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CREDIT APPRAISAL STANDARDS

The process of making loan is divided into four parts viz. pre sanction credit appraisal, sanction, documentation and monitoring and follow-up. Pre credit appraisal is most critical part of lending process as through this process bank takes decision to accept or reject a loan proposal. The terms and conditions on which the loan is sanctioned are also decided through the appraisal process. The quality appraisal ultimately determines quality of loan assets. And to ensure this banks over the years have evolved appraisal process, which a credit officer is require to learn through classroom as well as on the job training. The process of credit appraisal commonly involves assessment ofa) Managerial competence determines capacity and competence of the proponent to do business. A credit officer should know background of the proponent, his work experience, his qualification, his market report and his past dealing with other banks if any so as to satisfy himself about honesty, integrity and business ability of the applicant borrower. In case of legal person like Limited Liability Company, he should examine its charter to satisfy that it can engage itself in a particular line of business; it has requisite powers to borrow and execute documents. Credit officer should examine the adequacy and suitability of the management structure, quality of management and management capability under stress, personnel policies including succession planning, bargaining power with suppliers and financial strength. Since majority of loan default occurs due to managerial inefficiency, it is essential that managerial competence be assessed beyond doubt when a loan proposal is appraised. A KYC norm for proper identification of the borrower is also completed through this process. b) Technical feasibility involves assessment of availability of technology- latest or proven to produce required quantity and quality of goods. It also involves assessing availability of skilled manpower, availability of raw material, availability of machinery, pollution or environment clearance required if any so that project can be completed without time or cost overrun. c) Market appraisal is done through demand forecasting and stimulating demand through product promotion and selling strategies. Market appraisal also involves assessment of competitive advantage which unit enjoys, economic and social trends which may have bearing on the demand of the product, who are the major buyers, whether market demand is stable, seasonal or permanent, what substitutes are already available in the market, what is extent of competition from abroad, what are import restrictions, what product range and product mix is available, what distribution set up is required for marketing the product, how government policies are likely to impact the future of the industry, and whether raw material, skilled labor, power etc. is available for uninterrupted product of the unit. Overall objective of market appraisal is to satisfy that industry outlook is promising, there is no tariff or other barriers for growth and environmental and political factors are favorable. d) Financial viability is determined by assessment of cost of project and Promoters ability to raise requisites resources to meet the project cost. This also involves analyzing financial health of the borrower by examining current ratio, debt equity ratio, interest coverage ratio etc. In large borrowers cash flow is also analyzed to ensure that borrower will be able to serve its commitment for letter of credit, payment

of installment and service monthly interest. For the purpose of determining the viability of the project and the ability of the borrower to service its loan and give a reasonable return on the capital; estimates of cost of production, profitability, cash flow and projected balance sheets are obtained from the borrower/s at least for the period of repayment of debt. These are inter-related and are prepared on the basis of the estimated cost of the project, sources of finance envisaged and various assumptions regarding capacity utilization, availability of inputs and their price trend, selling price of end product etc. The credit officer should critically looked into the important assumption capacity utilization, cost of raw material, estimates of wages and salaries, estimates of administrative expenses, selling prices assumed and provision made for depreciation and statutory taxes. Verification/scrutiny of profitability is the core of qualitative appraisal of a loan proposal. The entrepreneurs are very often tempted to present a rosy picture. A prudent and skillful credit officer should not only critically verify the figures furnished by the entrepreneur but he should also satisfy himself with the basis of various assumptions which are basis of sales and profitability estimates. e) Assessment of financial requirement of the borrower for acquiring fixed assets and for meeting working capital requirement is final part of appraisal process. Terms and conditions of loan, interest rate, margin, security- both primary and collateral, repayment terms, period of limit and documents to be executed are all determined through this process. The exact nature of appraisal of a proposal depends upon various factors e.g. quantum of loan, nature of security, terms of repayment etc. For example a loan against fixed deposit of the bank or against NSC may not require detailed appraisal for technical feasibility or economic viability. Similarly while granting a home loan or personal loan to a borrower, appraising officer may simply look into KYC norms, loan requirement, repayment capacity and salary tie-up arrangement. However for granting loan to a corporate or manufacturing unit appraising officer may have to look into whole gamut of managerial competence, technological feasibility, economic viability, marketability of product, financial parameters and security available depending upon the risk perception of the particular borrower. It may be noted that each industry has got its own strength and weakness. Such strength and weakness may further vary from unit to unit even in same industry. Accordingly, for the purpose of financing a particular unit assessment should be based on evaluation of the strengths and weakness of the industry/unit. The inherent protective factors, competitive edge, level of technological up gradation, operational efficiency, managerial capability, cash flow trend, liquidity, past trend of servicing debts, government policies and status affecting the industry/ unit other related areas, has be critically examined while making credit appraisal. One of the most crucial element in credit appraisal process is availability of credit history of the borrower and also all relevant information of industry and trade in which the borrower is engaged or proposed to be engaged. An efficient credit appraisal system, therefore, presuppose that bank has access to credit information of the prospective

borrower and exercises due diligence while identifying and selecting a borrower, it has done thorough study of potential of industry and trade in which the borrower is engaged, it call for all necessary information for appraisal of loan proposal in a single sot, it has a efficient delegation of power system which not only take into account efficient decision process but also set up mechanism of rigorous post credit follow up and monitoring system to ensure timely preventive measure as soon as soon any weakness is noticed in conduct of account or health of the borrowing unit.