A Report On

THE CORPORATE CREDIT MONITORING AND FOLLOW-UP PRACTICES OF INDIAN BANK

By Chiranjit Basu

INDIAN BANK, G .C. AVENUE BRANCH KOLKATA

A Report
1

On

THE CORPORATE CREDIT MONITORING AND FOLLOW-UP PRACTICES OF INDIAN BANK
By

Chiranjit Basu
Enrollment No. 09BSHYD0234

INDIAN BANK, G .C. AVENUE BRANCH KOLKATA
A report Submitted in partial fulfillment of The requirements of MBA Program of IBS Hyderabad
SUBMITTED TO: Company Guide: Faculty Guide: Mr. P. K. Misra Prof. L. Sridharan Senior Manager ICFAI Business School Indian Bank, Ganesh Chandra Avenue Branch Hyderabad Kolkata Date of submission: 21st May, 2010
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AUTHORIZATION

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 supervision. Mr. P. K. Misra KOLKATA Senior Manager May 21, 2010 Indian Bank, G. C. Avenue

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ACKNOWLEDGEMENT
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 me. 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 organization. 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 possible. 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.

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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

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TABLE OF CONTENTS:
AUTHORIOZATION……………………………………………………………… ……………………………….3 ACKNOWLEDGEMENT………………………………………………………… ……………………………….4 ABSTRACT………………………………………………………………………… ………………………………....8 INTRODUCTION…………………………………………………………… ………………………………….9
1. 1.1

STATEMENT OF THE PROBLEM………………………………………………………………… 10

1.2

OBJECTIVE OF THE STUDY…………………………………………………………………………11 LAYOUT OF THE STUDY…………………………………………………………………………….1 1 PROFILE OF THE COMPANY……………………………………………………………………… ……12
2.

1.3

REVIEW OF LITERATURE………………………………………………………………… ……………..13
3.

GENERAL METHODOLOGY……………………………………………………………… …………….17
4. 6

4.1

METHODS OF CREDIT APPRAISAL……………………………………………………………..17 MONITORING OF IMPLEMENTATION PROJECT……………………………………20 CREDIT FACILITIES FOR CAPITAL………………………………………………21 SANCTION & DISBURSEMENT CREDIT………………………………………………….28 POST-SANCTION MONITORING ADVANCES…………………………………………30 MONITORING OPERATIONS ACCOUNT………………………………………….37 IDENTIFICATION OF WILLFUL ACCOUNTS……………………………40
5.

4.2

OF WORKING OF OF

4.3

4.4

4.5

4.6

IN

THE DEFAULTERS’

4.7

CREDIT RISK ASSESSMENT…………………………………………………………………. ………….42
5.1 CATEGORIZATION

OF RISK & EVALUATION………………………………………….43

ITS

5.2 FINANCIAL

APPRAISAL………………………………………………………………… ……………46
5.2.1 BROAD

STEPS FOR FINANCIAL APPRAISAL……………………………………………………..……47 ANALYSIS……………………………………………………………………………. .………………..…49

5.2.2 RATIO

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5.2.3 SENSITIVITY

ANALYSIS………………………………………………………………. …………………………52
5.2.4 BREAK

EVEN ANALYSIS…………………………………………………….. ………………………………….53 CYCLE………………………………………………………………………………… …………….53

5.2.5 OPERATING

5.2.6 MAXIMUM

PERMISSIBLE FINANCE…..............................................................54

BANK

PRACTICAL CASE STUDY………………………………………………………………………… ………56
6. 6.1

ASSESSING THE PROMOTERS’ BACKGROUND…………………….…………………….56 LIABILITY CREDIT

6.2

ANALYSIS OF ASSET & STATEMENT……………………………………………58 ACTIVITIES PROPOSED IN PROPOSAL…………………………………….61 THE

6.3

6.4

ECONOMIC FEASIBILITY……………………………………………………………………… …...61 INDUSTRY ANALYSIS………………………………………………………………………… ………62 INDUSTRY GROWTH………………………………………………………………………… ………62 SMEs IN AUTO COMPONENTS INDUSTRY…………………………………………………62
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6.5

6.6

6.7

6.8

TECHNICAL FEASIBILITY……………………………………………………………………… …...63 FINANCIAL APPRAISAL……………………………………………………………………… ………63 ANALYSIS………………………………………………………………………… …..70

6.9

6.10 SENSITIVITY

6.11 BREAK

EVEN ANALYSIS………………………………………………………………………… ….72 PERMISSIBLE FINANCE…………………………………………………73 BANK

6.12 MAXIMUM

6.13 CREDIT

RISK ASSESSMENT…………………………………………………………………… ….74 STUDY ON THE NPA ACCOUNTS BANK………………………………………………80
7.

OF

THE

7.1

OUT OF ORDER STATUS…………………………………………………………………………… 80
7.2

INCOME RECOGNITION…………………………………………………………… ………………81 NORMS FOR ASSET CLASSIFICATION………………………………………………………..8 1
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7.3

7.4

SPECIAL MENTION ACCOUNTS ………………………………………………........82

(SMA)

7.5

NPA LOANSA THEORETICAL PERSPECTIVE………………………………………………85

CONCLUSION……………………………………………………………… ………………………………..94
8.

LIMITATIONS OF THE STUDY…………………………………………………………………………. 95
9. 10. RECOMMENDATIONS……………………………………………………

……………………………….96
11. REFERENCES………………………………………………………………

………………………………..114

LIST OF ANNEXURES ANNEXURE 1………………………………………………………………………………… ……………….99 ANNEXURE 2………………………………………………………………………………… …………….102 ANNEXURE 3………………………………………………………………………………… …………….103 ANNEXURE 4………………………………………………………………………………… …………….106
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ANNEXURE 5………………………………………………………………………………… …………….107 ANNEXURE 6………………………………………………………………………………… …………….110 ANNEXURE 7………………………………………………………………………………… …………….113

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Abstract

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. Prerelease 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
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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.

Section One: INTRODUCTION

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
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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: http://www.hsbc.com/ tips on credit management [accessed 15th April, 2010].

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

1.1 STATEMENT OF THE PROBLEM: 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
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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.

1.2 OBJECTIVE OF THE STUDY:  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.

1.3 LAYOUT OF THE STUDY:
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 study. Section two is on a brief introduction on the profile of Indian bank in which organization the thesis work is done.
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Section three elucidates the review of literature related to the work done in this project. 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 nonperforming 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.

Section Two: PROFILE OF THE COMPANY
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
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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//www.indianbank.co.in [accessed 15th April].

Section Three: REVIEW OF LITERARTURE
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.
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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:// www.bis.org/ [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.

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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: http://www.ssrn.com/ [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 Marketbased 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: http://www.ssrn.com/ [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.,
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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
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utilized to their full potential (Joshi, Dr. Amitabh, Analysis of Non-Performing Assets of IFCI Ltd (2003).

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Section Four: GENERAL METHODOLOGY
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 parts: 1. Pre sanction appraisal 2. Disbursement 3. Post-sanction Monitoring and Analysis

4.1 METHODS OF CREDIT APPRAISAL:
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 proposal. 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
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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 requires. 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
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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. no 1.

Key Ratios Current Ratio

Bench Mark (Minimum) i. 1.33(without inclusion of annual maturing term 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 Ratio* TOL/TNW

i. 2:1 for medium and large scale industries ii. 4:1 for infrastructure projects 3:1 for all borrowers with exception to the following sectors 5:1 for infrastructure project 9:1 for contractors otherwise 3:1 (including guarantees-NFB)

3

4 5

DSCR Interest coverage ratio Security Coverage

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

6

i. 1.25 times of advance value for WC limits
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Ratio 7 FACR

ii. 1.20 for term loans 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 manufacturing companies and other projects. All the credit proposals for manufacturing sector for limits of more than Rs. 1 Crore shall accompanied by Industrial Development Officer’s (IDO) report on Technical viability of the proposal. for the be the

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.

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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,
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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:
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i.

For individuals/ Proprietorship concerns

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

ii. For partnership / Joint Hindu Family firms Add a. Capital invested in the business b. Undivided profits/ deduct accumulated losses, if any c. Total worth of individual partners iii Limited companies Add Paid up capital and Free Reserves Less 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
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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 Bank 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 basisi. ii. 20% of the projected annual turnover 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
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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 year. 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 Capital.
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
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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 godown/unit 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
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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
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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 statement: 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
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  

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.

4.4 SANCTION AND DISBURSEMENT OF CREDIT: 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
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communication should clearly divide the terms and conditions into Predisbursement 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 submitted. 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 contract/arrangement, 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
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the parties concerned duly executed by them. The documents should be duly filled in and properly stamped before obtaining the signature of the borrowers. 4.4.1.1 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 completeness in documentation. only pre-disbursement conditions and

A live case showing the Pre Release Audit report is given in Annexure 3. 4.5 POST SANCTION MONITORING OF ADVANCES: 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
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projections made. Monitoring also includes anticipation of problems in advance and taking suitable corrective measure in consultation with the borrower. 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:
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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
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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: 4.5.4.1 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. 4.5.4.2 Where there are large volumes of stocks, thorough stock inspection should be taken up on a small portion in quantity but significant in value. 4.5.4.3 All the establishments of the borrower in the same city like factory, go-down and office should be inspected on each inspection. 4.5.4.4 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. 4.5.4.5 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. 4.5.4.6 The supplementary data on consumption, production, sales etc., shall also be verified with the books of accounts of the borrower.
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4.5.4.7 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 4.5.5.1 General working and tempo of activity 4.5.5.2 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. 4.5.5.3 No. of shifts worked and labor statements 4.5.5.4 Purchase/sales returns, quality control, scrap/wastage management 4.5.5.5 Maintenance of Account Books and Records 4.5.5.6 Slow-moving/old stocks and book debts 4.5.5.7 Statutory liability/pressing creditors 4.5.5.8 Difficulties, if any, experienced in carrying out inspections. 4.5.5.9 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. 4.5.5.10 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. 4.5.5.11 Internal Reports of the company as to age and quality of book debts, sales returns of finished goods may also be scrutinized. 4.5.5.12 Consignment stocks in and out to be supported by proper records.

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4.5.5.13 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. Meeting and holding discussions with the borrower and key personnel and also the auditors of the unit. Inspection officials satisfying themselves that the borrower is agile and committed to his responsibilities. Supplementing and constantly updating bank’s knowledge about the operations of the borrower in particular and the industry in general.

3. 4. 5.

4.5.7-Benefits: 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 reveal.

An example of a Stock inspection for a trading company is shown in Annexure 4.

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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;
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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 securities:
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 immediately. 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 inspection. 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 taken.
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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. QIS- I Compare the information with projections for the whole year. Any variation over 10% should be scrutinized. QIS- II 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.

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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. QIS III 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: 4.6.3.1-Scope: 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.
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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.
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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. 4.6.3.2-Study 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
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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 www.cibil.com 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.

Section Five: CREDIT RISK ASSESSMENT
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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
49

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 under1. 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.

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Ratios considered for financial risk assessment: Working Capital 1. Current ratio 2. TOL/TNW 3. PBDIT/ Interest 4. PAT/ Net Sales (%) 5. ROCE or ROA (%) 6. (Inventory+ receivables)/ Sales (In Days) Net Term Loans Project debt/ equity TOL/ TNW Gross average DSCR of the Project Gross average DSCR for all loans Terms of payment (Years)

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.

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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 Development; 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
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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 2 3 4 5 6 7 8 CRM – 1 CRM –2 CRM –3 CRM –4 CRM –5 CRM –6 MOODY’S RRM CRM –7 = > 2 LACS TO <25 LACS

>= 25 LACS IN TRADE SECTOR >= 25 LACS IN NBFC >= 25 LACS TO 100 LACS SSI >= 2 LACS IN HOME LOAN >= 2 LACS IN VEHICLE LOAN >= 100 LACS IN MANUFACTURING SEGMENT >= 25 LACS BUT NOT COVERED ABOVE

A Practical example of credit rating through RAM model is given in the Practical Case Study Section.

5.2 FINANCIAL APPRAISAL:
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.
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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 conclusions.

Step 1- Determination of the relevant Information
5.2.1.1 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.
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5.2.1.2 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.

5.2.1.3 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 projectwhich is technically called the ‘ project debt/ equity gearing’. Break-up of Equity and debt components: Equity components include 1. Share capital a. Equity shares b. Preference shares 2. Internal cash accruals (Including general reserve, profit and loss account balance etc.) 3. Any other (like central or state subsidies etc.) c. Deferred payment facilities
55

Debt components include a. Debentures

b. Term loans

d. Unsecured loans e. Any other (like central/ state tax loans, development loans) 5.2.1.4 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.

5.2.1.5 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.

5.2.1.6 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. 5.2.1.7 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 finances.

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
56

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.

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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/ salesNet 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/ salesCash 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 employedROCE= PBIT/ (total debt + tangible net worth) PBIT= profit before interest and taxes Total debt= total outside liabilities as explained under point no.6 before. 9. Current assets holding level58

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.
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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 project 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
60

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 Finance): 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: PROJECTED GROSS …………………a CURRENT ASSETS……………………………………………..

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) …………………………………………….……………………..b GROSS CURRNT ASSETS ……………………………………………………………………………A Less: CURRENT LIABILITIES BORROWING…………………………..B OTHER THAN (a-b) BANK

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WORKING CAPITAL GAP (A-B)…………………………………………………………….. …………….C LESS 25 % MARGIN (A)……………………………………………………………………. …..……………D ACTUAL PROJECTED NET CAPTIAL………………………………………………....E WQORKING

WORKING CAPTIAL GAP MARGIN(C-D)……………………………………………….. …………....F WORKING CAP NWC………………………………………………………………………………….G GAP-

MAXIMUM POSSIBLE BANK FINANCE (MPBF)…………………………….F or G 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 judgment. 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.

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Section Six: PRACTICAL CASE STUDY
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

63

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:

CREDIT REPORT AS ON 31.03.10 1. NAME OF THE BORROWER: Rajeev Deb 2. FULL ADDRESS: 35 A, Golf Club, Kolkata 3. WHEN ESTABLISHED: 2004 4. IF THE PARTY IS DOING OTHER BUSINESS, GIVE DETAILS OF THE TRADE NAME & ADDRESS: Mr.

NA

5. PARTICULARS OF MEANS: A. Immovable Properties: i. Value of land as per manager’s estimate: 5. 10 lakhs ii. Value of buildings as per manager’s estimate iii. Book value of plant and machinery if any Rs. --64

B. Liquid assets: i. Investments in business Rs. 88.63 lakhs ii. Other assets Rs. 33.10 lakhs Sub Total 126.83 lakhs C. Particulars of borrowing: i. From the bank: -ii. From other banks: iii. From private persons: NIL Rs.

---

Less Rs.

Estimate worth 126.83 lakhs 6. REASONS FOR THE CHANGE IN WORTH, IF ANY: assets

Rs. increase in other

7. OTHER INFORMATION: I. Estimated net earnings per year: Rs. 14.00 lakhs II. How long has he/ the concern been dealing with our bank: since 1974 III. Nature of dealing with us: satisfactory IV. Comments regarding the nature of his/concern’s Transaction: sound/ speculative/ conservative/overtrading 8. Nature and extenet of credit facilities enjoyed by the individual/ proprietary concern at different offices of the bank as also at other banks: a. At the Bank’s Offices : Name of the Nature office facility of Limit sanctioned Date sanction of Remarks

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b. At other Banks: Name of the Nature office facility of Limit sanctioned Date sanction of Remarks

9. The name and addresses of persons , banks, from whom enquiries are made: Date of opinion
Name & address of persons/banks from whom opinion received

His/their Information estimated worth given orally or in of the property writing orally

Existing Rs. 120 lakhs customer Mr. N. Rastogi

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. Date Branch Manager

6.2 Analysis of Asset and Liabilities Statement:

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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:

DETAILS OF ASSETS AND LIABILITIES OF Mr. Krishnakanta Deb of M/s Horizon Limited AS ON 31.03.10 Immovable property, land Name of the village or taluk where the lands are situated At Kamal gazi, south 24 Parganas, WB Ancestral If Extent in Add. Of Total or self- encumber acres, registered value acquired ed to what wet/dry office extent

Selfacquired

-----

0.75 19.05.98 acres only

20,00,00 0/-

Total 20,00,000/-

Buildings

Name of Ancestral the vill. or self Or town acquired where they are situated

If Add. Of Total encumber registered value ed to what office extent

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Resident 2- B Golf ial Heights house(1) Kol-32 Res. House (2) Machine ry etc.

Self acquired

----

14.11.200 0 Jadavpur kolkata

1,00,00,00 0/26,00,000/ -

---Self acquired

Total 1, 26,00,000/-

Liquid assets

Nature stock

Cash and bank balance Realizable book debts

----------

of If amoun Market encumber t value ed to what extent -------

Total value

3,95,000/-

Investment in business ---Investment in Govt. promissory notes, shares etc. Other movable properties like life LIC Jewellery and ornaments 1888000/18,88,000 /68

37,37,000 /-

policies etc. premium (state their policy nature) Rs. 6781876/-

761876/Total 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
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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 years.

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
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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 present.

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:
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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 Liabilities
Unit: M/s. Horizon Limited Year Past 1st Yr audited Previous Yr’s audited Last yr’s audited Amounts (in Lakhs) Current Yr’s estimates Future Yr’s projectio Future Yr’s projectio

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ns Mar-07 Mar-08 Mar-09 Mar- 10 Mar-11

ns Mar-12

CURRENT LIABILITIES
1. Short borrowing banks i. From bank term from 100.00 applicant 59.00 59.00 72.00 72.00 72.00 72.00 100.00 100.00 100.00 100.00 100.00

ii. From other banks iii. Sub total (A)

2. Sundry creditors 3. Provision taxation for

147.89 11.96

179.19 16.57

219.43 21.71

250.00 31.41

325.00 54.40

350.00 67.07

4. Install. Of prop. Term loan due within one yr 5. Other CL and provisions(due within 1 yr) a. Sd Cr for others b. Bills payable c. Sd Cr for capital Goods d. Liab. For Exp.+ Prov. For bonus Sub total (2 TO 9) (B) 6. Total Current Liabilities (A+B) 53.09 40.65 61.79

60.00

60.00

60.00

75.00

97.50

105.65

17.41 26.52 1.54

18.27 15.22 1.54

36.41 17.22

40.00 20.00

52.00 26.00

57.00 27.30

7.62

5.62

8.16

15.00

19.50

21.35

212.94 271.94

236.41 308.41

302.93 374.93

416.41 516.41

536.90 636.90

582.72 682.72

TERM LIABILITIES
7. Prop. Term loan excluding Instal.<1 yr 8. Unsecured (directors sources) 9. Other loan own 43.03 67.92 81.27 340.00 280.00 220.00

100.00

100.00

100.00

term

20.00

116.72

143.41

100.00

100.00

100.00

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liabilities-corporate borrowings 10. Total term Liabilities (7 to 9) 11. Total Outside Liabilities (6+10) 63.03 184.64 224.68 540.00 480.00 420.00

334.97

493.05

599.61

1056.41

1116.90

1102.72

NET WORTH
12. Ord. share/ prop’s./ Partners’ Capital 13. General reserve 14. Surplus(+)/ deficit(-) in P&L a/c 15. Share premium account 16. Net worth 180.47 180.47 180.47 297.97 297.97 297.97

31.16

31.16

31.16

31.16

31.16

31.16

22.62

44.89

83.77

150.02

266.68

410.65

30.67

30.67

30.67

61.34

61.34

61.34

264.92 599.89

287.19 780.24

326.07 925.68

540.49 1596.90

657.15 1774.05

801.12 1903.84

17. TOTAL LIABILITIES (11+16)

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

13. Adv. To suppliers of capital goods 14. receivables (over 6 months) 15. Total Other Non Current Assets 16. TOTAL ASSETS (8+12+15)

37.64 2.19 39.83 599.89

38.68 7.2 45.88 780.24 11.97 11.97 925.68 30 30 1596.21 39 39 1771.8 50 50 1900.04

75

Financial (Rs. In Crores) Performanc e indicators Year ending
Paid up capital Reserves surplus Intangible assets Tangible worth net &

indicators: Last 2 years Current year estimate Audited 31.03.09
2.82 1.08

Projections for next year 31.03.11
5.00 1.00

Audited 31.03.07
2.20 1.20 -3.41

Audited 31.03.08
2.30 1.07

31.03.10
3.80 1.00

3.37

3.90

4.80

6.00

Long term liabilities Capital employed Net block Investments Non current assets Net working capital Current assets Current liabilities Current ratio Debt ratio equity 3.05 6.20 3.15 1.97 0.72 0.93 19.31 --3.06 8.02 4.96 1.62 0.33 1.47 23.83 23.38% 1.26 3.37 11.30 7.92 1.43 0.27 2.03 29.75 24.84% 1.55 4.30 12.40 8.10 1.53 0.19 1.69 33.50 12.59% 1.84 5.50 13.80 8.30 1.66 0.15 1.38 38.50 24.92% 2.20 3.40 0.352 3.06 3.37 0.316 3.06 3.90 0.528 3.06 4.80 0.500 3.00 6.00 0.500 3.00

TOL/TNW Net sales % increase over last year Operating profit before interest

76

Interest Other income Net profit before tax Net profit after tax Depreciation Cash accruals DSCR Interest coverage ratio(%) Gross profit/ net sales % Net profit/ net sales Inventory turnover ratio (days) Receivables/ gross sales (days) Current assets/gross sales % Sundry creditors/ purchases (days)

-0.08 0.66 0.66

0.35 0.10 0.988 0.988

0.48 0.10 1.17 1.17

0.60 0.10 1.34 1.34

0.70 0.10 1.70 1.70

0.66

0.988

1.17

1.34

1.70

--

3.91

3.61

3.33

3.51

5.30 4.15 31.64

5.21 3.94 21.94

5.49 4.00 38.13

5.71 4.42 37.92

50.03

87.27

72.67

69.87

33.68

37.99

37.01

35.84

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:
77

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 20082009 and estimated other income of Rs. 10.00 lakhs during 20092010.
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 respectable. 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.

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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 solvency. 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:

changes 1. net sales

avera ge level 1961. 38

Cost Volume- Price Analysis or Sensitivity 10% 10% dec. increase in in sales 10% dec. in var cost vol sales price 1961.38 1765.24 1765.24

analysis 5% inc. in var cost

5%dec 55 dec. in s/vol in s/price 1863.3 1961.38 1 1863.31 79

2. variable exp 3. contribution ( 1-2) 4. fixed exp 5. operating profit (3-4) 6. break even analysis

1588. 81 372.5 7 176.0 2 196.5 5 926.6 5

1747.69 213.69 176.02 37.67 1615.62

1429.93 335.31 176.02 159.29 926.66

1588.81 176.43 176.02 0.41 1761.14

1668.25 293.13 176.02 117.11 1177.78

1509.3 7 353.94 176.02 177.92 926.65

1588.81 274.5 176.02 98.48 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 economy.

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,
80

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 analysisBreak Even Analysis audite audite audite d d d March' March' March' 07 08 09
459.09 481.84 616.7 650.19 796.72 801.7

M/s Horizon Limited

estima ted March' 10
1155 1189.14

project ion March' 11
1696 1707

projecti on March' 12
2140 2152.1

Net Sales sale value of production variable expenses RM, Stores, Power, labor, other Mfg. exp. 40% of selling, Gen & Admn. Exp interest on working capital Total Contribution fixed expenses Salary, depreciation, TL intt., other Intt. 60% of selling, gen & admn exp. Total

377.08 18.14 0 395.22 86.62

520.88 20.03 0 540.91 109.28

647.15 20.49 0 667.64 134.06

920 26 7 953 236.14

1288 33.8 14.25 1336.05 370.95

1682.1 40.56 14.25 1736.91 415.19

38.43 27.22 65.65

43.89 30.05 73.94

44.02 30.73 74.75

96.48 39 135.48

146.44 50.7 197.14

139.56 60.84 200.4

81

total cost operating profit profit after tax

460.87 20.97 12.57

614.85 35.34 22.27

742.39 59.31 38.88

1088.48 100.66 65.56

1533.19 173.81 115.1

1937.31 214.79 142.42

Break Even sales
cash break even sales

347.95
289.06

417.27
347.06

444.24
364.78

662.66
450.53

901.33
600.9

1032.9 2
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 Committee):

Permissible

Bank

Finance

(Tandon

The following table shows the calculation of the MPBF by Short Term Bank Credit Method (STBC method) Year Ending Estimates March ‘10 Projected March ‘11
82

A. Projected Gross Current Assets (to be in line with past actuals or any variation should be justified) B. Current Liabilities other than Bank Borrowings & excluding AMTL C. Working Capital Gap (A-B) D. 20% Margin on Gross Current Assets E. Actual/ Projected NWC excluding AMTL F. Gross Current Assets- Margin (C-D) G. Gross Current Assets- NWC (C-E) H. Maximum Permissible Bank Finance (F or G whichever is lower)

13.51

20.50

7.51 6.00 2.70 2.40 3.29 3.60 3.29

7.80 12.70 4.10 4.10 8.60 8.60 8.60

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 modelThe overall rating- AA Country risk- Moderate Financial statement quality- Good [Note: the RAM rating tables are all fictitious, no confidential data has been provided] Circle: Bengal CEO: Mr. Rajeev Dev
83

Constitution: Private Limited Baking with us since: New Banking arrangement: Sole Banking Rating By external agency: CRIS INFAC (by CRISIL) Credit Rating:
Branch Financial parameters Sales growth Current ratio Interest coverage ratio TOL/TNW Net profit/ sales Return on employed 5 5 5 5 5 capital 5 5 5 5 80%of sales 1.96 3.17 1.98 85.22% projection 88.63% projection 96.41% projection 106.56% projection 107.89% projection projected 3 5 5 5 of 4 of 4 of 5 of 5 of 4 40 Parameter Value Audited score

Debtors holding period Inventory holding period Creditors holding period Total parameters

financial 45

Managerial parameters Marketing experience 3 Hands experience on 3

84

Conduct accounts

of

group NA 3 the 3 3

NA Family business 133.05% Clear

NA 3 2 3 11

Succession planning Net worth promoters Credit history of

Total managerial 12 parameters

Industry parameters Number traded of products 2 2 2 2 2 2 2 2 2 2 As per INFAC the CRIS

Product seasonality Product availability Product marketability Threat of substitutes Threat of imports Supply source Client base Regulatory issues Bank’s loan policy

Industry risk score for Auto parts

Total parameters Operational parameters Servicing of within 15days

industry 20

8

interest 2

Yes

2 NA 85

Servicing of installment NA within 15 days

Non return of cheque/bill 2 purchased/ discounted Utilization of limits( MIN. 70%) FB 2

Yes Yes Yes Yes Yes Yes No No

2 2 2 2 2 2 0 0

Routing of turnover (MIN. 2 70%) Timely submission stock statements of 2

Timely submission of 2 audited balance sheet Timely submission renewal proposal Adequacy coverage of of 2

insurance 2 of 2

General compliance sanction terms

Total operational 18 parameters

14

Total score for obligor 95 rating Obligor rating to be awarded grade 76.84%

73 A

Facility rating Tenor of advances Security structure Availability collateral Total of 20 80 18.07 70

specified NA 100 88.07

86

Facility rating to be awarded

grade

88.07%

AAA

Normalize obligor score 70 to 70% Normalize facility score 30 to 30%

53.29 26.42

Total final risk 100 score(obligor risk score+ facility score)

80.21

Final integrated credit AAA rating grade

AA

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:

87

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 hindrances. Price realization- satisfactory 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. Entry barrier: NIL 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. 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. 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 risk.
88

ii. iii.

iv.
v.

vi.

vii.

D. Direction of measuresi. ii.

risk

management

and

suggested

remedial

Credit risk rating assigned for last two years is AA under IRM-2 The obligor rating was not satisfactory because of the following reasons 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 increased.  As per CRIS INFAC parameters, the industry is a risky one and thus a meager 43% has been awarded.

89

Section Seven: STUDY ON THE NON-PERFORMING ACCOUNTS OF THE BANK

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 sanctioned limit/ drawing power from 31.12.2008. in excess of

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.
90

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 uncollected. 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 recovery. 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
91

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.
92

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 subsequent adverse asset classification.

repayment

prospects

and

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 responsible.
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 observed,
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.
93

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

monthly

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 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 A Type of Accounts Accounts that will be out of SMA category Accounts that will be restructured / proposed to be restructured and hence will not become a problem account. Accounts where no scope of recovery and may require provisioning and are categorized as potential NPA accounts.
94

monthly

B

C

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
95

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.
96

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 payment. 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,
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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 Allahabad Bank Andhra Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Central Bank of India Corporation Bank 3.16 0.84 2.22 3.00 1.84 1.77 2.74 0.76 2005-06 1.05 0.44 2.07 2.43 0.89 1.39 2.01 0.86 200607 0.60 0.15 0.65 1.64 0.85 1.02 1.19 0.61 2007-08 0.45 0.13 0.46 0.86 1.07 0.66 1.30 0.38 200809 0.65 0.10 0.35 0.45 0.71 0.56 0.94 0.27
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Dena Bank Indian Bank Indian Overseas Bank Punjab National Bank Syndicate Bank UCO Bank Union Bank of India United Bank State bank of India State Bank Hyderabad

4.95 2.13 2.22 1.77 2.03 2.00 2.45 1.67 1.64 of 1.21

3.99 0.98 1.22 0.44 1.13 1.72 1.45 1.16 1.33 0.25

2.46 0.56 0.63 0.09 0.82 1.49 1.46 0.95 1.16 0.27

1.63 0.37 0.38 0.14 0.51 1.27 0.94 0.91 0.99 0.19

1.16 0.18 0.31 0.45 0.44 1.34 0.59 0.93 0.93 0.12

7.5.4 RECOVERY OF EXISTING NPA LOANS
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:
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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 applicable, within the ambit of bank’s policy. advances wherever

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.
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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 accounts. 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.

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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 etc. 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 NPA.

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.,
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1XP {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 Period 1 year 2 year 3 year 4 year 5 year 6 year 7 year 8 year 9 year Rate of interest (compounded quarterly) 10% 1.10* 1.22 1.34 1.48 1.64 1.81 2.00 2.20 2.43 11% 1.11 1.24 1.38 1.54 1.72 1.92 2.14 2.38 2.66 12% 1.13 1.27 1.43 1.60 1.81 2.03 2.29 2.58 2.90 13% 1.14 1.29 1.47 1.67 1.90 2.15 2.45 2.78 3.18 14% 1.15 1.32 1.51 1.73 1.99 2.28 2.62 3.01 3.45 15% 1.16 1.34 1.56 1.80 2.09 2.42 2.80 3.25 3.76 16% 1.17 1.37 1.60 1.87 2.19 2.56 3.00 3.51 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.

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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
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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 system. 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 continuously. 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.

Section Nine: LIMITATIONS OF THE STUDY
In spite of immense opportunity of learning the various aspects of credit appraisal and monitoring practices for large borrowers, there are some
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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 are:
 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 inaccessible to the study. the Bank makes certain files

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.

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Section Ten: RECOMMENDATIONS
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 problem. 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 postsanction 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 context.

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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.
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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.

ANNEXURE 1
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PROJECT IMPLEMENTATION PROGRESS REPORT
PROJECTS UNDER IMPLEMENTATION INVOLVING ACQUISITION OF CAPITAL ASSETS/ PROJECT COST OF RS. 1 CRORE AND ABOVE REPORT FOR THE QUARTER ENDED: JUNE/SEP/DEC/MARCH- 2009 (To be submitted by the borrower within 8 weeks from end of respective quarter) Name and address of the concern Branch Total project cost Term loan component Participating banks Name of the bank INDIAN BANK, G. C. AVENUE, KOLKATA Date of financial closure Date of common loan agreement Date of commercial operation date as per common loan agreement Draw down details: As per common loan agreement 400 lakhs Actual draw down(bank wise) 307.80 lakhs Reasons for variations if any Project under progress Amount sanctioned 400 Lakhs 31.03.10 08.11.07 March, 2009 Rate of interest BPLR+ 0.5% M/s Horizon Limited Kolkata 770 lakhs 400 lakhs

Time schedule: Details %age of completion expected as per project report 100% 100% 100% 100% Actual completion Reasons for variation if any Project start Fro april 08 Do do

Land and shed building Plant & machinery Other infrastructure

95% 5% 90% 90%

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A. Status of the project (cost incurred): S no. particulars cost incurred Estimated date of completion as per appraisal note Cumulati ve upto the 30.06.09 quarter 177 2 437 37 653 Expected date of completion remarks

In lakhs

During the quarter June 09

1 2 3 4

Land and shed Building Plant machinery Others Total cost project and

180 84 470 37 771

3 41 41

A. Details of mobilization of funds: S no. particulars Estimated in the proposal mobilized Budgete d resource mobilizat ion during the next quarter Cumulat ive up to the quarter As per estimate when proposed to be raised Remarks(in dicate the name of the bank where the actual credit is received)

In lakhs

During the quarter

1

Share capital promoters others Unsecured loan Term loans 500 42.28 407.80 271 2.48 245.67

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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:

ANNEXURE 2
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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 movables  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 receivables  F72A- letter of indemnity for collection of bills  F87- Letter of pegging  F104- Notice from our borrower to his debtor in connection with our advance  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

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ANNEXURE 3 PRE RELEASE AUDIT REPORT
BRANCHG. C. Avenue Circle: kolkata Name of the borrower: Details of existing facilities with present balance: facility OCC (FB) stocks, book debts Ad hoc NFB limit 75.00 D/L 75.00 balance As on 18.04.09 77.48 lakhs excess -overdue -Since --

25.00 --

25.00 -----

Details of facilities sanctioned: Nature of facility OCC (FB) stocks and book debts limit 150.00 margin Fully paid stock25% Book debts (up to 90 days)- 50 % Interest/ commission BPLR Period of sanction One year

particulars 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 properties

yes   

no

NA

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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 documentation. Execution Documents are signed/ executed by the executants in the presence of 2 officers of the bank to avoid difficulty in identification All the pages and schedules of the documents are signed in full in the same style CONSTITUTION OF THE BORROWER Limited Companies Certified copy of memorandum and Articles of association is obtained INSURANCE Adequate insurance cover with bank clause is taken and the policies are in force as under: Details of security stocks Book debts Value of security 99 lakhs 130 lakhs Amount of insurance policy 100 lakhs 130 lakhs Whether policy in joint name with agreed bank clause yes yes Risks covered Remarks       

Fire & burglary fire

Valid & adequate Valid & adequate

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Valuation report by bank’s approved engineer is obtained Declaration regarding Relatives working in the bank is obtained Liability with other bank is obtained SECURITY- PRIMARY/ COLLATERAL Appropriate documentation is done as per documentation manual by way of pledge/ hypothecation/ mortgage, depending upon the nature/ type of security offered

 

DETAILS OF DOCUMENTS:

NATURE OF FACILTY

LIMIT SANCTIONED

DETAILS OF DOCUMENTS OBTAINED D2, D27, D 27 A, D 34A, D 57, D101, D105, F163, F164, F172, F29, F71, F87, F202, F93, F104

DATE OF DOCUMENTS 14.08.2009

OCC

150 LAKHS

PARTICULARS 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

YES   

NO

NA

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ANNEXURE 4
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.

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ANNEXURE 5
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 down. 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, 1906547 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 English china flakes Norfloc Powder Painta Clara (Italy) Sodium phosphate Kg 4200 24345 150 92 Rate 15.50 5.00 345.00 189 Value 65100.00 121725.00 51750.00 17388.00

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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 verification.

Sundry Debtors: The details of sundry Debtors as on 31.10.2009 are as follows compared to 30.09.2009: Period < 90 days >90 days Total As on 31.10.2009 545.87 59.56 605.43 As on 30.09.2009 534.23 61.24 595.47

A total sale from total sale between 01.04.2009 to 31.10.2009 was 1570 lakhs. So the credit allowed is, 605.43 1570/ 7 months = 2.699 months. This seems to be above normal i. e., 2 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) Add: Sales (01.04.2009 to 31.10.2009) 755.12 1245.78 2000.90 Realization from Drs (01.04.2009 to 31.10.2009) Closing debtors 1457.80 543.10

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

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Rs (In Lakhs) <90 days Less: advance Total 203.46 4.59 198.87

Calculation of drawing Power as on 31.10.2009: Rs i. ii. Stock Less: sundry creditors for stock 54344221.98 17634678.14 36709543.84 iii. Less: margin (25%) on stock 9177385.96 27532157.88 iv. Add: sundry debtors <90 days 54587345.98 82119503.86 v. Less: margin (50%) on debtors 27293672.99 54825830.87 vi. Net value for Drawing Power vii. Sanction limit viii. Balance with bank as on 31.10.2009 54825830.87 450 lakhs 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%.

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ANNEXURE 6
Quarterly information system form – I (For traders and merchants exporters) ESTIMATES FOR THE ENSURING QUARTER ENDING…… 31.03.2010
NAME OF THE BORROWER: A. Estimates for the current accounting year indicated in the annual plan XYZ TRADING COMPANY PVT. LIMITED a. Sales Turnover 1. 2. 3. b. c. B. Estimates for the ensuring quarter ending a. Domestic sales Exports Total 3350.00 -3350.00 -3350.00

Other Income Gross income (Total a+b) Sales Turnover 1. 2. 3. Domestic sales Exports Total

850.00 --850.00 --850.00

b. c. C. Estimates of current assets and current liabilities for the ensuing quarter ending

Other income Gross income (total a+b)

Current assets 1. 2. Stock in trade( month’s cost of sales) a. Receivables other than deferred and exports (including bills purchased & discounted by bankers)+ (month’s domestic --b. Export receivables(including bills purchased & discounted by bankers) +(month’s --3. advance 150.00 to export suppliers of sales) merchandise sales) 450.00

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4. other current assets including cash and 200.00 5. total(estimates) 1550.00 bank current balance assets

Current Liabilities: 6. short term bank borrowing including bills purchased/ discounted: 450.00 7. sundry 200.00 creditors (trade)

(including those covered under usance letter of credit/ co acceptance facility from --8. 9. advance payment from customers statutory --current (estimated) current banks) --liabilities liabilities liabilities

10. other 15.00 11. total 665.00

Quarterly information system form – II (For traders and merchants exporters) PERFORMANCE DURING THE QUARTER ENDED…… 31.03.2010
NAME OF THE BORROWER:
A. ESTIMATES FOR THE CURRENT ACCOUNTING YEAR INDICATED IN THE ANNUAL PLAN a. 1. 2. 3.

XYZ TRADING COMPANY PVT. LIMITED
SALES TURNOVER Domestic sales Exports total Amount in lakhs 3350.00 --3350.00

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b.

Other income

----

c.

Gross income (total a+b)

3350.00

B.

ACTUAL GROSS INCOME DURING THE CURRENT ACCOUNTING YEAR

DURING THE QUARTER GROSS INCOME 690.00 640.00 -----

CUMULATIVE POSITION GROSS INCOME 690.00 640.00 ----

1ST quarter ended 2nd quarter ended 3rd quarter ended 4th quarter ended

C.

Data relating to the latest compiled quarter ended: Estimates Actuals

Sales turnover a. i. ii. Total b. c. Other income Gross income Total a+b Sales turnover Domestic Exports

625.00

625.00

625.00 -625.00

D.

Current assets and current liabilities for the latest completed quarter ended: Estimates Actuals 535.00 590.00

CURRENT ASSETS 1. 2. Stock in trade a. receivables in cluding bills purchased/ discounted by bankers advance to suppliers other current assets total current assets CURRENT LIABILITIES 6. 7. Bank borrowing short term Sundry creditors

3. 4. 5.

70.00 160.00 1355.00

387.00 262.00

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8. 9.

advance payment customers statutory liabilities

from

--10.00 659.00

10. other current liabilities 11. total current liabilities

ANNEXURE 7

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 Balance sheet march’09 As per statement 30th Jan ‘10 (Rs. In Crores)

A. Raw Material B. Work in Process

1.72 0.30 1.50 3.52

1.98 3.15 1.80 6.93

C. Receivables D. Total Current assets
Less: Sundry creditors (including Advance received, accepted LCs) Less: Margin@25% for stocks and Book Debts upto 90 days, @40 % for book debts Above 90 days upto 180 days) Eligible Drawing Power Balance Outstanding

0.99

0.37

0.63

1.67

1.90 3.32

4.89 4.25

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Section Eleven: REFERENCES
[1] Altman, Edward I. and Herbert A. Rijken, 2004, "How Rating Agencies Achieve Rating Stability," Journal of Banking and Finance 28 (November), pp. 2679-2714. [2] Basel Committee on Banking Supervision, (2004), International Convergence of Capital Measurement and Capital Standards: a Revised Framework, June 2004, Basel, Switzerland. [3] Berger, Allen, Sally Davies and Mark Flannery, 2000, "Comparing market and supervisory assessments of bank performance - who knows what when", Journal of Money credit and Banking 32 (3) (August), 641-667. [4] Blume, Marshall E., Felix Lim, and A. Craig Mackinley, (1998), The declining credit quality of U.S. corporate debt: myth or reality?, Journal of Finance, Vol. LIII No. 4, pp. 1389-1413. [5] Calem, Paul and Michael LaCour-Little, (2001), Risk-based capital requirements for mortgage loans, Finance and economics discussion series no. 2001-60, Federal Reserve Board, Washington D.C, forthcoming in: Journal of Banking and Finance. [6] Cantor, Richard, 2004, "An Introduction to Recent Research on Credit Ratings,"Journal of Banking and Finance 28 (November), pp. 2565-2573. [7] Carey, Mark and Mark Hrycay, 2001. "Parameterizing Credit Risk Models with Rating Data," Journal of Banking and Finance 25, 197-201. [8] Das, Sanjiv, Darrell Duffie, Nikunj Kapadia, and Leandro Saita, 2007, Common Failings: How Corporate Defaults are Correlated, Journal of Finance 62(1), pp. 93-118.
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[9] Dell’Ariccia, Giovanni, and Robert Marquez, 2004, "Information and bank credit allocation", Journal of Financial Economics 72, 185—214 203 [10] Diamond, Douglas, 1984. "Financial Intermediation and Delegated Monitoring" Review of Economic Studies, 51, 393-414. [11] Estrella, Arturo, (2004), The cyclical behavior of optimal bank capital, Journal of Banking and Finance, 28, pp.1469-1498. [12] English, William B. and William R. Nelson, 1998, "Bank Risk Rating of Business Loans," Board of Governors of the Federal Reserve System, April, working paper [13] Fama, Eugene F., 1985. “What’s Different About Banks?” Journal of Monetary Economics, 15, 29-40. [14] Grunert, Jens, Lars Norden, and Martin Weber, 2005. "The Role of Nonfinancial Factors in Internal Credit Ratings," Journal of Banking and Finance 29, 509-531. [15] Jacobson, Tor, Jesper Lindé, and Kasper Roszbach, 2006, "Internal Ratings Systems, Implied Credit Risk and the Consistency of Banks’ Risk Classification Policies," Journal of Banking and Finance 30, 1899-1926 [16] 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), 700-720. [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 (November), pp. 2715-2746. [19]Mester, Loretta J., Leonard I. Nakamura, and Micheline Renault, 2007, "Transactions Accounts and Loan Monitoring," Review of Financial Studies 20 (May), 529-556.

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[20] Norden, Lars, and Martin Weber, 2007, "Checking Account Information and Credit Risk of Bank Customers," Working paper. [21] Povel, Paul, Rajdeep Singh and Andrew Winton, 2007, "Booms, Busts, and Fraud", Review of Financial Studies 20 (4), pp. 1219-1254 [22] Takang Felix Achou, Ntui Claudine Tenguh, 2008, Bank Performance And Credit Risk Management, University of Skovde. [23] Treacy, William and Mark Carey, 2000, "Credit Risk Rating Systems at Large U.S. Banks", Journal of Banking and Finance 24, pp.167-201.27
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