, along with his or her credit report, affects his or
her ability to borrow money through financial institutions such as banks.

The factors which may influence a person’s credit rating are:

i. Ability to pay a loan

ii. Interest

iii. Amount of credit used

iv. Saving pattern

v. Spending patterns

vi. Debt

Thus, credit rating enables the investors to draw up the credit-risk profile
and assess the adequacy or otherwise of the risk premium offered by the
market. It saves the investor’s time and enables him to take quick decision
and provides him better choices among available investment opportunities.
Issues have a wider access to capital along with better pricing. Issuers with a
high credit rating can raise funds at a cheaper rate thereby lowering their
cost of capital. It acts a s a marketing tool for the instrument, enhances the
company’s reputation and recognition and enables even lesser known
companies to raise funds from the capital market.

This way, credit rating is a tool in the hands of financial intermediaries, such
as banks and financial institutions that can be effectively employed for
taking decision relating to lending and investments.

5.1 Categorization of Risk and Its Evaluation:

In the Credit Risk Assessment System, all possible factors that go into
appraising the risk associated with a loan proposal have been taken into
account. These factors have been broadly classified as under-

1. Financial Risk

2. Industrial Risk

3. Management Risk

4. Country Risk

In order to arrive at the overall risk rating, the factors duly weighted are
aggregated and calibrated to arrive at a single point indicator of the risk
associated with the credit decision

1. Financial Risk:

The financial risk of the project is ascertained on the basis of the

financial data and related documents provided by the client. The credit
analyst generally redraws the financial statements of the client
incorporating the changes which he deems fit. The financial risk aspect
of a credit proposal is indicated by the following parameters:

i. Latest financials of the unit (financial ratios)- there are a few

selected number of ratios (actual for the existing companies and
projected for the new companies) considered by Bank which throw
light on the operational and financial risk aspect of the borrowing
company. These ratios are also referred as ‘Quantitative (Static)’
parameters of the company. Six ratios have been considered for the
purpose of risk assessment in Working Capital credit proposals and
five ratios in case of Term Loan assessment proposals.

Ratios considered for financial risk assessment:

Working Capital Term Loans

1. Current ratio Project debt/ equity


3. PBDIT/ Interest Gross average DSCR of the


4. PAT/ Net Sales (%) Gross average DSCR for all


5. ROCE or ROA (%) Terms of payment (Years)

6. (Inventory+
receivables)/ Net
Sales (In Days)

ii. Average financials over a period of time- the latest financial ratios of
the company are now compared with its own average over a period
of time. This mode of comparison is also referred to as comparison
on ‘quantitative (dynamic)’ parameters of the company.

iii. Comparison of latest financial with the industry average- the latest
financial ratios of the company are also compared with the latest
available industrial average. This mode of comparison is also known
as ‘quantitative (dynamic)’ parameters.

iv. Risks which are not transparent- there are several risk aspects that
are not gauzed from reading of the figures provided by the financial
statements. These risks are inherent in the off- balance sheet
liabilities, court cases, contingent liabilities etc. of a company. A fair
idea of these risks can also be had from the Auditor’s Notes and
qualifications pointing out the various adverse features on the
operations/ standing/ strength of the borrowing company. These
risks are referred to as the ‘qualitative’ factors.

2. Industrial Risk:

One of the important elements in the process of appraising a credit

proposal is to study the current trend in the industry. A credit analyst
is required to select a specific value statement, which, in his opinion
describes the industry situation vis-à-vis the borrowing unit to the
closest possible extent. This would enable the credit analyst to assign
a score for the perceived risk. The following are the industry risk
parameters prescribed by the Bank against which the credit analyst
has to comment:

a. Competition/ market

b. Industry cyclicality

c. Regulatory

d. Technology

e. Inputs profile

f. User profile

3. Management risk:

The prime factors of management are skill and integrity of promoters

of the project. Some elements of good management are:
i. Aggressive and growth-oriented approach;
ii. Well-developed and adequate facilities for Research and
iii. Dynamism and flexibility in approach to problems.

The credit analyst has to select a value statement in respect of each

management risk parameters, which most closely matches with his
perception of the borrowing unit.

4. Country Risk:

Country risk is the risk that a borrower will not be able to service its
obligations to pay because of cross border restrictions on the
convertibility or availability of a given currency. It is also an
assessment of the political and the economic risk of a country. Country
risk is assumed to exist when 25% or more of the borrower’s cash
flows or assets are located outside India. The bank provides a ready
reference table which is referred to by the analyst to incorporate the
effect of the country risk.

Various Credit rating Models in Indian bank:

1 CRM – 1 = > 2 LACS TO <25 LACS

3 CRM –3 >= 25 LACS IN NBFC
4 CRM –4 >= 25 LACS TO 100 LACS SSI

A Practical example of credit rating through RAM model is given in the

Practical Case Study Section.


Financial appraisal or financial feasibility test is concerned with the

identification of the financial strengths and weaknesses of a firm from the
available accounting data and financial statements. The basis for financial
analysis, planning and decision making is financial information. Financial;
information is needed to predict, compare and evaluate the firm’s earning
abilities. The Profit and Loss account shows the operating activities of the
concern and the Balance Sheet depicts the balance value of acquired assets
and liabilities at a particular point of time. For the purpose of obtaining the
material and relevant information necessary for ascertaining the financial
strengths and weaknesses of an enterprise, it is necessary to analyze the
data depicted in the financial statements.

The test for financial feasibility of the project is conducted on the basis of the
financial data and related documents provided by the client. The credit
analyst generally redraws the financial statements of the client incorporating
the changes which he deems fit. For redrawing the financial statements, the
analyst takes the help of the information provided by the client. This redrawn
information is then put to test to ensure that the project meets the following
minimum financial criteria:

1. The estimated cost of the project is reasonable and complete and has a
reasonable chance of materializing as per projections.

2. The financial arrangements are comprehensive without leaving any

gaps and ensure cash availability as and when needed.

3. The borrower’s repaying ability as judged from the project operation is

demonstrable with a reasonable margin of safety.

5.2.1 Broad Steps of Financial Appraisal:

A. The fits task of the financial analyst is to determine the information

relevant to the decision under consideration from the total information
contained in the financial statement.

B. The second step is to arrange information in a way to highlight

significant relationships.

C. The final step is the interpretation and drawing of the inferences and

Step 1- Determination of the relevant Information Accounting Information:

The accounting data and figures are available from the financial statements.
These are important because mere overlook can give an indication of the
health of the entity requesting the financing. The accounting information
provided by the client can be altered by the analyst as per his understanding
of the economy, industry and the business of the client.

54 Cost of project:

Correct estimation of the total cost of the project is important as it has a

bearing on the means of financing and profitability.

The cost estimates should be scrutinized item by item (wherever possible by

a comparative analysis of the cost estimates of similar projects in the same
industry) with a view to ensure that they have been arrived at realistically
after taking into account all relevant cost optimization factors. A very
reliable test is to express the total cost of the project in terms of per unit of
installed capacity and compare it with per unit cost of similar projects in the
same industry.

Inaccurate estimation of total project cost will have an adverse impact on

the ultimate course of the project. Underestimation will inevitably lead to a
cost overrun and hamper the project implementation. Overestimation, on the
other hand, will inflate the total project cost giving scope for diversion of
excess funds for other purposes. Means of financing:

The credit analyst is to examine the proportion of the ‘debt’ and ‘equity’
components envisaged in the tie-up of the means of financing of the project-
which is technically called the ‘ project debt/ equity gearing’.

Break-up of Equity and debt components:

Equity components include Debt components include

1. Share capital a. Debentures

a. Equity shares

b. Preference shares

2. Internal cash accruals b. Term loans

(Including general reserve,

profit and loss account balance

3. Any other (like central or state c. Deferred payment facilities

subsidies etc.)

d. Unsecured loans

e. Any other (like central/ state

tax loans, development loans) Estimated sales:

Volume of sales depends upon how much can be produced and how much
can be sold. A detailed market study would establish as to how much the
company can sell. But how much a company can produce depends upon the
capacity installed and the capacity utilization. Estimated Cost of production:

Cost of production include cost of raw material consumed, cost of utilities,

factory overhead, selling and administrative overhead, depreciation,
financial expenses, payments for royalty and know-how, preliminary
expenses written off, taxation etc. the credit analyst ahs to examine the
estimates of all these expenses with reference to data of the similar plants in
the same industry. Estimated Profitability:

The credit analyst has to examine the reliability of the estimates of revenue
and cost figures to arrive at a reliable estimate of the profitability of the unit
concerned. This is an important criterion as the repayment ability of the
borrower will depend upon the profitability of the business. Security:

The credit analyst has to check the value of security provided by the client.
Generally bank asks for primary and collateral securities to safeguard its

Step 2- Arrangement of information

There are various tools at the disposal of the credit analyst that can be used
for the purpose of arranging the information. These tools organize

information in such a way that can be used to draw inferences. These are
explained as under:

5.2.2 Ratio Analysis:

The relationship between two or more accounting figures/ groups is called

financial ratio. It helps to express a relationship between two accounting
figures n such a way that users can draw conclusions about performances,
strengths and weaknesses of a firm. Some of the important ratios used for
the purpose of both financial appraisal and credit rating are as follows:

1. Current ratio: - current ratio= current assets/ current liabilities

(excluding annual maturing term liability).

2. Interest coverage ratio: interest coverage ratio=PBDIT/ interest

PBDIT= profit before depreciation, interest and tax

Interest= interest+ finance charges

3. Debt service coverage ratio:-

DSCR= (PAT+ interest on term commitments)/ (installments on term

commitments+ interest on term commitments)

PAT= profit after tax

Term commitments= all term borrowings including deferred credit.

4. Debt equity ratio-

Debt equity ratio= long term debts/tangible net worth

Long term debt includes all term borrowing including deferred credit as
well as annual maturing term liabilities.

5. Total outstanding liability(TOL)/ tangible net worth(TNW)-

TOL includes all form of debts such as current and term liabilities, off
balance sheet liabilities, subordinated debts, optionally convertible
debentures. Redeemable preference shares having residual maturity
of less than 12 years, deferred payment credits, bills discounted etc.

TNW= net worth- intangible assets.

Net worth= paid up equity capital, free reserves (excluding revaluation
reserve), preference share capital due for redemption after 12 years,
deferred tax liability, instruments such as compulsorily convertible
preference shares, share application money and fully convertible
debentures, central/ state subsidy, long term unsecured loan from a.
government, b. government agencies redeemable beyond 7 years and
c. from promoters usually subordinated to institutional loans.

Intangible assets= items such as good will, miscellaneous expenditure,

deferred payment expenditure, preliminary/ pre operative expenses,
deferred tax asset, accumulated losses etc.

6. Net profit/ sales-

Net profit= profit after tax

Sales= sales-excise duty (i.e., net sales)

This analysis is to be made as a ratio or percentage and not on

absolute terms. This is to be compared with accepted projections.
Where accepted projections are not available, the same may be
compared with previous year’s actual.

7. Cash profit/ sales-

Cash profit= net profit+ depreciation

Sales= sales- excise duty (i.e., net sales)

This analysis is to be made as a ratio or percentage and not on

absolute terms. This is to be compared with accepted projections.
Where accepted projections are not available the same may be
compared with previous year’s actual.

8. Return on capital employed-

ROCE= PBIT/ (total debt + tangible net worth)

PBIT= profit before interest and taxes

Total debt= total outside liabilities as explained under point no.6


9. Current assets holding level-

Current assets holding level= current assets/ sales

Sales= sales- excise duty

This analysis has to be made as a ratio or percentage and not on

absolute terms. This is to be compared with accepted projections.
Where accepted projections are not available, the same may be
compared with previous year’s actuals.

10. Debtor holding period-

Debtor holding period= (average debtors/ sales) X 365

Average debtors= (opening debtors+ closing debtors)/2

Sales=sales- excise duty

11. Inventory holding period:

Inventory holding period= (cost of sales/ average inventory) X 365

Average inventory= (opening inventory= closing inventory) /2

12. Creditors holding period:

Creditor holding period= (average creditors/ purchases) X365

Average creditors= opening creditors+ closing creditors) / 2

Creditors= sundry creditors + bills payable+ drawee bill outstanding

5.2.3 Sensitivity Analysis:

Dealing with uncertainty is an inescapable part of planning and decision

making. Sensitivity analysis is the practical way of assessing the degree of
sensitivity of the solution for many types of decision. All the factors except
one are held constant and the value of one being studied is altered,
increment by increment in both upward and downward directions. At each
alteration the result is noted. This process is repeated for each of the factors
in the problem and the sensitivity of the solution to changes in the values of
each of the factors is thus identified. The purpose of sensitivity analysis is to
determine how varying assumptions will affect the measures of investment
worth. After assembling all the sensitivity data, a judgment can be made as
to whether the picture presented is acceptable or not.
Steps involved in sensitivity analysis:

1. Identification of variables

2. Evaluation for possibilities for these variables

3. Selection and combination of variables to calculate the return of the


4. Substituting different vales for each variable in turn while holding all
other constant to discover the effect on the rate of return

5. Comparison of original return with this adjusted return to indicate the

degree of sensitivity of the change in variables

6. Subjective evaluation of the risk involved in the project

5.2.4 Break-even Analysis:

The relationship between cost, sales and profit at different levels of activity
can be known from the Break-even Analysis. The break-even point is the
level of activity or sales at which neither a profit nor a loss is made. At this
point, the sales revenue exactly equals the total costs.

The break-even point is important to the management of a firm because it

indicates the lowest level to which the activity can drop without putting the
continued life of the firm in jeopardy. It may not necessarily be fatal for a
concern to operate below the break-even point occasionally, but in the long
run it must operate above this level.

The break even analysis can also take the form of a chart, known as the
Break-Even Chart, which depicts at a glance the estimated results of trading
at various levels of activity. The chart shows the fixed and variable costs and
sales revenue so that profit and loss at a given level of production or sales
can be ascertained.

5.2.5 Operating cycle:

The operating cycle is the duration from the time cash is invested in goods
and services to the time that investments produce cash. Operating cycle is

one of the most convenient tools for the working capital requirement of a
business unit. It consists of:

i. Conversion of cash into raw materials

ii. Conversion of raw materials into work-in-progress

iii. Conversion of work-in-progress into finished goods

iv. Conversion of finished goods into debtors/ receivables

v. Conversion of receivables into cash.

5.2.6 Tendon Committee Norms (Maximum Permissible Bank


in July, 1974, the RBI constituted a study group under the chairmanship of
Mr. P. L. Tandon. This group was asked to gives its recommendations on
various issues concerning the working capital financing by the Banks.

The group views the role of a banker is only to “supplement the borrower’s
resources in carrying a reasonable level of current assets in relation to his
production requirements”.

While working out the Maximum Permissible Bank Finance (MPBF), the
export receivables should be deducted from total current assets before
working out the margin of the borrower. Format for the following:



Less: EXPORT RECEIVABLES( export rec. are to be excluded from current

assets for computation of margin, reason being that, as a measure of export
promotion, corporate need not maintain any margin for export receivables)





WORKING CAPITAL GAP (A-B)……………………………………………………………..

LESS 25 % MARGIN (A)…………………………………………………………………….




WORKING CAPTIAL GAP MARGIN(C-D)………………………………………………..





whichever is lower.

Step 3- Interpretation and Inferences

Whether the credit will be sanctioned or not depends on the interpretation of
and inferences drawn from the results. The quality of interpretation provided
by the above mentioned tools and drawing of inferences from them depends
on the knowledge and experience of the credit analyst. This is the most
subjective area as it requires the application of the analyst’s personal

To reduce the subjectivity, bank proposes certain benchmarks as regards

certain common results. The credit analyst is required to compare his finding
vis-à-vis the benchmarks set and common on the results, it should be noted
that the benchmarks are not provided for all the results, hence the credit
analyst is always responsible for his inferences drawn.


The methodology explained earlier has been applied to appraise a credit

proposal by a company named ‘Horizon Limited’ (Name changed). The
company pertains to the Auto Components Industry. The reason for
requesting for the loan is to enhance the volume of production of its existing
products as well as produce certain new products. The company has
requested to sanction the following facilities:

1. Term loan of Rs.400 Lakhs

2. Cash credit of Rs. 100 Lakhs

For the purpose of credit appraisal, the company has provided the audited
financial statements of the last three years and the projected financial
statements for the next seven years. Besides, the company has also
provided the details of the collateral that can be provided, the necessary
legal documents, the promoters’ personal details and such other necessary
document as required to be submitted. The credit appraisal performed is
explained as under:

6.1 Assessing the Promoters’ Background:

As explained earlier, when a client comes, the primary focus of the credit
analyst is in the qualitative factors rather than the quantitative factors of the
project. The qualitative factors are analyzed by probing into a simple enough
question, “Who is the person behind the project?” The answer to this
question is the most subjective and equally critical. The bank obtains this
information by asking the promoter to fill up a form. Compilation of credit
report is done at this stage. The credit report for Mr. Rajeev Deb, promoter of
Horizon Limited is shown below:

AS ON 31.03.10


Rajeev Deb
35 A, Golf Club, Kolkata


A. Immovable Properties:
i. Value of land as per manager’s estimate: Rs.
5. 10 lakhs
ii. Value of buildings as per manager’s estimate --
iii. Book value of plant and machinery if any --

B. Liquid assets:
i. Investments in business
Rs. 88.63 lakhs
ii. Other assets
Rs. 33.10 lakhs
Sub Total Rs.
126.83 lakhs

C. Particulars of borrowing:
i. From the bank:
ii. From other banks: --
iii. From private persons: -- Less


Estimate worth Rs.

126.83 lakhs



I. Estimated net earnings per year: Rs.
14.00 lakhs
II. How long has he/ the concern been dealing with our bank: since
III. Nature of dealing with us:
IV. Comments regarding the nature of his/concern’s
Transaction: sound/ speculative/

8. Nature and extenet of credit facilities enjoyed by the individual/

proprietary concern at different offices of the bank as also at other

a. At the Bank’s Offices :

Name of the Nature of Limit Date of Remarks

office facility sanctioned sanction

b. At other Banks:

Name of the Nature of Limit Date of Remarks

office facility sanctioned sanction

9. The name and addresses of persons , banks, from whom enquiries are

Date of opinion Name & address of His/their Information

persons/banks from estimated worth given orally or in
whom opinion
of the property writing
Existing Rs. 120 lakhs orally
customer Mr. N.

I have made independent enquiries about the position of the above party
and I am satisfied that the information above furnished is correct to the best
of my knowledge and belief.

Branch Manager

6.2 Analysis of Asset and Liabilities Statement:

Any fresh or renewal credit proposal should be accompanied with A & L
Statement obtained separately for each applicant and guarantor. The A & L
statement of Mr. krishnakanta Deb, another promoter of Horizon Limited, is
analyzed as below:


M/s Horizon Limited AS ON 31.03.10

Immovable property, land

Name of Ancestral If Extent in Add. Of Total

the or self- encumber acres, registered value
village or acquired ed to what wet/dry office
taluk extent
where the
lands are
At Kamal Self- ----- 0.75 19.05.98 20,00,00
gazi, acquired acres only 0/-
south 24


Name of Ancestral If Add. Of Total
the vill. or self encumber registered value
Or town acquired ed to what office
where extent
they are

Resident 2- B Golf Self ---- 14.11.200 1,00,00,00
ial Heights acquired 0 0/-
Res. ---- Jadavpur 26,00,000/
House Self kolkata -
(2) acquired

ry etc.
1, 26,00,000/-

Liquid assets
Nature of If amoun Market Total
stock encumber t value value
ed to
Cash and ---- ---- ---- 3,95,000/-
book debts
in business
---- 37,37,000
Investment /-
in Govt.
shares etc.
Jewellery 1888000/-
Other and 18,88,000
movable ornaments /-
like life LIC
policies etc. premium 761876/-
(state their policy
Rs. 6781876/-
Grand Total Asset
Rs. 21381876/-

I/ we hereby declare that the above is a true and correct statement

of my/ our assets and liabilities and that the lands and buildings
stand in my/ our name/s.

Date: 13.04.10
signature: Krishnakanta Deb

6.3 Activities proposed in the Proposal:

The company pertains to the Auto Components industry. The main products
of the company include steering knuckles, rocker arms, oil and gas segment
parts, hubs, front axle beams and connecting rods. Due to a favorable
industry scenario and a good business in the last few years the company is
trying to expand its business. The primary objective of the company is to
enhance the volume of production of its existing products. Besides, the
company proposes to produce two new products- transmission parts and
crankshafts. The company also envisages enhancing its supply of the auto
components parts to the SPZs and 100% EOU units.

Presently the steering knuckles are manufactured to be supplied to the tier- I

players in the market. The company manufactures a wide range of rocker
arms for diesel engine applications and it also supplies connecting rods for
the diesel engine industry for automobiles. The company, in the oil and gas
segment, manufactures products ranging from valves, chokes, casing heads,
shells etc.

The company proposes to manufacture transmission parts for passenger

cars and SUVs, used in manual as well as automated transmission. It will
include a wide variety of parts such as input shafts, gears, sleeve
transmission counter shafts, and output shafts etc. moreover, a wide variety
of crankshafts ranging from single cylinder crankshafts for light duty
applications to large 12 cylinder crankshafts for heavy duty applications is
also proposed to be manufactured.

6.4 Economic Feasibility:

Indian continues to be one of the fastest growing economies in the world.
During 2007-2008, the Indian economy grew at a robust pace for the fifth
consecutive year. Real GDP growth, estimated at 8.7% in 2007-08, is in tune
with the average annual GDP growth of 8.7% in the five year period 2003-04
to 2007-08. Another positive feature underpinning growth is the sharp rise in
the rate of savings and investment in recent years, which rose to 34.8% and
35.9% respectively in 2008-09.

The Indian auto component industry is expected to witness healthy growth in

sales on the strength of strong growth in exports even as the domestic
demand may be impacted by automotive segment specific growth rates in
the short to medium term. Major growth is expected to come from the
outsourcing demand from auto companies in USA and Europe. The sales
growth for auto-component players from domestic market is likely to be
volume led as realizations may increase only modestly.

The global auto component industry is likely to reach $ 1.9 trillion by 2015,
of which around 40% ($700 billion) is estimated to be sourced from low-cost
countries. (LCCs) like India. The ‘Vision 2015 for the Indian Automotive
Component Industry’, suggests that the export potential is huge.

Another survey by Frost and Sullivan estimate that the auto components
export in India is likely to increase to about $8 Billion by FY2010. Thus it is
expected that the growth for auto components demand is to be propelled by
the growth in exports, expected to increase by 30- 35% in the next couple of

6.5 Industry Analysis:

The Indian auto component industry has been navigating through a period of
rapid changes. Driven by global competition and the recent shift in focus of
global automobile manufacturers, business rules are changing and
liberalization has had sweeping ramifications for the industry. The Indian
auto component industry is one of the few sectors in the economy that has a
distinct global competitive advantage in terms of cost and quality. The value
in sourcing auto components form India includes low labor cost, raw material
availability, technically skilled manpower and quality assurance. An average
cost reduction of nearly 25-30% has attracted several global automobile
manufacturers to set base since 1991.

6.6 Industry Growth:

Production of auto ancillaries was estimated at $ 10 billion in 2005-06 and
has been growing at a robust 20% per annum since 2000. Exports of auto
components have been strongly growing at 24% per annum since 2000. This
growth in exports if sustained for another five years will see India’s auto
components export touch $ 5 billion by 2011 from the $ 2.5 billion at

6.7 SMEs in Auto Components:

Auto component SMEs are one of the fastest growing within the SME
category of industries. These units are key contributors to the total
production of auto components and also have a significant share in the
exports of the industry. Cost competitiveness, customer orientation and lead
time are some of the key factors the auto component SMEs will have to
imbibe to survive in the new global set up. At the same time, these
companies face the limitations of being SMEs, like:

i. Low capital base

ii. Limited generation of surplus funds for reinvestment due to tight

working capital cycle

iii. Lac of awareness of business opportunities

iv. Inadequate exposure to international environment

v. Limited geographical diversity of markets

vi. Obsolete technology

vii. Poor infrastructure facilities.

6.7.1 Prospects:

Looking forward, it is the best of times for Indian auto component
manufacturers. The industry displays tremendous potential in generating
employment and boosting entrepreneurship in the country. Capitalizing
on this growth prospect will mean keeping pace with global developments
and imbibing capabilities that will give an edge to Indian SMEs in
surviving this rapidly changing competitive environment.

6.8 Technical feasibility:

Technical feasibility was carried out by the technical experts of the bank.
The feasibility report, fully verified and approved by the bank, has been
used for the purpose of credit appraisal.

6.9 Financial Appraisal:

As explained earlier, financial appraisal takes a three step process which
is explained as under:

Step 1- Determination and computation of the Relevant Information:

Following is the redrawn financial statements of the client:

Analysis of Balance Sheet

Unit: M/s. Horizon Limited Amounts (in Lakhs)

Year Past 1st Yr Previous Last yr’s Current Future Future

audited Yr’s audited Yr’s Yr’s Yr’s
audited estimates projectio projectio

ns ns

Mar-07 Mar-08 Mar-09 Mar- 10 Mar-11 Mar-12

1. Short term
borrowing from
banks 100.00 100.00 100.00

i. From applicant 59.00 72.00 72.00

59.00 72.00 72.00 100.00 100.00 100.00
ii. From other banks

iii. Sub total (A)

2. Sundry creditors 147.89 179.19 219.43 250.00 325.00 350.00

3. Provision for 11.96 16.57 21.71 31.41 54.40 67.07


4. Install. Of prop. 60.00 60.00 60.00

Term loan due
within one yr

5. Other CL and 53.09 40.65 61.79 75.00 97.50 105.65

within 1 yr)

a. Sd Cr for others 17.41 18.27 36.41 40.00 52.00 57.00

b. Bills payable 26.52 15.22 17.22 20.00 26.00 27.30

c. Sd Cr for capital 1.54 1.54


d. Liab. For Exp.+ 7.62 5.62 8.16 15.00 19.50 21.35

Prov. For bonus

Sub total (2 TO 9) (B) 212.94 236.41 302.93 416.41 536.90 582.72

6. Total Current 271.94 308.41 374.93 516.41 636.90 682.72

Liabilities (A+B)

7. Prop. Term loan 340.00 280.00 220.00
excluding Instal.<1

8. Unsecured loan 43.03 67.92 81.27 100.00 100.00 100.00

(directors own

9. Other term 20.00 116.72 143.41 100.00 100.00 100.00


10. Total term 63.03 184.64 224.68 540.00 480.00 420.00

Liabilities (7 to 9)

11. Total Outside 334.97 493.05 599.61 1056.41 1116.90 1102.72

Liabilities (6+10)

12. Ord. share/ 180.47 180.47 180.47 297.97 297.97 297.97
prop’s./ Partners’

13. General 31.16 31.16 31.16 31.16 31.16 31.16


14. Surplus(+)/ 22.62 44.89 83.77 150.02 266.68 410.65

deficit(-) in P&L a/c

15. Share 30.67 30.67 30.67 61.34 61.34 61.34

premium account

16. Net worth 264.92 287.19 326.07 540.49 657.15 801.12

17. TOTAL 599.89 780.24 925.68 1596.90 1774.05 1903.84


Analysis of Profit and Loss Account
Analysis and Sheet
of Balance other Financial Indicators:
Unit: Horizon Limited Amount (in Lakhs)
past 1st yr Prtev. Yr's Last yr's current yr's future yr's future yr's
audited audited audited estimates projections projections
r March,07 March,08 March,09 March,10 March,11 March,12
1. cash and bank balances 19.38 9.95 11.22 20 26 28.6
2. investment except long term
(fixed deposits with banks) 9.64 9.69 22.88 30.6 30.6 30.6
3. receivables (up to 6 months) 83.63 125.26 185.76 200 300 390
4. inventory: 187.48 268.99 309.86 425 530.5 583.55
i. raw materials 149.9 196.77 232.36 310 403 443.3
a. imported 0 18.72 19.68 60 78 85
b.indigenous 149.9 178.05 212.68 250 325 357.5
ii. Finished goods 37.39 70.88 75.86 110 121 133.1
iii. Other consumable spares 0.19 1.34 1.64 5 6.5 7.15
5. adv. To suppliers of raw
materials 5.23 16.66 9.28 20 30 33
6. advance payment of taxes 7.58 12.88 19.43 31.41 54.4 67.07
7. other current assets 3.06 11.56 37.11 105 136.5 148.6
a. prepaid exp+ adv. To empl. 1.07 0.82 3.72 5 6.5 7.15
b. excise duty receivables 1.66 4.51 10.34 25 32.5 34.5
c. VAT refundable 0 3 0 0 0 0
d. other advances 0.33 3.23 23.05 75 97.5 107.25
8. Total Current Assets 316 454.99 595.54 832.01 1108 1281.42
9. gross blocks 277.57 304.97 386.02 787.56 823.87 823.87
10. capital work in process 30.67 51.02 22.13 80 0 0
11. depreciation to date 64.18 76.62 89.99 133.36 199.07 255.25
12. Net Block 244.06 279.37 318.17 624.8 568.62


13. Adv. To suppliers of capital

goods 37.64 38.68
14. receivables (over 6 months) 2.19 7.2 11.97 30 39 50
15. Total Other Non Current
Assets 39.83 45.88 11.97 30 39 50

16. TOTAL ASSETS (8+12+15) 599.89 780.24 925.68 1596.21 1771.8 1900.04

Financial indicators:
(Rs. In Crores)

Performanc Last 2 years Current Projections

e indicators year for next
estimate year

Year Audited Audited Audited 31.03.10 31.03.11

ending 31.03.07 31.03.08 31.03.09

Paid up capital 2.20 2.30 2.82 3.80 5.00

Reserves & 1.20 1.07 1.08 1.00 1.00


Intangible --

Tangible net 3.41 3.37 3.90 4.80 6.00


Long term

Capital 3.40 3.37 3.90 4.80 6.00


Net block 0.352 0.316 0.528 0.500 0.500

Investments 3.06 3.06 3.06 3.00 3.00

Non current

Net working 3.05 3.06 3.37 4.30 5.50


Current assets 6.20 8.02 11.30 12.40 13.80

Current 3.15 4.96 7.92 8.10 8.30


Current ratio 1.97 1.62 1.43 1.53 1.66

Debt equity 0.72 0.33 0.27 0.19 0.15


TOL/TNW 0.93 1.47 2.03 1.69 1.38

Net sales 19.31 23.83 29.75 33.50 38.50

% increase -- 23.38% 24.84% 12.59% 24.92%

over last year

Operating -- 1.26 1.55 1.84 2.20

profit before

Interest -- 0.35 0.48 0.60 0.70

Other income 0.08 0.10 0.10 0.10 0.10

Net profit 0.66 0.988 1.17 1.34 1.70

before tax

Net profit after 0.66 0.988 1.17 1.34 1.70



Cash accruals 0.66 0.988 1.17 1.34 1.70


Interest -- 3.91 3.61 3.33 3.51


Gross profit/ 5.30 5.21 5.49 5.71

net sales %

Net profit/ net 4.15 3.94 4.00 4.42


Inventory 31.64 21.94 38.13 37.92

turnover ratio

Receivables/ 50.03 87.27 72.67 69.87

gross sales

Current 33.68 37.99 37.01 35.84

sales %

Sundry 30.06 71.58 38.22 36.21


Step 2 &3- arrangement of Information and their Interpretation:

These tools organize information in such a way that can be used to draw
inferences. Whether the credit will be sanctioned or not depends on the
interpretations of and inferences drawn from the results.

The various tools of the credit analyst to help arrange and interpret the
financial information are explained as under:

6.9.1 Analysis of financial indicators:

a. Sales: the firm’s sales for the year ended on 31.03.09 shows a
considerable growth. The sales turnover shows an increase by 24.84%
over the previous year. The firm has estimated a net sales target of Rs.
33.50 Crore for the year ending on 31.03.10 and achieved 18.44
Crores up to November 2009 which is 82.57% of annualized
achievement. Thus, the target of Rs. 33. 5 Crores is quite reasonable.
This is justified by the growing demand of auto components parts.
Another reason for the sales of the projected period to increase
substantially is the increase in the production capacity. This is because
the company plans to apply the term loan funds for the installation of
fixed assets in order to boost production capacity.

b. Other income: the firm’s other income consists of interest on deposit

with banks, profit on sale of assets and other miscellaneous receipts.
The interest earned from the deposit is Rs. 9.46 lakhs during the 2008-
2009 and estimated other income of Rs. 10.00 lakhs during 2009-

c. Operating profit: operating profit before interest shows a rise to 1.55

Crores, an increase of Rs. 0.288 Crores during the year 2008-2009
compared to previous year. In spite of increase of market price and
cost of sales and global recession, the firm has managed to achieve a
growth of 122. 82% during the last financial year. The estimated gross
profit before interest is Rs. 194.00 lakhs and net profit is Rs. 134.00
lakhs an increase of 117.62% and 114.25% respectively which are also

d. Current assets: current assets as on 31.03.09 show increase over the

same in the previous year mainly due to increase in the cash and bank
balances, inventory and sundry receivables. The debt collection period
has increased. The inventory turnover period shows reduction during
the year ended 31.03.09. This has happened due to last recession in
the industries but management of the firm is much competent to
control its inventory.

e. Current liabilities: this mainly consists of sundry creditors and bank

borrowings. Sundry creditors have subsequently increased during
31.03.08 to 31.03.09. The estimated Current liabilities show an
increase due to increase in sundry creditors and bank borrowings.

f. Current ratio: the current ratio was 1.97 in 2006-07, 1.62 in 2007-08
and 1.43 in 2008-09. The estimated Current Ratio during 2009-10 is
1.53 which indicates that the current ratio of the firm is favorable.

g. Net Worth: the net worth of the firm shows increase due to profit
retained in the firm. The capital increased to Rs. 2.82 Crores during the
year 2008-09 from Rs. 2.32 Crores as on 2007-08.

h. TOL/TNW: the ratio shows upward trend during the year 2008-09. The
ratio was 1.47 in 2007-08 and 2.03 in 2008-09, which indicates lower

i. Gross profit: gross profit for the year 2008-09 is Rs. 1.55 Crores
against a sale of 29.75 Crores, an increase of 24.84% over the
previous year’s figure. The firm’s projection for the current year is Rs.
1.84 Crores, a hike of 18.62% which is lower than previous year.
Though the growth is more on a lower side, 18.62% hike is quite
acceptable since the sales growth is also lower than the previous year.

j. Net profit: the net profit/ net sales ratio show a continuous rise starting
from FY2008-09 to 20010-11. The net profit shows an increase of Rs
18.48 lakhs during the year ended 2008-09. The total NP during the FY
2008-09 is 117. 28 lakhs. Thus estimated NP of Rs. 134.00 lakhs in the
year 2009-10 is reasonable.

k. Net Working Capital: NWC for FY 2007-08 is Rs. 3.06 Crores and Rs.
3.38 Crores for FY 2008-09. The estimated Net Working Capital for
2009-10 is Rs. 4. 30 Crores.

6.10 Sensitivity Analysis:

The following table shows the effect of changes in the sales price, sales
volume or variable costs on the contribution, profit and break even sales:

Cost Volume- Price Analysis or Sensitivity analysis

avera 10% 10% dec. 5% inc.
ge increase in in sales 10% dec. in in var 5%dec 55 dec.
changes level var cost vol sales price cost in s/vol in s/price
1961. 1863.3
1. net sales 38 1961.38 1765.24 1765.24 1961.38 1 1863.31
2. variable 1588. 1509.3
exp 81 1747.69 1429.93 1588.81 1668.25 7 1588.81
contribution 372.5
( 1-2) 7 213.69 335.31 176.43 293.13 353.94 274.5
4. fixed exp 2 176.02 176.02 176.02 176.02 176.02 176.02
5. operating 196.5
profit (3-4) 5 37.67 159.29 0.41 117.11 177.92 98.48
6. break
even 926.6
analysis 5 1615.62 926.66 1761.14 1177.78 926.65 1194.83

6.10.1 Inferences from sensitivity analysis:

From the sensitivity analysis table given above, we can find the sensitivity of
the profitability and break-even sales to a change in the following factors:

a. Changes in Variable Costs:

The changes in the variable costs have highly adverse effects over the
profitability and the break-even points. As a result of a 10%increase in
the variable costs, the profits decline by as much as 81% over the
average level. The break even sales also increase by 74% over the
average. Thus, the analysis indicates that the variable costs from a
major chunk of the total costs as such the profitability is highly
sensitive to changes in the variable costs. The situation is not
comfortable particularly because of the high inflation persistent in the

b. Changes in sales Volume:

The effect of changes in the sales volume is moderate on the

profitability and the break-even point. As a result of a 10% fall in the
sales volume, the profits get reduced around 20% whereas the break
even sales are not at all affected.

c. Changes in the Sales Price:

It can be seen that the sales price is the most crucial factor among the
three factors mentioned here. For a 10% decrease in the sales price,
the profit of the company falls from Rs. 196.55 Lakhs to 0.41 Lakhs.
Moreover, the breakeven sales volume almost gets doubled. Thus, the
analysis indicates that the company is not in a situation to tackle any
recession in the industry. During the period of recession the company
can incur heavy losses if the situation is not improved. It is for this
reason that the client has been asked to provide high collateral
securities in spite of the promising performances.

6.11 Break- Even Analysis:

The relationship between cost, sales and profit at different levels of activity
can be known from the Break even analysis. The following table shows the
break even analysis-

Break Even Analysis

audite audite audite estima project projecti
M/s Horizon Limited d d d ted ion on
March' March' March' March' March' March'
07 08 09 10 11 12
Net Sales 459.09 616.7 796.72 1155 1696 2140
sale value of production 481.84 650.19 801.7 1189.14 1707 2152.1
variable expenses
RM, Stores, Power, labor, other Mfg.
exp. 377.08 520.88 647.15 920 1288 1682.1
40% of selling, Gen & Admn. Exp 18.14 20.03 20.49 26 33.8 40.56
interest on working capital 0 0 0 7 14.25 14.25
Total 395.22 540.91 667.64 953 1336.05 1736.91

Contribution 86.62 109.28 134.06 236.14 370.95 415.19

fixed expenses
Salary, depreciation, TL intt., other
Intt. 38.43 43.89 44.02 96.48 146.44 139.56
60% of selling, gen & admn exp. 27.22 30.05 30.73 39 50.7 60.84
Total 65.65 73.94 74.75 135.48 197.14 200.4

total cost 460.87 614.85 742.39 1088.48 1533.19 1937.31
operating profit 20.97 35.34 59.31 100.66 173.81 214.79
profit after tax 12.57 22.27 38.88 65.56 115.1 142.42
Break Even sales 347.95 417.27 444.24 662.66 901.33 2
cash break even sales 289.06 347.06 364.78 450.53 600.9 743.35

6.11.1 Inferences from break even Analysis:

The break even point is important to the management of a firm because it

indicates the lowest level to which the activity can drop without putting the
continued life of the firm in jeopardy. A casual glance at the Break-Even
analysis table will indicate that the break even point is continuously
increasing which is not a good sign. But, this is not the actual situation.
Though the break even point is increasing continuously, it is increasing at a
lesser pace than the net sales. If we find out the break-even sales to net
sales ratio, it will be seen that the break even point shows a declining trend.
For the financial year 06-07, the break even sales were approximately 76%
of the net sales. This ratio will fall to 48% as per projections.

In spite of this, the break even point still continues to be high. This indicates
that the profitability potential of the company is limited. More than half of
the revenue goes in for covering the costs of production. Hence, in adverse
situations, the company can incur losses.

Thus, the analysis indicates that the credit should be granted to the
company with caution and the borrowers should be asked to provide
high collateral securities.

6.12 Maximum Permissible Bank Finance (Tandon

The following table shows the calculation of the MPBF by Short Term Bank
Credit Method (STBC method)

Year Ending Estimates Projected

March ‘10 March ‘11

A. Projected Gross Current Assets 13.51 20.50
(to be in line with past actuals or any variation
should be justified)
B. Current Liabilities other than Bank 7.51 7.80
Borrowings & excluding AMTL
C. Working Capital Gap (A-B) 6.00 12.70
D. 20% Margin on Gross Current Assets 2.70 4.10
E. Actual/ Projected NWC excluding AMTL 2.40 4.10
F. Gross Current Assets- Margin (C-D) 3.29 8.60
G. Gross Current Assets- NWC (C-E) 3.60 8.60
H. Maximum Permissible Bank Finance 3.29 8.60
(F or G whichever is lower)
From the above table it is available that the borrowing is within the
prescribed limits under STBC method. Hence, the funds requested for
working capital can be extended by the bank.

6.13 Credit Risk Assessment:

According to the credit risk assessment carried out in accordance with the
bank’s RAM model-

The overall rating- AA

Country risk- Moderate

Financial statement quality- Good

[Note: the RAM rating tables are all fictitious, no confidential data has been

Circle: Bengal

CEO: Mr. Rajeev Dev

Constitution: Private Limited

Baking with us since: New

Banking arrangement: Sole Banking

Rating By external agency: CRIS INFAC (by CRISIL)

Credit Rating:

Branch Parameter Value Audited score

Financial parameters

Sales growth 5 80%of projected 3


Current ratio 5 1.96 5

Interest coverage ratio 5 3.17 5

TOL/TNW 5 1.98 5

Net profit/ sales 5 85.22% of 4


Return on capital 5 88.63% of 4

employed projection

Debtors holding period 5 96.41% of 5


Inventory holding period 5 106.56% of 5


Creditors holding period 5 107.89% of 4


Total financial 45 40


Marketing experience 3 Hands on 3


Conduct of group NA NA NA

Succession planning 3 Family business 3

Net worth of the 3 133.05% 2


Credit history 3 Clear 3

Total managerial 12 11

Industry parameters

Number of products 2 As per the CRIS

traded INFAC

Product seasonality 2 Industry risk score


Product availability 2 Auto parts

Product marketability 2

Threat of substitutes 2

Threat of imports 2

Supply source 2

Client base 2

Regulatory issues 2

Bank’s loan policy 2

Total industry 20 8


Servicing of interest 2 Yes 2

within 15days

Servicing of installment NA NA
within 15 days

Non return of cheque/bill 2 Yes 2
purchased/ discounted

Utilization of FB 2 Yes 2
limits( MIN. 70%)

Routing of turnover (MIN. 2 Yes 2


Timely submission of 2 Yes 2

stock statements

Timely submission of 2 Yes 2

audited balance sheet

Timely submission of 2 Yes 2

renewal proposal

Adequacy of insurance 2 No 0

General compliance of 2 No 0
sanction terms

Total operational 18 14

Total score for obligor 95 73


Obligor rating grade 76.84% A

to be awarded

Facility rating

Tenor of advances 20 18.07

Security structure 80 70

Availability of specified NA

Total 100 88.07

Facility rating grade 88.07% AAA
to be awarded

Normalize obligor score 70 53.29

to 70%

Normalize facility score 30 26.42

to 30%

Total final risk 100 80.21

score(obligor risk
score+ facility score)

Final integrated credit AAA AA

rating grade

A. Financial parameters:

i. Net sales increased by 0.35%

ii. PAT increased by 34.54% but far from projection.

iii. Current ratio is increased from 1.76 to 1.80 however it is all

above the benchmark level.

iv. TOL/TNW- 1.98 well within the benchmark level.

v. Interest coverage ratio- 3.17 –comfortable.

vi. NWC detected marginally by about 5.50 lakhs.

vii. Comment on servicing of interest/ installments with FIS- regular.

B. Managerial Risk:

i. Comment on the competency of the management, change of
management, diversification undertaken during the period of
review appearance of director’s name in the defaulter’s list
(RBI/ECGC) - Mr. Rajeev Dev is the key person and is having vast
experience in the field of this business. The unit is improving under
his guidance. Other partners are equally competent.

ii. Threat of take-over of the management of the company: NIL

iii. Group accounts: NIL

C. Business/ industry risk:

i. Demand and supply: the firm deals with auto ancillary parts for
domestic as well as international car making companies. The
firm is selling the products to reputed private as well as public
sector companies. Demand and supply is met without

ii. Price realization- satisfactory

iii. Competitiveness- since the dealing products are high in demand,

there exist competition in the market. This risk is mitigated by
way of huge experience of the firm in this line of activity.

iv. Entry barrier: NIL

v. Performance of the industry/industry trend/ performance of the

unit vis-a-vis the industry: - the products traded by the firm have
good demand. The business is also affected by seasonal and
festive demands.

vi. Government policy- the governments thrust on auto sector is

favoring the business. But at the same time, government’s
policies on pollution control are adding concern.

vii. Critical/ key factors affecting the performance of the industry

and mitigation techniques- the unit is importing materials for
domestic sales in a considerable quantum. So the duty is one of
the prime factors in competitive cost. So a good balance of
domestic purchase and import will help the unit to mitigate this
D. Direction of risk management and suggested remedial

i. Credit risk rating assigned for last two years is AA under IRM-2

ii. The obligor rating was not satisfactory because of the following

 Net profit was less so no marks are attributed on NP/sales

and Return on Capital employed.

 Though the TOL/TNW is within the benchmark, still it is high

enough on the risk perception. Thus marks are reduced.

 Creditors’ holding period in comparison to last year is


 As per CRIS INFAC parameters, the industry is a risky one

and thus a meager 43% has been awarded.


Non performing assets, including a leased asset, become non-performing

when it ceases to generate income for the bank. A non performing asset
(NPA) is a loan or an advance where,

i. Interest and/ or installment of principal remain overdue for a period of

more than 90 days in respect of a term loan.

ii. The account remains “Out of order” in respect of an overdraft/ cash

credit (OD/CC).

iii. The bill remains overdue for a period of more than 90 days in the case
of bills purchased and discounted.

Banks should classify an account as NPA only if the interest charged during
any quarter is not serviced fully within 90 days from the end of the quarter.

7.1 Out of Order Status:

An account should be treated as ‘out of order’ if the outstanding balance

remains continuously in excess of the sanctioned limit or drawing power. In
OD/OCC accounts where the outstanding balance in the principal operating
account is though less than the sanctioned limit/ drawing power, but there
are no credits continuously for 90 days as on the date of balance sheet or
credits are not enough to cover the interest debited during the same period,
these accounts should be treated as ‘out of order’.

An OD/ OCC account will become NPA as on 31. 03.2009,

1. If the outstanding balance remains continuously in excess of

sanctioned limit/ drawing power from 31.12.2008.

2. In cases where the outstanding balance in the principal borrowal

account is less than the sanctioned limit/ drawing power, yet if there
are no credits in the account continuously from 31.12.2008.

3. If credits in the account are not enough to cover the interest debited in
the account from 01.01.2009.
7.2 Income Recognition:

1. In accordance with the policy of income recognition, branches should

not charge and take to income account interest on any NPA even if
guaranteed by the government. Income recognition should be based
on record of recovery only and should not be recognized if remain

2. The availability of security or net worth of borrower/ guarantor should

not be taken into account for the purpose of treating an advance as
NPA or otherwise, as income recognition is based on record of

3. However, interest on advances against term deposits, NSCs, IVPs, KVPs

and life policies may be taken to income account on the due date,
provided adequate margin is available in the accounts.

4. Fees and commissions earned by the banks as a result of

renegotiations or rescheduling of outstanding debts should be
recognized on an accrual basis over the period of time covered by the
renegotiated or rescheduled extension of credit.

7.3 Norms for Asset Classification:

Sub Standard Asset: a sub standard asset is one which has remained NPA for
a period less than or equal to 12 months.

Doubtful Asset: an asset is classified as doubtful if it has remained in the sub

standard category for a period of 12 months.

Loss Asset: a loss asset is one where the bank or internal or external
auditors or RBI inspectors have identified it as loss asset, but the amount is
not written off wholly. Such an asset is considered uncollectable and of such
little value that its continuance as a bankable asset is not warranted
although there may be some salvage or recovery value.

7.3.1 Asset classification to be borrower wise and not facility wise:

Prudential norms application should be borrower wise and not facility or

account wise. This implies that even if one of the facilities of the borrower is
NPA, then all the facilities of that borrower are also to be treated as NPA.
Hence, in the case of multiple facilities enjoyed by the borrower, the worst
classification of NPA under which any facility falls should be adopted for all
other facilities also. For example, a borrower is enjoying four facilities under
the different categories of classification as furnished here with:

Facility A: Standard

Facility B: Sub standard

Facility C: Doubtful

Facility D: Loss

In the above case, the facilities A, B and C should be reclassified as Loss

adopting the worst classification of Facility D to comply with the prudential
norms guidelines.

7.4 Special Mention Accounts (SMA)

The NPA is more likely to be resolved in terms of recovery, if the company is

in operation. For this to be effective, the Bank has placed an Early Alert
System for identifying the weakness in an account at an early stage which
could capture early warning signals in respect of accounts showing first signs
of weakness. The accounts falling under this monitoring mechanism are
termed as Special mention Accounts. This system shall be an integral part of
the risk management process of the Bank.

Under the Early Alert System, for internal monitoring purpose, branches are
required to designate a time limit for overdue accounts to determine the
threshold for a proactive intervention - well before the account becomes
NPA. This is to enable the branch to assess whether the default is due to
some inherent weakness or due to a temporary liquidity or cash flow
problem and accordingly calibrate its response. For example, where there is
a default in an account for 30 days, it may be shifted to a special category.
Out of the accounts, those that show promise may be considered for
granting incremental facility for specific purposes, such as for capital
expenditure, by ensuring strictest possible end use of the money. All the
accounts displaying unsatisfactory features/early warning signals should be
put under potential NPA list for follow up and time bound action to prevent
their slippage.

7.4.1 Characteristics of Special Mention Account (SMA)

i. The asset has potential weaknesses which deserves close

management attention and which can be resolved through timely
remedial action.

ii. If left un-corrected, the potential weaknesses in Special mention assets

may result in deterioration of the repayment prospects and
subsequent adverse asset classification.

iii. Often a bank's weak origination/servicing policies are the reason

behind classification of an asset under the Special mention category
though there may be cases where technical or other factors are also

iv. Apart from continuing irregularities, Special Mention Accounts may

also be categorized on the basis of factors such as inadequate cash
flows and management integrity.

7.4.2 Features in the Borrowal Account to Identify SMA:

An account must be regarded as SMA if any of the following features are


i. Default in payment of interest / installment due beyond 30 days.

ii. Persisting irregularity due to excess drawal beyond 30 days in Cash

Credit account.

iii. Shortfall in Drawing Power in Cash Credit account not regularized within
a week.

iv. Devolvement of LC / DPG installment and non-payment of the same

beyond 15 days.

v. Non-creation of Primary securities affecting the ultimate recovery

prospects in the account.

vi. Delayed / non-submission of Stock Statements, other monthly
information data for 2 months continuously.

vii. Default in payment of interest / installment due beyond 30 days.

viii. Persisting irregularity due to excess drawal beyond 30 days in

Cash Credit account.

ix. Shortfall in Drawing Power in Cash Credit account not regularized within
a week.

x. Devolvement of LC / DPG installment and non-payment of the same

beyond 15 days.

xi. Non-creation of Primary securities affecting the ultimate recovery

prospects in the account.

xii.Delayed / non-submission of Stock Statements, other monthly

information data for 2 months continuously.

7.4.3 Categorization of SMA

All Special Mention Accounts are to be categorized into "A" or "B" or "C" as
detailed below:

Category Type of Accounts

A Accounts that will be out of SMA


B Accounts that will be restructured /

proposed to be restructured and
hence will not become a problem

C Accounts where no scope of recovery

and may require provisioning and are
categorized as potential NPA

7.4.4 Monitoring of SMA accounts

i. Accounts are to be specifically classified under A, B and C categories

based on recovery prospects in tune with the narration under remarks
column in the SMA statements.

ii. Accounts under SMA category with overdues for less than 90 days
have to be followed up for recovery/rehabilitation/rephasement for
retaining the accounts under Standard category.

iii. Accounts with overdues for more than 90 days have to be taken up for
recovery / enforcement of securities without further loss of time. Need
based rehabilitation of accounts with overdues beyond 90 days may be
considered as per norms.

7.4.5 Pre- SMA Accounts

In order to monitor large value standard advances of Rs.25 lakhs and above
more closely, an exclusive category of accounts known as Pre-SMA Accounts
has been defined. For facilitating identification of accounts under this
category, a list of possible signs of incipient sickness are identified and
furnished in the Short Review Format.

7.5 Non Performing Loans- A Theoretical Perspective:

A credit transaction involves a contract in between two parties: the borrower
and the creditor (bank) subject to a mutual agreement on the terms of
credit. The terms of credit are defined over five critical parameters: amount
of credit, interest rate, maturity of loans, frequency of loans and collateral.
Optimizing decision pertaining to the terms of credit could differ from the
borrower to that of the creditor. As such the mutual agreement between the
borrower and creditor may not necessarily imply an optimal configuration for
both. At this juncture, distinction between a defaulter and a non performing
loan account is in order. A default entails a violation of the loan contract or
the agreed terms of the contract, while a non performing loan entails that
the borrower does not renege from the loan contract but fails to comply the
repayment schedule due to evolving unfavorable conditions. However, from
the perspective of corporate finance, a common perspective is that both the
cases of defaulter and non performer imply similar financial implication, i.e.,
financial loss to banks. Moreover in the Indian context, regulatory and
supervisory process does not focus on such a distinction between default
and non performers as far as prudential norms are concerned. The NPL is
defined as past due concept, taking into account either non payment of
interest due, principal or both. For simplicity, this common perspective
prevails in the rest of the theoretical analysis. The most important reason for
default could be mismatch between borrower’s terms of credit and creditor’s
terms of credit. The problem of default can be elucidated as follows:

Let the borrower make an internal assessment of his economic activity for
which he requires external financial support. An optimal configuration for the
borrower involves that he could carve out a contract C (A*, r*, m*, n*, S*)
defined over the amount of finance (A*), interest rate (r*), maturity (m*),
installments (n*) and collateral (S*) for his profitable economic activity. On
the other hand, based on competing portfolio considerations, the creditor
could carve out a contract C (A, r, m, n, S). When a borrower enters the
credit market, he searches for a bank that could agree to his terms of credit.
It may not, however, be possible for him to find a suitable creditor. Since, the
borrower faces financial constraints he will have to compromise and agree to
the terms of credit stipulated by the creditor. Once the financial constraint is
overcome, the borrower explores the opportunity for making changes to the
loan contract. A decision to default entails that he wants to turn an
unfavorable loan contract to a favorable one. The default option, however,
involves both costs and benefits.

7.5.1 Benefits:

1. Let us consider the parameter Loan Maturity (m). a default option

entails that the borrower wants to lengthen the maturity of the loan.
By lengthening the maturity of the loan, ceteris paribus, the defaulter
could reduce the real burden of credit since the Present Value of credit
would decrease with increase in loan maturity. However, if the
borrower is highly bank dependent, a borrower may not consider
defaulting on a short term loan, even though such loans involve high
present value of debt burden. In this case, the default option will affect
the credit worthiness of the borrower, for which he may face
difficulties in approaching banks for further financial support.
Moreover, if economic conditions turn more favorable, implying strong
business growth, the borrower would require an increased financial
support from banks to expand his business. In this situation, if the
borrower has availed a short term loan, he would not prefer default
option in order to maintain his credit worthiness.

2. If the borrower anticipates that interest rates(r) are likely to increase in

future, a default option would benefit him enjoy the existing credit
facility at a relatively lower interest rate. On the contrary, if interest
rates are likely to fall, the borrower would prefer repaying the loan
amount in due course of time or even earlier, if possible through pre

3. The default option also provides an opportunity for the borrower to use
the installment payments (n) for investment in more profitable
activities. However, installments of loan constitute a method of
payment, which could be similar across banks. Accordingly, this may
not be a major factor of influence on loan defaulters.

4. The amount of credit (A) could play a critical role in influencing the
borrower’s decision to default on bank loans. A very large amount of
credit, ceteris paribus, involves high present value of loan burden. The
amount of loan will have significant effect on legal cost and may not
induce defaulters under certain circumstances. Moreover, for a
genuine bank dependent borrower, default may not be an option since
it would involve reputation cost, which in turn, could affect the
borrower’s resources to financing or fresh financing for other
productive activities.

7.5.2 Cost:

A defaulting borrower is likely to face three major costs: reputation

cost, legal and bankruptcy costs and penalty charged by banks after
disposal of the case in the court. The reputation cost for the defaulter
is likely to be higher, if there is provision for exchange of information
on defaulters across banks or creditors. In the case of a company
registered in the stock market, reputation cost could arise from the
adverse movement of the company’s stock price. For all companies,

loss of reputation could signal bad financial condition and thus, affect
overall business. In fact, it is precisely with this objective that Credit
Information Bureau (CIB) receives policy support in most countries.

The legal Costs will arise if the banks are prompt in filling suits against
the defaulters. There are mainly two components: initial fixed costs on
account of stamp duties in response to defend the loan suits and other
costs on account of preparation of the law suit and a fixed sum, which
could be charged by lawyers in order to pursue the case. So, higher
the stamp duty, higher the legal costs and lower incentives for
defaulters. An interesting point here to note is that, for very small
borrowers, the fixed cost of law suit could be higher than the credit
amount, thus, providing no incentives for default.

Thus, in view of the above, it is now apparent that before choosing the
default option, a rational borrower has to make an assessment of all
the benefits and costs associated with it.

7.5.3 Overview of Performance: Based on Net NPA

There have been noticeable improvements in the health of banks in terms of
asset quality. Further, pre and post reform NPA levels are not strictly
comparable as there has been a significant tightening of accounting norms.

Name of the Bank Net NPA/ Total Asset

2004-05 2005-06 2006- 2007-08 2008-

07 09

Allahabad Bank 3.16 1.05 0.60 0.45 0.65

Andhra Bank 0.84 0.44 0.15 0.13 0.10

Bank of Baroda 2.22 2.07 0.65 0.46 0.35

Bank of India 3.00 2.43 1.64 0.86 0.45

Bank of Maharashtra 1.84 0.89 0.85 1.07 0.71

Canara Bank 1.77 1.39 1.02 0.66 0.56

Central Bank of India 2.74 2.01 1.19 1.30 0.94

Corporation Bank 0.76 0.86 0.61 0.38 0.27

Dena Bank 4.95 3.99 2.46 1.63 1.16

Indian Bank 2.13 0.98 0.56 0.37 0.18

Indian Overseas Bank 2.22 1.22 0.63 0.38 0.31

Punjab National Bank 1.77 0.44 0.09 0.14 0.45

Syndicate Bank 2.03 1.13 0.82 0.51 0.44

UCO Bank 2.00 1.72 1.49 1.27 1.34

Union Bank of India 2.45 1.45 1.46 0.94 0.59

United Bank 1.67 1.16 0.95 0.91 0.93

State bank of India 1.64 1.33 1.16 0.99 0.93

State Bank of 1.21 0.25 0.27 0.19 0.12


Better standards of credit appraisal and close monitoring of standard assets
will enable the branches to restrict the NPA to the minimum level.
Concurrently recovery of existing NPAs has to be given utmost importance in
view of the likely impact on the profitability. Recovery policy aims at
expediting recovery while pegging the sacrifice at the lowest possible level.
With this objective in focus, the policy guidelines are revisited and
refashioned at least once in a year to equip the branches for efficient
handling of the NPA portfolio. While framing recovery policy guidelines , the
feed back received from the field level functionaries, our experience in
handling proposals received from branches all over the country and the
corporate goals are factored in besides the market development, economic
scenario etc.

The implementation of the prudential norms for income recognition, asset

classification (IRAC) and provisioning for credit portfolio of banks has brought
in rapid reforms in the Indian banking industry and the NPA management in
banks has assumed greater importance. Greater emphasis was laid for
recovering the dues and keeping the NPA level at the lowest possible level
as it will have direct impact on the profitability of the bank.

Objective of loan recovery policy:

A. Reduce NPA book by enhancing the level of credit monitoring and
expediting recovery of NPAs.

1. Effective follow up/ monitoring of the borrowal accounts.

2. Regular recovery of periodical interest and installments due.

3. Proper classification of accounts under Special Mention Account (SMA)

category and close monitoring thereof.

4. Prompt recovery of critical amount to avoid slippage.

5. Obtention of stock statements from the borrowers in time/ inspection

of securities charged periodically.

6. Obtention of other financial statements and MSOD.

7. Timely review or renewal of the credit limits.

8. Rephasement/ restructuring of standard advances wherever

applicable, within the ambit of bank’s policy.

9. Timely revival/ rehabilitation of the potentially sick and viable units.

10. Corporate debt restructuring.

B. Reduce the level of NPAs through recovery by adopting various legal and
other measures:

1. Persistent contact/ follow up with the borrowers for recovery.

2. Enforcement of SARFAESI Act 2002 and recovery by selling the

properties within 100 days of issuing notice.

3. Filling of suits in appropriate civil courts/ DRTs

4. Invoking provisions of Revenue Recovery Act wherever applicable.

5. Referring the cases to Lok Adalat for settlement through conciliation

6. Settlement through compromise.

7. Execution of decrees within one year from the date of decree.

C. Upgrade the existing NPAs by improving the quality of assets:

1. Upgrade the accounts by recovering the critical/overdue amount.

2. Rephasement/ restructuring/ rehabilitation of accounts wherever
possible/ justified, within the ambit of bank’s policy.

3. Recovery of amount as per approved scheme in respect of BIFR/ CDR


D.Recovery strategies:

1. Persuasion/ personal contacts with the borrowers and guarantors.

2. Seizure and disposal of securities through enforcement of SARFAESI

Act 2002 in chronic cases.

3. Engage detectives/ recovery agents for identifying/ locating non

mortgaged properties owned by the borrowers/ guarantors and attach
them before judgment also.

4. Settlement through compromise, which is the most time efficient tool

for resolving NPA. However, the amount of OTS should be acceptable
and in terms of policy.

7.5.5 Negotiated settlement policy of the bank:

1. Determining the minimum recoverable compromise amount based on

the present paying capacity of the borrower at stipulated rates of
return on the dues of the bank.

2. Laying due emphasis on recovery of at least the NPV of the realizable

value of the securities.

7.5.6 Guidelines for compromise / negotiated settlements:

1. Every compromise proposal should be substantiated with the

justification giving the reasons as to why the bank should accept the
compromise mode of recovery like failure of unit, government policies,
court orders, continuous losses and non viability, death of principal
promoter, deteriorating status of securities etc.

7.5.7 Quantum of compromise amount/ sacrifice to be accepted/
minimum recoverable amount:

The norms for arriving at the MRA or the sacrifice to be accepted are only
indicative. It is the responsibility of the branch head or circle head to
negotiate for maximum and higher amounts taking into account the NPV of
realizable value of available securities, net worth of the borrower/ guarantor

7.5.8 RBIs directive on compromise settlement:

RBI vide their circular dated October 4,2007 has advised that banks during
compromise settlements, should ensure that OTS amount should generally
not be less than the net present value of the realizable value of available
securities. NPV is arrived at based on future cash flows, NPV is the present
worth of an amount to be received at a future date and arrived at by
applying a discount rate at yield on advances of the bank for the previous
quarter. Assuming that the likely time that may be required to realize the
value of security is two years, the NPV of the assets will be less than the
realizable value. NPV of the realizable value of available securities net of the
cost of realization has to be compared with that of MRA and efforts made for
maximizing recovery. The NPV of the realizable value of available securities
net of the cost of realization should be assessed objectively.

The method of arriving at quantum of compromise amount has been

modified by the board by grouping NPAs into three categories as follows:

i. NPAs with total dues of Rs. 2 lakhs and below:- the category
generally encompasses small loans and government sponsored
scheme loans wherein mostly securities charged to the bank are
hypothecation of goods created out of loan proceeds disbursed,
value of which may be negligible or nil when the account becomes

ii. NPAs with total dues of above Rs. 2 lakhs and up to Rs. 25 lakhs

iii. NPAs with total dues of above Rs. 25 lakhs

7.5.9 Calculation of net present value of securities:

The for arriving at the present value (discounted value) of an amount

receivable at a future date is present value in reciprocal of compound
interest factor, i. e.,

{1/ R/100} n

Where, R= rate of interest (1/4th of annual rate of interest)

N= number of quarters

P= principal (amount recoverable on a future date)

The discount rate will be the yield on advances of the yield on advances of
the preceding quarter rounded off suitably and will be informed to the circle
offices periodically. Yield on advances for the quarter ended March 2008
being 10.81, the discount rate will be 11% till further notice. The discounting
factor for finding out the present value of future amount is shown below:

Ihkjhkjh Rate of interest (compounded quarterly)

10% 11% 12% 13% 14% 15% 16%

1 year 1.10* 1.11 1.13 1.14 1.15 1.16 1.17

2 year 1.22 1.24 1.27 1.29 1.32 1.34 1.37

3 year 1.34 1.38 1.43 1.47 1.51 1.56 1.60

4 year 1.48 1.54 1.60 1.67 1.73 1.80 1.87

5 year 1.64 1.72 1.81 1.90 1.99 2.09 2.19

6 year 1.81 1.92 2.03 2.15 2.28 2.42 2.56

7 year 2.00 2.14 2.29 2.45 2.62 2.80 3.00

8 year 2.20 2.38 2.58 2.78 3.01 3.25 3.51

9 year 2.43 2.66 2.90 3.18 3.45 3.76 4.10

*to get present value, divide the future amount by

For arriving at NPV of the realizable value of the available securities, bankers
have to calculate the NPV by applying the discount rate to be informed by
HO: recovery department. The time taken for realization of securities should
normally be 1-3 years depending upon the case history, legal status, nature
of litigations etc.

Section Eight: CONCLUSION
The face of the financial services market is changing rapidly. Competition is
getting tougher by the day and with financial liberalization under the WTO,
banks in India will have to benchmark themselves against the best in the
world. A strong and growing economy needs a very robust banking and
financial system. For a strong and resilient banking and finance system,
banks need to go beyond peripheral issues and tackle significant issues like
improvement in profitability, efficiency and technology while achieving
economies of scale through consolidating and exploring available cost
effective solution. These are some of the issues that need to be addressed if
the banks are to succeed, not just survive, in the changing milieu.

Riding on the momentum of competitiveness, the banks are forced to grant

credit on a much larger scale. This results in lesser time per proposal. To add
to this, there is no room for mistakes. Hence, it requires that the banks have
to maintain and continuously update their credit appraisal and monitoring

It is necessary to have a proper credit monitoring system installed because

in the growing economy the banks will have to adhere to more important
business rather than recovery of the credits gone bad. This would mean that
once the credit goes bad, the bank will lose on the profitability frontier.
However, it should be noted that mere one time preparation of a system
shall not suffice the cause. It will have to be regularly updated in the light of
the recent developments.

Indian Bank has always been a pioneer in the banking industry. It has its own
system of credit rating installed on the lines of the BASEL II norms. The bank
has huge collection of deposits and has been efficiently utilizing it for the
growth of the economy. The contribution of the bank in the development of
rural India has been extraordinary. As explained earlier, the Bank has
formulated a system of credit appraisal and monitoring which are apt in
tackling the requirements of the lending procedure. The system is updated

The future for any bank lies in properly allocating its funds. For this a sound
credit management system is necessary. With a liberalized economy in India,
the banks are now in a race in which only the most disciplined, committed
and innovative shall win.


In spite of immense opportunity of learning the various aspects of credit
appraisal and monitoring practices for large borrowers, there are some

inherent limitation in the study which are unavoidable and can be best
explained in the light of the duration and scope of the study. Some of them

 In depth study of the documentation part and having a

thorough exposure in the vast and complex procedure of post
sanction follow up require a substantial amount of time which
is beyond the scope of this project.

 Confidentiality policy of the Bank makes certain files

inaccessible to the study.

There are few more limitations in the study that can be seen from the
limitations of the credit appraisal and monitoring itself. Such as:

 Window Dressing: the clients, while drawing the financial

statements do resort to window dressing. Thus, the financial
statements show a better picture than the actual situation.
This is done to obtain the applied loan.

 Projected Data: credit monitoring involves analyzing the

projected financial of the company. Moreover, the analyst
also tries to look into the future economic and industrial
scenario. But these are all forecast and forecasts may turn to
be wrong.

 Personal Bias: in interpretation of the financials of the

company, the analyst has to use his own judgment. Besides,
in estimating the industrial and management risk, the
analyst has to choose from the defined value statements.
This involves his personal opinion too. Thus there are
possibilities of personal bias.

 Risk analysis: Rating models only give the estimated level

of risk. The factors in these credit rating models, based on
which the risk is calculated, may change very rapidly making
the whole process futile. These factors are also affected by
all foregoing limitations and therefore, the calculated risk
may be incorrect. Some factors may be difficult to judge.

While the Bank has a sound credit appraisal, disbursement and monitoring
system at its disposal, few recommendations can be cited to make the
system more pro active in studying the borrowal accounts and detect any
early signal of slippage of borrowal accounts into NPA category.

1. Comparison of the projections with actuals especially sales and profit

on a monthly basis (presently it is done on quarterly basis).

2. Analyzing financial data of associate/group companies. To keep a tab

on how the associate companies are doing. To become alert when
most of the associate companies run in loss.

3. If comparison of QIS II statement with earlier quarters reveals undue

movement in the composition of current assets and current liabilities,
it will certainly indicate whether the borrower is heading for a liquidity

4. To show a helping attitude and try to understand the genuine

problems of the client and suggest possible remedial measures.

5. To keep a check on the transactions in between the associate

companies. Any abnormal transaction may signal siphoning of funds.

Apart from the above mentioned recommendations with regards to the post-
sanction follow up of corporate advances, few recommendations are made to
mitigate the proportion of Non-Performing assets of the Bank.

1. Don’t Eliminate- Manage:

Studies have shown that management of NPAs rather than elimination

is prudent. India’s growth rate and bank spreads are higher than
western nations. As a result, we can support a non-zero level of NPAs
which balances the risk vis-à-vis return appropriate to the Indian

2. Effectiveness of Asset Reconstruction Companies (ARCs):

Concerns have been raised about their relevance in India. A significant

percentage of the NPAs of the public sector banks are in the priority
sector. Loans in rural areas are difficult to collect and banks by virtue
of their sheer reach are better placed to resolve these loans. Asset
reconstruction companies should focus on the larger borrowers.
Further there is a need for private sector and foreign participation in
the ARCs. Private parties will look to active resolution of the problem
and not merely regard it as a book transaction. Moving NPAs to an ARC
does not get rid of the problem.

3. Well Developed Capital Markets:

A capital market brings liquidity and mechanism for write-off of loans.

Without this, the bank may seek to postpone the NPA problem for fear
of capital adequacy problem and resort to tactics like over greening.
Monitoring by bond holders is better as they have no motive to sustain
uneconomic activity. Further the bank can manage credit risks better
as it is easier to sell or securitize loans and negotiate credit
derivatives. India’s debt market is relatively under developed and
attention should be focused on building liquidity and volumes.

4. Contextual Decision Making:

Regulations must incorporate a contextual perspective (like temporary

cash flow problem) and clients should be handled in a manner which
reflects true value of their assets and future potential to pay. The top
management should delegate authority and back decisions of this kind
taken by mid-level managers.

5. Securitization:

The Resolution trust Corporation has helped develop the securitization

market in Asia and has taken over around $ 460 billion as bad assets
from over 750 failed banks. Its highly standardized products appeal to
a broad investor base. Securitization in India is still in a nascent stage
but has potential in areas like mortgage backed securitization. ICRA
estimates the current market size to be around Rs. 3000 Crores.

6. Legal Issues:

There have been instances of banks extending credit to doubtful

debtors (who willfully default on debt) and getting kick backs.
Ineffective legal mechanism and inadequate internal control
mechanisms have made this problem thrive. Quick action has to be
taken on both counts so that both the defaulters and the authorizing
officers are held liable.



(To be submitted by the borrower within 8 weeks from end of respective quarter)

Name and address of the concern M/s Horizon Limited

Branch Kolkata

Total project cost 770 lakhs

Term loan component 400 lakhs

Participating banks

Name of the bank Amount sanctioned Rate of interest


Date of financial closure 31.03.10

Date of common loan agreement 08.11.07

Date of commercial operation date as per March, 2009

common loan agreement

Draw down details:

As per common loan Actual draw Reasons for variations if any

agreement down(bank wise)

400 lakhs 307.80 lakhs Project under progress

Time schedule:

Details %age of completion Actual completion Reasons for variation

expected as per if any
project report

Land and shed 100% 95% Project start

building 100% 5% Fro april 08

Plant & machinery 100% 90% Do

Other infrastructure 100% 90% do

A. Status of the project (cost incurred):

S particulars cost incurred Estimated Expected remarks

no. date of date of
completion completion
as per

In During Cumulati
lakhs the ve upto
quarter the
June 09 quarter

1 Land and shed 180 3 177

2 Building 84 - 2

3 Plant and 470 41 437


4 Others 37 - 37

Total project 771 41 653


A. Details of mobilization of funds:

S particulars Estimated mobilized Budgete As per Remarks(in

no. in the d estimate dicate the
proposal resource when name of
mobilizat proposed the bank
ion to be where the
during raised actual
the next credit is
quarter received)

In lakhs During Cumulat

the ive up
quarter to the

1 Share capital

promoters 271 2.48 245.67



Term loans 500 42.28 407.80

3 Others

Total 653.47

A and B should tally with each other(cost incurred and amount mobilized should tally with
each other)

Status of approvals:

Whether all statutory approvals are in place? Yes

Certified that the company has brought in Rs. 245.67 lakhs on various dates as per the
details annexed to this statement and utilized a sum of Rs.653.47 lakhs towards various
expenses as indicated in the table A of this report.

Chartered accountant:

Certified that the details of expenditure incurred detailed in the table A and stage/
percentage of completion in the time schedule are correct.

Approved engineer/ lenders’ engineer:

In this context, a live case of documentation is taken up. A private limited company, XYZ
Sales Private Limited wants a renewal/ enhancement sanction from the bank. They are
existing customers of the bank and the bank has to take up the disbursement of sanction
ticket only after proper documentation has been done.

The company enjoys credit facilities in the form of Open Cash Credit (stocks and book debts)
and Imported Letter of Credit (LC). The documents that are needed to be executed in this
regard are as follows:

I. OCC/ Stock and Book Debt:

 D2- Joint and several DPN

 D27- agreement for increase of cash limit
 D27A- agreement for extension of hypothecation or pledge of
 D57- Agreement of guarantee
 D101- agreement of hypothecation of movables
 D105- agreement for OCC
 F4- rent letter
 F45- Board resolution
 F46- negative lien on fixed and liquid assets of limited company
 F52- statement of book debts from borrowers
 F71- power of attorney for collection of bills, book debts and other
 F72A- letter of indemnity for collection of bills
 F87- Letter of pegging
 F104- Notice from our borrower to his debtor in connection with our
 F106- Auditor’s certificate on book debts
 F163- Statement of inventories and receivables
 F164- Consent letter of borrowers for disclosure of information
 F164A- Consent letter of guarantors for disclosure of information
 F172- declaration by borrower regarding details of relatives
working in the bank
 F189- details of family members of borrower and guarantor
 F202- Format of letter of undertaking by corporate borrowers
 F203- Certificate of compliance

II. Imported Letter of Credit:

 D48- agreement of imported LC

 D48A- Application of import LC
 D73- Agreement for hypothecation oif goods received under
advance payment guarantees/ LCs etc.

III. Property/ extension of Equitable mortgage:

 D34A- Extension of EM – Third Party



BRANCH- G. C. Avenue
Circle: kolkata

Name of the borrower:

Details of existing facilities with present balance:

facility limit D/L balance excess overdue Since

OCC (FB) 75.00 75.00 As on -- -- --

stocks, 18.04.09
book debts 77.48

Ad hoc 25.00 25.00

NFB -- -- -- -- --

Details of facilities sanctioned:

Nature of facility limit margin Interest/ Period of

commission sanction

OCC (FB) stocks 150.00 Fully paid stock- BPLR One year
and book debts 25%

Book debts (up

to 90 days)- 50

particulars yes no NA

Correctness of documentation 

Application obtained kept along with the documents 

Assets and liabilities and credit report of the borrower and 

guarantors obtained are in order

Where the borrower’s/ guarantor’s declared net worth exceed

Rs. 50 lakhs, the following documents are obtained,

1. Certificate from CA

2. Photo copies of title deeds in case of immovable

3. A declaration that any disposal of properties will be 
intimated to the bank

4. A declaration that additional liability assumed will be
intimated to the bank

Copy of sanction ticket is signed by the borrower agreeing to 

the terms and conditions of sanction

Documents obtained are as prescribed in the documentation 

manual/ sanction ticket and in complete set

Documents selected are appropriate to the legal status of the 

borrower, type of the credit facility, nature of security

Service charges 

Documents are affixed with required value of adhesive/ special 

adhesive stamps before execution, as per local stamp act

Comments: non judicial stamp papers are used for



Documents are signed/ executed by the executants in the 

presence of 2 officers of the bank to avoid difficulty in

All the pages and schedules of the documents are signed in full 
in the same style


Limited Companies

Certified copy of memorandum and Articles of association is 



Adequate insurance cover with bank clause is taken and the policies are in force as

Details of Value of Amount of Whether policy in Risks covered Remarks

security security insurance joint name with
policy agreed bank clause

stocks 99 lakhs 100 lakhs yes Fire & Valid &

burglary adequate

Book 130 130 lakhs yes fire Valid &

debts lakhs adequate

Valuation report by bank’s approved engineer is obtained 

Declaration regarding

Relatives working in the bank is obtained 

Liability with other bank is obtained 


Appropriate documentation is done as per documentation 

manual by way of pledge/ hypothecation/ mortgage, depending
upon the nature/ type of security offered




OCC 150 LAKHS D2, D27, D 27 A, D 14.08.2009

34A, D 57, D101,
D105, F163, F164,
F172, F29, F71, F87,
F202, F93, F104


All other documents/ undertaking/ authorization letters specifically 

stipulated in the sanction letter are obtained

All other loan papers are in order 

Pre sanction visit made 

Observations made during Stock Inspection for Anonymous
Chemicals Private Limited, Kolkata

Various observations that can be made during a stock inspection of a

trading firm involved in trading of Industrial chemicals may be as follows:

i. The Board of the bank showing the name of the branch and the
hypothecation charge is not visible properly.

ii. There is no adequate fire distinguishing mechanism in the go downs.

iii. Few stocks are not kept in a proper manner. They are left under
the open sky without proper roofing.

iv. Stocks are kept on bare floor which might hamper the quality of
the chemicals.

v. The condition of the go down needs immediate attention.

vi. Few stocks of an associate company have been kept in the go

down of the borrower, though the stocks belonging to the associate
company have not been kept separately or marked.

vii.There are few stocks which have become obsolete. In this regard,
the maintenance of FIFO method is doubtful.

XYZ Trading Company private limited

Stock and Book Debt Audit

Company profile:

XYZ trading company was established in 1985 which is a partnership firm engaged in trading the
industrial paints and sheds.

Company’s operations are being controlled from a fully furnished office situated at 89/2 , Hindustan
park, Cal-23. The goods are stocked at Tollygunj, cal-34.

Physical verification of Stocks:

Physical verification of raw materials were done by us at random basis on 09.11.2009 at Tollygunj go

The stock position as on 05.11.2009(opening) with the position as on 30.09.2009( as per stock
statement submitted) by adding there to and deducting there from subsequent receipts and issues
and found the same in order.

Stock Holding compared to Sales:

As observed, total sale between 01.04.2009 to 31.10.2009 was 5441804 Kg. whereas the stock level
as on 31.10.2009 was 1436547 kg. So the stock holding was,


5441804/7 months

= 2.45 months.

As observed, the stock holding is within the normal permissible level.

Valuation of Stock:

As verified, all materials are valued at weighted average purchase price on FIFO basis, which is in
conformity with the Accounting standard.

Slow Moving Stock:

During the verification, it was noticed that some of the materials are non-moving since long which
seems to be very normal compared to total stock for Rs. 575114 lakhs. These are as follows:

Items Kg Rate Value

English china flakes 4200 15.50 65100.00

Norfloc Powder 24345 5.00 121725.00

Painta Clara (Italy) 150 345.00 51750.00

Sodium phosphate 92 189 17388.00

total 255963.00

It was observed that there was no obsolete stock.

Study/ analysis of cash Flow:

Cash flow statement up to 30.09.2009 was available and no discrepancy in this regard was found after

Sundry Debtors:

The details of sundry Debtors as on 31.10.2009 are as follows compared to 30.09.2009:

Period As on 31.10.2009 As on 30.09.2009

< 90 days 545.87 534.23

>90 days 59.56 61.24

Total 605.43 595.47

A total sale from total sale between 01.04.2009 to 31.10.2009 was 1570 lakhs. So the credit allowed

605.43 = 2.699 months. This seems to be above normal i. e., 2 months.

1570/ 7 months

The reconciliation of sundry Debtors as on 31.10.2009 is shown as under:

Rs (In Lakhs)

Opening Debtors ( as on 01.04.09) 755.12

Add: Sales (01.04.2009 to 31.10.2009) 1245.78


Realization from Drs (01.04.2009 to 31.10.2009) 1457.80

Closing debtors 543.10

Sundry creditors:

The position of sundry creditors as on 31.10.2009 is as follows:

Rs (In Lakhs)

<90 days 203.46

Less: advance 4.59

Total 198.87

Calculation of drawing Power as on 31.10.2009:


i. Stock 54344221.98

ii. Less: sundry creditors for stock 17634678.14


iii. Less: margin (25%) on stock 9177385.96


iv. Add: sundry debtors <90 days 54587345.98


v. Less: margin (50%) on debtors 27293672.99


vi. Net value for Drawing Power 54825830.87

vii. Sanction limit 450 lakhs

viii. Balance with bank as on 31.10.2009 24358765.55 (Dr)

QIS Statement:

The QIS Statement was submitted up to September ’09. It is observed that the actual sale was Rs. 590
lakhs against the projection made for Rs. 800 lakhs. So the achievement was 73.75%.

Quarterly information system form – I

(For traders and merchants exporters)



A. Estimates for the current accounting a. Sales Turnover

year indicated in the annual plan
1. Domestic sales 3350.00

2. Exports --

3. Total 3350.00

b. Other Income --

c. Gross income (Total a+b) 3350.00

B. Estimates for the ensuring quarter a. Sales Turnover

1. Domestic sales 850.00

2. Exports ---

3. Total 850.00

b. Other income ---

c. Gross income (total a+b) 850.00

C. Estimates of current assets and Current assets

current liabilities for the ensuing
quarter ending 1. Stock in trade( month’s cost of sales) 450.00

2. a. Receivables other than deferred

and exports (including bills purchased

& discounted by bankers)+ (month’s

domestic sales)

b. Export receivables(including bills

purchased & discounted by bankers)

+(month’s export sales)


3. advance to suppliers of merchandise


4. other current assets including cash

and bank balance


5. total(estimates) current assets


Current Liabilities:

6. short term bank borrowing

including bills purchased/


7. sundry creditors (trade)


(including those covered under usance

letter of credit/ co acceptance facility

from banks)

8. advance payment from customers ---

9. statutory liabilities

10. other current liabilities


11. total (estimated) current liabilities


Quarterly information system form – II

(For traders and merchants exporters)




YEAR INDICATED IN THE 1. Domestic sales 3350.00
2. Exports ---

3. total 3350.00

b. Other income ----

c. Gross income (total a+b) 3350.00



1ST quarter ended 690.00 690.00

2nd quarter ended 640.00 640.00

3rd quarter ended --- --

4th quarter ended --- ---

C. Data relating to the latest compiled quarter ended:

Sales turnover Estimates Actuals

a. Sales turnover

i. Domestic 625.00 625.00

ii. Exports

Total 625.00

b. Other income --

c. Gross income 625.00

Total a+b

D. Current assets and current liabilities for the latest completed quarter ended:

CURRENT ASSETS Estimates Actuals

1. Stock in trade 535.00

2. a. receivables in cluding 590.00

bills purchased/ discounted
by bankers

3. advance to suppliers 70.00

4. other current assets 160.00

5. total current assets 1355.00


6. Bank borrowing short term 387.00

7. Sundry creditors 262.00

8. advance payment from --

9. statutory liabilities --

10. other current liabilities 10.00

11. total current liabilities 659.00


Here the monthly drawing limit for XYZ sales private Limited for the
month of February, 2010 has been calculated as follows:
Chargeable Current Asset As on date of As per statement 30th
Jan ‘10

Balance sheet march’09 (Rs. In Crores)

A. Raw Material 1.72 1.98

B. Work in Process 0.30 3.15

C. Receivables 1.50 1.80

D. Total Current assets 3.52 6.93

Less: Sundry creditors (including

Advance received, accepted LCs) 0.99 0.37

Less: Margin@25% for stocks and

Book Debts upto 90 days, @40 % for 0.63 1.67

book debts Above 90 days upto 180


Eligible Drawing Power 1.90 4.89

Balance Outstanding 3.32 4.25

Section Eleven: REFERENCES

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Achieve Rating Stability," Journal of Banking and Finance 28 (November), pp.

[2] Basel Committee on Banking Supervision, (2004), International

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[3] Berger, Allen, Sally Davies and Mark Flannery, 2000, "Comparing market
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[4] Blume, Marshall E., Felix Lim, and A. Craig Mackinley, (1998), The
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[6] Cantor, Richard, 2004, "An Introduction to Recent Research on Credit

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[7] Carey, Mark and Mark Hrycay, 2001. "Parameterizing Credit Risk Models
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[8] Das, Sanjiv, Darrell Duffie, Nikunj Kapadia, and Leandro Saita, 2007,
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[10] Diamond, Douglas, 1984. "Financial Intermediation and Delegated

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[11] Estrella, Arturo, (2004), The cyclical behavior of optimal bank capital,
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[12] English, William B. and William R. Nelson, 1998, "Bank Risk Rating of
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[14] Grunert, Jens, Lars Norden, and Martin Weber, 2005. "The Role of Non-
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[15] Jacobson, Tor, Jesper Lindé, and Kasper Roszbach, 2006, "Internal
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[16] Keys, Benjamin J., Tanmoy Mukherjee, Amit Seru, Vikrant Vig, 2009,
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[17] Krahnen, Jan Pieter, and MartinWeber, 2001, "Generally Accepted

Rating Principles: A Primer," Journal of Banking and Finance 25, 3-23.

[18] Löffler, Gunter,2004, "Ratings versus Market-based Measures of Default

Risk in Portfolio Governance," Journal of Banking and Finance 28
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[19]Mester, Loretta J., Leonard I. Nakamura, and Micheline Renault, 2007,

"Transactions Accounts and Loan Monitoring," Review of Financial Studies 20
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[20] Norden, Lars, and Martin Weber, 2007, "Checking Account Information
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[21] Povel, Paul, Rajdeep Singh and Andrew Winton, 2007, "Booms, Busts,
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[22] Takang Felix Achou, Ntui Claudine Tenguh, 2008, Bank Performance
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[23] Treacy, William and Mark Carey, 2000, "Credit Risk Rating Systems at
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