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UNIT 20 Fundamentals of Human Resources

20.0 Objectives
20.1 Introduction
20.2 The Perspective
20.3 Relationship between H R M & H R D and their Structure and Functions
Check Your Progress (A)
20.4 Role of H R Professionals
Check Your Progress (B)
20.5 Development of H R Functions in India
Check Your Progress (C)
Let Us Sum Up
Answers to Check Your Progress (A, B, C)
Terminal Questions
Suggested for Further Reading
After reading this unit, you should be able to:
(a) appreciate the fundamentals of Human Resource Management;
(b) understand the comprehensive perspective of H R M and the relationship with
Human Resource Development;
(c) understand the role of H R professionals; and
(d) get to know the development of H R functions in India.
The effective utilization of people in any organized effort has always been a
pressing problem in society. For a long time management theories have been
characterized by a search of universal solution to provide practitioners with pr
that can be applied to all kinds of organizations with universal success. This i
s mainly
due to the fact that the organizations are primarily social systems. They combin
e people
humanity and technology. It is, therefore, not possible for every
and science
organization to have the same type of people and same level of technology. Thus,
human behavior in relation to an organization has assumed a great significance a
nd forms the major subject matter of various studies conducted in the field of h
resources management to provide the basis for the organizational development pro
and to improve the organizational effectiveness. In his book THE LAND -MARKS OF
TOMORROW, Peter Drucker the famous management guru observes: 'no matter how
much we can quantify, the basic phenomena are qualitative one's: change and
innovations, risk and judgments, growth and decay, dedication, vision, rewards a
motivation, so on and so forth. The discipline we need cannot be a technical dis
though it will have many technical areas. It must be a truly humanistic discipli
Practitioners and managers have come to recognize the complex world in which
they must operate and have become increasingly willing to accept help from behav
scientists in identifying and resolving organizational problems. An organization
is a
planned coordination of the activities of a number of people for the achievement
common organizational objectives through involvement of people to assigned funct
and through a hierarchy of authority and responsibility using appropriate techno

The characteristics of an organization and its success are largely influenced by
managerial and organizational factors. Thus, the study of human behavior at work
cannot be studied in isolation, ignoring various inter-dependent complexities. I
work, originally, was organized around the technology available and rules of che
cks and
Organizations today have realized that they need to respond to changes
occurring in the environment; be it technology, business dimension, strategies,
customer expectations or the emerging markets. Their experience reveals that aft
er due
analysis, it is relatively easy to think and decide upon a response to business
technology dimension; but, the implementation is often a slow process or a diffi
cult one
to go through. This is because it involves convincing people, changing their hab
its and
mindset, the established ways of thinking and perception. And even the 'best' st
can fail if not implemented in the right spirit. The people component is thus be
the key factor to success of the strategy; be it for survival or growth or achie
People management has been the most intriguing aspect of managing an
organization all along. The organizations have recognized its contribution in th
e total
framework but this aspect is so dynamic that it does not seem to reach a level o
stability. The technology, the system and its subsystems or the infrastructural
tend to get stabilized at least for a certain period in their evolution process,
but people
management tends to remain an 'alive* issue.
One of the reasons for this lies in its being different in nature compared to an
other resource the organization depends upon. The other resources are passive
the sense that they do not react or their reaction can be controlled or predicte
d. But
human resource is not so. This resource is capable of responding to the treatmen
t given
to it and the response is not standard or uniform. Even a slight variation can c
waves. Ultimately, organizations exist for producing products and services to me
human needs. Thus, manpower occupies the central place, looked at from any point
any organizational activity.Organizations have attempted to deal with people its
employees according
to the understanding prevalent about human behavior at any point in time. The
variations have been characterized from a rather mechanistic approach to a
philosophical one. The evolution of new approaches has been triggered by researc
h in
the field of management as well as social sciences. Human affairs in any organiz
are influenced by a wide variety of emotions like love and hate, human needs and

expectations, human values, beliefs and perceptions, traditions and culture, and
also by
technical, social, economic, demographic and political changes and developments.
unit examines how these approaches have converged in the present perspective of
An appropriate beginning to understand the fundamentals of people
management would be to appreciate the foundations of an organization. An
organization is primarily a ramification of the fact that there is an interdepen
implied in the satisfaction of needs of individuals alongside with the achieveme
nt of
organizational objectives. An organization is coming together of individuals in
order to
attain a common goal/purpose. As defined by Edgar Schein, 'An organization is th
rational coordination of the activities of a number of people for the achievemen
t of some
common explicit purpose or goal, through division of labour and function and thr
ough a
hierarchy of authority and responsibility.' (Schein, 1979). Such a coming togeth
er can be
formal or informal. In a formal setup, there is a given goal, a structure, expli
cit roles and
relationships in order to coordinate the activities whereas in an informal organ
these aspects evolve as an outcome of the group process.
Drawing from this definition we can see that there are two interdependent
aspects, i.e. one about people and the other about activities. Historically, two
streams of
thoughts have developed; one, on how to organize the activities most systematica
and analytically so that specificity in the work processes and operations can be
about, and the other, on how to understand an individual's relation to a given a
now recognized as 'work'. Obviously, enough thinking has developed in both these
spheres over the years and the two perspectives have affected each other due to
high degree of their association and interdependence.
The beginning of these two perspectives can be seen in the work of Robert
Owen (1771-1858) and Charles Babbage (1792-1871). Owen, a manager by
profession, claimed that a manager's best investment was in his workers ('vital
machines' as he called them). He believed in providing better conditions for wor
which he thought would result in higher productivity. Whereas Babbage, a profess
or of
mathematics, was an early advocate of division of labour. He believed in applyin
scientific principles to work processes to increase productivity and reduce expe
Whichever may be the focal point, cooperation of individuals to coordinate the a
in an organization is the beginning of people management. Organizations have
attempted to explore the best way of achieving this and continue to do so. The g

of people management lies in the evolution of management thoughts itself. Theref

ore, in
order to trace the development of people management as a function, we have to st
the various theories of management.During the flurry of the industrial revolutio
n, the view of the coordination of
activities taken by organizations was very simplistic. It focused on the 'activi
ties' that
related to the work situation alone, i.e. doing the work. It was assumed that pe
would do the work they have been employed for (paid for). This was also supporte
d and
subsequently highlighted by the 'scientific management' approach conceptualized
pioneered by Frederick Taylor (1850-1915) famous for his 'division of labour' co
and 'time and motion' studies and further substantiated by Gantt and Gilberths.
Some of
the major assumptions in this approach could be summarized as:
(a) the tasks can be broken down to simple units for people to understand and pe
(b) people will do a given activity in return for money
(c) people will have to do what is defined by the organization and in turn by te
The simplicity of this approach ignored many important and vital aspects of
human behavior which were later brought to the forefront. First of all, it conce
only on the activities implied in the 'work' but certain other activities (behav
ior) which
take place as a natural outcome were not considered. For instance, fatigue, bore
the need to converse with others (not related to work), the relationships that m
ay grow
out of the interactions, etc., were not seen as relevant for managing. The persp
controlled and predicted the activities of people strictly related to work; and
it chose to
let go of the other aspects. It was this simplistic mechanical approach that pri
marily was
responsible for the rise of labor unions and labor unrest. Though certain factor
s like
periodic economic depression, immigration of workers, aggressive stance of the
management in combating the efforts of labor to unionize, delayed strengthening
of the
collective bargaining as a process, the genuineness of issues made it a permanen
formal factor of organizations. The concept of unionism also for the first time
made the
organizations aware of the role of external socio-political pressures.
In addition to this, certain developments in the internal environment of the
organization gave rise to a few new issues. For instance, the tightly structured
planned work systems could not instill meaning/ pride in the work that individua
ls did
and this had an adverse effect on productivity. This was the beginning of the aw
about the crucial role played by emotions in work situations. This realization l
ed to the
entire spectrum of research in the area of work motivation. The impact of 'Hawth

Studies' carried out by Elton Mayo and others at Western Electric Company during
1924-33, is a landmark in the evolution of the management thought and human
approach in management. These studies pointed out to various dimensions of human
behavior that were not considered to be of any significance in the restricted ap
taken earlier. The human relations movement that followed replaced the 'rational
economic man' by the 'social man' perspective. It focused on the role played by
various relationships that develop at work as an outcome of the organizational
interactions. Following the revelations, the people management systems were gear
ed to
take care of the relationships with supervisors, colleagues and groups.
Later researchers like Chris Argyris, Abraham Maslow, Douglas McGregor and
Fredrick Herzberg highlighted dimensions of motivation that are rooted in the gr
need of an individual. The central theme of their arguments was that individuals
motivated by other than monetary factors too. They emphasised that individuals l
ike to perceive meaning in the activities they do, they like to experience a sen
se of
responsibility while performing a task, and have a sense of achievement when the
is complete. If some of these elements are missing in the 'work' they do, the
performance can be limited. In other words, they need to feel proud about what t
hey are
doing. Their involvement in the process of deciding their activities may determi
ne the
level of their performance and satisfaction. Therefore, the perspective of peopl
management should provide for these components. This was the beginning of the
present developmental approach towards people management.
The Development of People Management Functions
The history of management of people as a distinct managerial function goes back
to the end of the nineteenth and the beginning of the twentieth century. With a
significant increase in the number and size of organizational units as a sequel
to the
Industrial Revolution, there was a need to have special departments like finance
accounting, production, etc. However, it was much later that the need for a depa
to manage people in the organizations was felt. In India the experiment on group
behavior in Ahmedabad mills by Prof. A. K. Rice in 1952 is a significant contrib
A Few organizations had a post of welfare secretary to meet the needs of the
workers and prevent workers from forming unions, (Werther and Davis, 1982). Thes
social secretaries, as they were called, marked the birth of specialized human r
management as distinct from the day-to-day supervision of personnel by operating
managers. The units dealing with such activities were mostly termed as Time Offi
ce in
textile mills and factories and as establishment section in banks and commercial
They were, in fact, engaged almost entirely in promoting the organizational
maintenance objective, although this was not widely recognized (Miner, 1969). Pe

it was in the chemical and pharmaceutical industries, the term personnel officer
initially used in 1960s.
Although the fundamental activities involved in people management, viz.,
acquiring, training, evaluating and compensating the employees continued, the
broadened understanding of human behaviour contributed to the maturing of this
function. As Fred Luthans observes, 'These examples offer ample evidence that th
personnel function was very much in existence before the 1930s. However, the maj
change in the practice of management that included the personnel function, with
accompanying concern for the human element, did not occur until the sociopsychological upheavals in the late 1920s and early 1930s. (F. Luthans, 1985)
In general, it appears that there have been two major traditions or trends withi
personnel management over the years. One of these, stemming largely from economi
and accounting, emphasized a hardheaded, profit-minded approach to the utilizati
on of
human resources; the other, with its origins in social work and certain subfield
s within
social psychology, took more of a social welfare viewpoint. This duality of appr
appears to have hampered the development of the profession within certain segmen
of the American industry, and the signs of the split have still not entirely dis
The social welfare tradition has been viewed as antithetical to the 'real' organ
goal of productivity by many managers, both within and outside the personnel fie
ld. On the other hand, the feeling among those with a social welfare orientation
has been that
management generally paid more emphasize to productivity and profit and less to
employee satisfaction.
Only in relatively recent years there has been some lessening of this conflict a
an increasing number of firms have come to accept the view that there are really
primary types of organizational goals productivity and maintenance. Both appear t
o be
essential, yet some policies and procedures which maximize one may well do so at
expense of the other (Miner, 1969).
As can be observed, the changing perspective of HRM was triggered by greater
and wider understanding of human behavior in relation to the formal organization
Therefore, the evolution of approaches is characterized by the addition of the
dimensions rather than substitution. In this framework of change, the H R M as a
function in an organization matured to encompass the newer dimensions and deeper
aspects of given dimensions. In other words, none of the earlier aspects of peop
management were wiped out. They have become stabilized, reutilized and therefore
become less crucial in comparison to the newer dimensions.

The present perspective of H R M, to quote Sheth:

H R M assumes that the management of people is an integral part of the
resource management task within an enterprise for achievement of organizational
objectives. Human beings develop a stake in the enterprise as they work in it an
d hence
their motivation, development and growth constitute a critical factor in the dev
and growth of the organization. A crucial managerial responsibility is to make a
continuing effort to harmonize the interest and growth of the organization with
those of
the employees at all levels. Human sensitivity, trust in people and participativ
management are treated as a part of managerial culture and philosophy (Sheth, 199
As implicit in the above quotation, H R M serves as an umbrella for all function
old and new. It provides a guiding principle for developing new people related s
and also provides a yardstick to evaluate any existing subsystems in the area of
management. In addition, it subtly emphasizes that managing people is a line-and
function both. Every manager has to implement/practice a component of this funct
through his day-to-day actions. In other words, every system has a process
requirement. Preparing the line manager to appreciate a system, its rationale an
d the
linkage to the H R philosophy, forms a crucial component of the H R functionary
The process of adopting the changing perspective of H R M by any organization
is evident in the changing nomenclature of the function/department. Thus, at the
stage the labour and welfare department' being substituted or renamed as 'Person
and in the next stage brought under one HR functionary. A careful look reveals t
hat the
traditional activities still continue as sub-modules of the broad HRM function.
have put these either in the four traditional sub-modules of Acquisition, Develo
Motivation and Maintenance (De'Cenzo, 1988) or Planning and Administration, H R
D, Job and Salary, and Workers Affairs. (Pareek and Rao, 1981) The differences h
ere are
those of classifying. But by and large it can be observed that the conventional
component of people management is categorized under (Personnel) Administration a
Maintenance. The systems related to acquisition, (evaluation) promotion, adminis
salary and long-term benefits are under administration and the traditional labou
management, grievance and discipline management activities are covered under the
maintenance systems. The developmental systems such as induction and socializati
of the individuals, development and growth, performance appraisal and counsellin
career planning are covered under the nomenclature of Human Resource Development
(H R D). Another classification views two subsystems under HRM, viz. administrat

developmental and preventive (Mankidy, 1998). Looking at the comprehensive
coverage one tends to agree that H R M function as the continuation and enlargem
of the conventional areas of people management, certainly signifies 'maturation
of the
function of management of people as an integral part of enterprise management'
(Sheth, 1992).
Organizations increasingly compete with each other on the basis of effective
people management and development by tapping into the ideas of workers and
organizing their work in more effective manner and even by following the best pr
of other organizations. This can be possible if the organizations procure right
type of
people with right type of skills and attitude for right jobs who can be develope
d to meet
the present as well as future needs of manpower requirements. Besides the tradit
role of maintenance and management of manpower, the H R M has to play a crucial
role in human resource development, appraisal and utilization. Thus, H R D is
sometimes considered as a significant subsystem of H R M.
Wide range of activities are included within the boundaries of H R M. The roots
people management and development reside in the welfare tradition with focus on
improving organizational efficiency and effectiveness. It should also emphasize
need for continuous professional development (C P D) to meet the organizational
requirements. The development of professionals should be continuous because ther
e is
always scope for improvement of skills and performance. The individuals, however
have to own and manage their developmental needs. The development process should
have clear learning objectives that aim to satisfy individual and organizational
There is no conflict between the structure and functions of H R M and H R D the
difference is only in the approach and emphasis. While routine functions become
a part
of H R M, the H R D functions emphasize on organizational interventions for clim
development, employee and organizational development linked with organizational
goals/objectives and change management process. It may involve some element of
conducting surveys and research to seek employees' feedback and opinion, their
aspirations, and suggestions to handle the present organizational issues. It may
involve some element of innovations to formulate people related policies. Thus,
emphasis of H R D is on overall organizational development process which also
includes development of people.
Check Your Progress (A)State whether the following statements are true or false:
1. People component of an organization has always received due attention. ---- F
2. Industrial revolution led to the rise of unions. ---- False
3. Management theories and approach to people management are very closely relate
4. Scientific Management approach is the foundation of today's concept of Human
Resource Management. ---- False.
5. Labour Management to Human Resource Management is not just a quantitative

expansion of the people management function but is qualitatively different. ---True.

6. Personnel Management and H R D are synonymous terms. ---- False.
7. H R D and human relations movement are not the same. ---- True.
8. H R M and H R D are unrelated to each other. ---- False.
9. H R D is a subsystem of H R M. ---- True.
10. H R M is a subsystem of H R D. ---- False.
11. H R D and H R M are more or less same concepts. ---- False.
Corresponding to the evolution of the H R M, the role of the individuals handlin
this function (activities) has undergone change. This change is not only quantit
ative in
terms of added activities or responsibilities but also qualitative. The shift ha
s taken
place from traditional people's management to modern people's development. Thus,
role of HRD professionals assumes a greater significance.
Traditionally, this function was perceived merely in terms of the activities, an
was a part of the duties of supervisors/managers. The focus as a specialized fun
came along with external, socio-legal influences needing awareness of the employ
mentrelated legislations and their implications. As the function further developed i
n terms of
for recruitment, training, promotion, etc. this knowledge became essenti
Slowly, individuals who acquired this knowledge were relied upon by the shop-flo
managers. This led to the perception of personnel being a specialist job
a staff
function. Academics responded by designing courses with specific coverage of the
required skills and techniques. Individuals acquiring such qualifications joined
organizations as specialists-professionals and were mainly required to deal with
peoplerelated matters.
However, the maturing of this function from personnel to H R M and H R D,
highlighted that it cannot be totally delinked from the line managers, and that
the line
managers are the delivery points of this function. Hence, line-managers have to
the ability of people management including their development.
On the second platform, the professionalization of this function raised the issu
whether it should become a specialist function or could the line managers become
functionaries. Implied in the debate is the fact that the contents of the role o
f the functionaries include specialized skills and knowledge on one hand, and eq
important and pivotal, the philosophical orientation. The knowledge and skills a
re helpful
in developing systems but the ultimate success is decided by the human relation
orientation. The H R philosophy makes the difference. Such philosophical orienta
need not and is not the property of any profession per se. In other words, can o
ne with
such orientation pick up the professional knowledge and skills? Experience of in

indicates both the patterns.
The traditional function of people management existed in the narrow sense of the
term in ensuring the attendance, ensuring output and quality, good working condi
safety, hygiene, etc. Since these were to be ensured on the shop floor, the
responsibilities were with the supervisors/managers. However, when some of these
functions became a part of statutory obligations special personnel had to be app
Individuals with knowledge of these laws, rules and regulations started getting
preference in employment and the function was viewed as special. The bank unions
became important power centers in the 1960s, 1970s and 1980s, and for dealing wi
unions, industrial relations functions emerged and occupied a special position i
n the
banks. They also dealt with individual misconduct and disciplinary enquiries. Th
e focus
on administering the personnel activities like recruiting, training, promoting a
compensating made the personnel functions all the more a specialized function. W
further turn of events when the developmental perspective was recognized, the
orientation of the functionaries became crucial.
The emerging perspective highlighted 'along with the development of the whole
man, an integration of the people with the organization so as to make cooperativ
e action
easier and more meaningful, improve understanding between people, reduce useless
frustration, enabling (he individuals to serve the organizational objectives wit
hout losing
personal identity' (Pandey, 1990). This perspective implies that the staff-line
functionaries need to be partners in achieving the objectives of the H R D. Ever
y activity
/ system has a component that needs to be dealt with by the personnel / H R M
department and the line managers.
While viewing the functions of the developmental perspective as more dynamic
than the traditional personnel function, Pareek and Rao (1981) have grouped the
multiple functions under five headings as follows:
1. Supportive Role: This relates to the strengthening of the operating and execu
levels and consolidating the strengths in an organization.
2. Role of System Development and Research: This pertains to developing systems
that deal with people, their problems and organizational dynamics. This was alre
present in the traditional role.
3. Managerial role: This relates to performing managerial functions like plannin
g future
manpower, recruiting, utilizing by placement, returning, motivating-integrating
and their role, performance and potential assessment, planning the growth of
individuals, etc.4. Role of Developing Competence: This refers to developing tec
hnical, managerial,
and processing competence among the human resource. The new perspective also
includes helping and coping competence.
5. Process Role: An effective organization needs to respond to the changing
environment for which it has to develop coping skills. Creating necessary cultur
e and

values in the organization, diagnosing the problem at organizational level and t

corrective steps are the related responsibilities of the HR functionaries.
The above description reveals the qualitative orientation required in the HRD
perspective. As Sheth (1992) has pointed out 'underlying H R M is a progressive
reinforcement of values of democracy, liberalism, humanism and shared control ov
the workplace. It implies social commitment to the need for widening the base of
individual rights and corporate obligations.'
Pareek and Rao have identified the critical attributes for dispensing such a rol
These include:Technical
1. Knowledge of performance appraisal systems and their functioning in various
2. Knowledge of potential appraisal and mechanism of developing a system
3. Knowledge of various tests and measurements of behaviour
4. Ability to design and coordinate training programmes at worker, supervisor an
managerial levels.
5. Professional knowledge of personnel and management
6. Knowledge of behavioural sciences
7. Understanding of overall organizational culture
8. Knowledge of career planning, processes and practices
9. Knowledge and skills in counselling
10. Knowledge of techniques in behavioural research
1. Organizing ability
2. Systems development skills
1. Initiative
2. Faith in human beings and their capabilities
3. Positive attitude to others
4. Imagination and creativity
5. Concern for excellence
6. Concern for people and their development
7. Friendly, sociable and affable
8. Attitude for research and development work
9. Interest in learning new things
10. Ability to work as a team member
In view of the objectives of H R M and the critical attributes listed above, it
apparent that certain personality characteristics like initiative, faith in huma
n beings,
concern for the development of employees, and ability to work as a team member a
crucial. In the absence of these the first two sets of attributes may not achiev
e much.
H R functions in banks are generally not performed professionally, unlike other
corporates, Banks still consider H R D as a generalist discipline and any one fr
om the
cadre occupies the position of H R head. The C H has developed a H R Competency
Model (E T 26 February 2004) listing out 19 interlinked competencies for the H R
in the organizations. These competencies include nine behavioral competencies vi
communication, initiative, drive, creativity, self-confidence, teamwork, influen
problem solving and inter-personal skills. These nine behavioral competencies ha

been embedded in ten functional competencies, viz. business knowledge, change

management, diversity management, service orientation, execution excellence, fin
perspective, building expertise, personal credibility, relationship management a
strategic thinking and alignment.The H R functions in banks will have to undergo
drastic changes keeping in view
the challenges faced by the banks. H R D departments can no longer function in
isolation. They have to play an important role in coordinating various organizat
activities for improving overall effectiveness of banks.
Strategic Role in the Future
Accepting the importance of HR in the 21st century, Ulrich (1998) opines that 'H
has never been more necessary (as it is today). The efforts to achieve excellenc
through a focus on learning, quality, teamwork and re-engineering, are driven by
way organizations get things done and how they treat their people. Those are
fundamental HR issues.' He gives a new mandate for HR asking the professionals i
this field:
1. To become a partner with senior and line managers in strategy execution, help
ing to
move planning from the conference room to the marketplace.
2. To become an expert in the way work is organized and executed, delivering
administrative efficiency to ensure that costs are reduced while quality is main
3. To become a champion for employees, vigorously representing their concerns to
senior management and at the same time, working to increase employee contributi
that is, employees' commitment to the organization and their ability to deliver
4. And finally, to become an agent of continuous transformation, shaping process
es and
a culture that together improve an organization's capacity for change.
This new agenda for H R is a radical departure from the status quo. In most
companies today, H R is sanctioned mainly to play policy police and regulatory
watchdog. It handles the paperwork involved in hiring and firing, manages the
bureaucratic aspects of benefits, and administers compensation decisions made by
others. When it is more empowered by senior management, it might oversee recruit
manage training and development programmes, or design initiatives to increase
workplace diversity. But the fact remains: the activities of H R appear to be
d often
are disconnected from the real work of the organization. The new agenda, however
would mean that everyone engaged in H R's activities would in some concrete way
the organization better serve its customers or otherwise increase shareholder va
lue. To
that extent they are termed as HR Relationship Managers in some banks.
After conducting a study to find out the level of professionalism of H R M
functionaries, Agrawal and others (1990) conclude that the individual, his organ
academic institutions and the professional bodies, all have played a role in imp
capabilities of these professionals. Let us see what an individual, today, can d

o to
enhance his role as an H R functionary.
What an HR Professional can Do?
1. Acquiring additional professional qualifications relevant to their role requi
rements.2. Regular holding of study circle meetings amongst personnel officer/em
ployees with a
commitment for bringing improvements in HR professionals. The forum should be us
for sharing of experiences and latest developments in the field.
3. Exchange of ideas, views and sharing of experience amongst personnel fraterni
from different companies.
4. Association with and participation in the activities organized by various pro
bodies such as National Institute of Personnel Management, Management Associatio
Indian Society for training and Development.
5. Regular interaction between HR professionals and technologists; HR profession
should he familiar with latest technological developments affecting the organiza
tion so
that they can plan to disseminate new knowledge, skills and capabilities amongst
6. HR professionals should undertake problem-based project studies particularly
as a
part of various professional examinations. They should present their findings to
executives from the organization and should try to implement their project findi
Lastly. there is debate about who should become an H R functionary. Whether
organizations should employ those with specific academic qualifications or could
line managers with the right perspective become H R functionaries? The academics
guarantee knowledge but that can be acquired at any time. If one accepts the cri
of values and beliefs in becoming effective H R Managers, then anybody with such
values could be suitable. These values are not the prerogative of any particular
discipline or knowledge base. Secondly, the future role of H R Manager is to bec
ome a
partner in strategic planning in which case he needs to have technical knowledge
what the business activity of the organization is. In this case a line manager w
ith the
right attitude could subsequently acquire the knowledge to become an H R functio
The aim of the organization should he to place an individual with the required a
and so both the options could be kept open.
Check Your Progress (B)
State whether the following statements are true or false:
1. The role of the H R Functionaries has undergone qualitative change. ---- True
2. H R functionaries have total responsibilities about the management of human
resource in the organization. ---- False.
3. H R functionaries arc responsible for development of H R-related systems. --- True.

4. H R professionals must have qualifications in H R M. ---- True.

5. Line Managers should not meddle with the management of H R. ---- False.
6. Role of H R professionals is confined to H R activities of the organizations
hence they
should not be involved in strategic planning. ---- False.20.5 DEVELOPMENT OF HR
Evolution of Human Resource as a function needing specific attention has gone
through similar stages the world over. Primarily, whatever happened in the indus
trial era
in the U S or U K was during the British-Raj and as such its ripples were felt i
n India.
The communication was facilitated by the scientific advancement, and knowledge
travelled faster compared to earlier times. The world wars too contributed by cr
similar welfare issues across the nations.
At the time of independence very few Indian industrialists were seen.
Management and business perspective was not very obvious. However, in the area o
people management, Indians were visible as Labour Welfare Officers under the
provisions of the Factories Act. Their role was, initially, confined to being re
officers for the multitude of workers and badhlies, floating at the gates, keepi
ng the
muster rolls and leave records, running shabby canteens and toilet and change ro
facilities, and in wielding the security-cum-discipline stick. By the early 1950
s the
provisions of the Industrial Disputes Act of 1947 were beginning to percolate do
wn and
to this list of unattractive duties were added all the legalistic aspects of lab
management. Labour officers now had to become experts at drawing up charge sheet
evolving the intricacies of domestic enquiries, attending long drawn out concili
proceedings, and briefing, the mushrooming breed of labour lawyers.
By the 1960s the result of the focus on the activities required in the area of
people management was reflected in the demand for personnel professionals with
specific knowledge about people management systems and laws. Unlike other
professions like medicine, law or engineering, there were no definite academic
requirements for personnel executives (even today) but the personnel specialists
expanded their sphere of influence by cashing on the inadequacies and trained
incapabilities of engineers in line management. Most of the functions now perfor
med by
personnel were the forte of line managers. The growth of unionism, state interve
through a spate of legislation and code of practices, the stress on statutory we
lfare and
need for broader and consistent policies made it easy for personnel specialists
expand their role and enhance their status. The need for equipping individuals w
specific knowledge was satisfied by the forums like Indian Institute of Personne
Management (I I P M) and National Institute of Labour Management (N I L M)
established in the early phase of personnel management. The National Commission
Labour has observed that IIPM has the credit of making Personnel Management as a

profession. Any area of knowledge to gain the status of a profession has to fulf
ill three
main criteria, i.e. having a corpus of knowledge, a period of learning and appre
and a code of conduct. Indian Institute of Personnel Management (I I P M) establ
in 1947 played a significant role in this movement.
Another professional body created around the same time was the National
Institute of Labour Management. Its main aim was to foster, encourage and promot
e the
development of cordial relations between employers and employees. There is an
overlap in the purpose of both the institutes though the latter focused more on
relation between the two forces, viz., employers and employees. Appropriately, s
ubsequently in 1982 these two bodies merged to form the National Institute of
Personnel Management.
Thus, even though the subsequent era witnessed growth in the industry, the
personnel function still remained something to be interpreted by the individuals
than by the organization per se. So it mattered as to who is in charge and what
thinks about people management. The activities related to people management
remained restricted to their perspective of the duties of labour and welfare off
icers. This
is seen in the survey conducted by Monappa (1979) in which he has listed that
personnel activities typically included employment, training, watch and ward, fi
facilities, safety, housing, employee education, employee benefits, industrial r
insurance programmes, etc. The multinational companies were. to some extent,
influenced by the parent company and in many cases had well-established Personne
department and gave more attention to this due to their western experience; the
family controlled firms were slowly moving from the paternalistic to professiona
l style
and hence changed their outlook to personnel function. The public sector with an
to demonstrate being 'model employers' paid more attention to strengthening this
It is pertinent at this point to mention even during the early phases, India had
visionaries like J.N.Tata who sowed the seeds of Tata Iron and Steel Company at
Jamshedpur, had long back emphasized human factors in an organization. His
philosophy of building people in the organization was subsequently followed and
crystallized by his successors, making TISCO a successful and proactive organiza
The kind of perspective and actions taken by TISCO in an environment which was
novice to H R M was highly progressive at that point of time. This is important
for two
reasons. First, the history of TISCO which is indicative of how the personnel fu
matures in an organization and secondly, it highlights what pro-activity means.
were a number of actions taken by TISCO which was unheard of at that point in ti
The government has also enacted a few legislations related to employment and
employee welfare. The first and fundamental of these is the Article 16(1) of Ind

Constitution which ensures equal opportunity for employment. Drawing from this i
s the
Employment Exchanges (Compulsory Notification of Vacancies) Act, 1959, which
requires employers to notify the vacancies. The Apprentices Act of 1961 provides
training linked to employment. Certain other Acts like Child Labor Act, 1986, Bo
Labor System Act, 1976, Interstate Migrant Workmen Act, 1979 aim at safeguarding
interest and controlling exploitation of specific groups. The state and central
directive principles as guidelines, ensure attention to neglected sections of so
ciety like
the S C/S T, Ex-servicemen, physically handicapped, etc. Through legislations, t
government indirectly focused on eliminating any kind of exploitation by the emp
At times, such legislations are perceived as blocks to business growth by the
organizations. To avoid such government interventions, the organization needs to
proactive, futuristic strategies to people management visualized through the H R
perspective. An organization which is sensitive to the emerging issues with an
orientation to concern for people's welfare and growth in the organization can b
e said to
have an H R M perspective. It does not mean that there cannot be problems but th
dynamism to face them is crucial.The next transformation came in the 1980s; this
approach was introduced by
Indian academicians around the same time when the western world started talking
about H R D. The pioneering work done by Uday Pareek and T V Rao in the area of
clarifying the H R D focus and developing H R D systems is a benchmark in the
evolution of H R D in India. The focus of their work was on clarifying the devel
dimensions and its implication on other conventional systems. The government too
introduced employee participation and allocating share holding to workers. The
emerging hi-tech industries introduced 'knowledge workers' and in general an enl
outlook for personnel was envisaged. The H R D as a subsystem of H R M emerged a
a feature of this era.
A few organizations from the banking sector who initiated processes during this
period were State Bank of India, State Bank of Patiala. Bank of Baroda, and Cana
Bank. The establishment of National H R D Network in 1985 brought under focus th
experiences of organizations which had initiated H R D activities. As the name
suggested, it aimed at networking between the H R D professionals. The Indian So
for Training and Development established in 1970 gained specific focus as it cou
ld give
academic and developmental support to H R D functionaries through their training
programmes. Annual conferences of forums created by institutes like N I P M, Nat
H R D Network, Management Associations, I S T D, etc provided opportunities for
especially to H R functionaries
to get exposed to the developments
taking place in F I R M in organization across industries. Such networking can e

the speed with which H R M perspective becomes a way of life for more and more
Indian organizations.
It can be observed that the Indian organizations are aware of the crucial role o
management and development of human resource with respect and dignity and the
integrative perspective of bringing the individual and the organization closer.
Some of
the organizations have already adopted the approach formally
meaning that they h
policies which state this perspective.
A large number of organizations have the new approach on their anvil but are
perhaps still debating on the pros and cons. To them, T V Rao has to say, 'We mu
understand that corporations are not in the business of human resource developme
They are in their own business. But human resource development is an important t
which, unfortunately is being used in a limited sense. The corporate vision has
not been
attached to it. Actually, human resources must become the business of everyone i
n the
organization.' (Business Today, January 1996)
The principal mandate for the emerging people management is to develop and
execute policy programmes and practices that align all human activity to corpora
objectives. As Abhijit Gangopadhyay of Tata Institute of Social Sciences puts it
, 'The
major paradigm shift taking place in the management of human resources is the
progressive integration of conceptual values with operational values.' (Business
January 1996). Since this includes a change in the mind set, conscious steps are
required to be taken.
Check Your Progress (C)State whether the following statements are True or False:
1. Industrial Disputes Act was the beginning of management of people in India. --False.
2. At the time of independence, Indians were not among the industrialists but pe
and welfare officers were visible. ---- True.
3. Labour welfare, industrial relations, personnel administration were synonymou
s to
Personnel Management. ---- False.
4. The Personnel Management was accepted as a profession by 1960s. ---- True.
5. Some Indian organizations had adopted H R M approach long time ago even when
was not talked about. ---- True
Let Us Sum Up
In this unit, we examined how people management, a crucial element of any
organization, developed over the years maturing in its coverage and philosophy.
briefly sketched how the research in social sciences and management sciences hel
organizations to seek answers to the problems / situations created by the growin
complexity of the organizations. We have examined the relationship between H R M
the traditional personnel function and the humanistic, growth-oriented H R D
perspective. We have also traced the development of H R M as a function in the I

context. When compared to the trend in the West, we observed similar orientation
s in H
R M function in India. There has been a marked shift from labour welfare perspec
tive to
the emerging concern and the need to integrate individual and organizational nee
through conducive processes encompassed in the H R M perspective. Besides
identifying the landmarks we also observed the understanding of a few Indian
past and present.
Organization; Management Thought; Unions; Collective Bargaining; Staff; Labour;
Howthorne Studies; Scientific Management; Human Relations; Rational Man; Social
Man; Industrial Relations; Personnel Management; Human Resource Development;
Human Resource Management: Royal Commission; Factories Act; Industrial Disputes
Act; National Institute of Labour Management (N I L M); Indian Institute of Pers
Management (I I P M); National Institute of Personnel Management (N I P M);
Management Ethos; National H R D Network; Indian Society for Training and
Development (I S T D)
Terminal Questions
1. Compare the situations in India and other part of the world which influenced
development of management of H R as a function?
2. Would you say that development of H R M in India has been subjected to peculi
conditions substantiate your argument.
3. Describe the various stages of development of H R M.
4. Why is it imperative to study the evolution of management theory and thought
understand the evolution of the function of managing people'?5. What are the ben
chmark research findings which have contributed to the changes in
the perspective of management A human resource?
6. What is the relation between H R M, P M, I R and H R D?
7. How modern H R D approach is different from traditional H R M?
8. Critically examine the role of H R professionals in banks. How can the role b
e made
more effective?
9. Suggest the structure, role and functions of an ideal H R department in a med
iumsize bank.
10. Identify the role of line manager vis-a-vis H R manager for the development
employees. Is there any role conflict or overlap? Examine critically.
Suggested for Further Reading
Banerjee, R, 'FIRM Profession Past and Present' in HRM 2000: Indian
Perspective, ed. K B Akhilesh, D R Nagaraj, NIPM, Wiley Eastern Ltd., 1990.
Business Today, 'Managing People', The Business Today Experiential Guide to
Managing Workforce 2000, Fourth Anniversary Issue; January, 1996.
De'Cenzo and Robbins; PersonneIIHRM, Prentice-Hall, 1988.
Luthans, R Organisational Behaviour, McGraw-Hill, 1985.
Miner, J B, Personnel and Industrial Relations A Managerial Approach,
Macmillan, 1969. Monappa, A, Personnel Management, Tata McGraw-Hill, 1979.
Pandev. S N, Human Side of Tata Steel, Tata McGraw-Hill, 1989.
Pareek, U and Rao T V, Designing and Managing Human Resource System,
Oxford and IBH, 1981.
Ramesha, K, 'Human Resources Management in India' in HRM 2000: Indian
Perspective, EEd. K B, Akhilesh and D R Nagraj, Wiley Eastern. 1990.
Schein. E; Or-ganisational Psvchologi-, Prentice-Hall. 1979.
Sheth, N R; 'Some Thoughts on HRM' in Emerging Issues in HRM, Pramod

Varna, Oxford and IBH Publishing Co, 1992.

Tripathi, P C. Personnel Management, Sultan Chand & Sons, New Delhi.
Venkata, Raman C S, and Srivastava B K: Personnel Managetnent and Human
Resources. Tata McGraw-Hill Publishing Company Ltd.. New Delhi, 1991.
Werther, W B, and Davis K, Personnel Management and Human Resources,
McGraw-Hill, 1982
PAPER 1Advanced Bank Management
UNIT 21 Development of Human Resources
21.0 Objectives
21.1 Introduction
21.2 HRD and its Subsystems
Check Your Progress (A)
21.3 Training and Development
Role and Impact of Training
Check Your Progress (B)
21.4 Attitude Development
Check Your Progress (C)
21.5 Career Path Planning
Check Your Progress (D)
21.6 Self-Development
Check Your Progress (E)
Let Us Sum Up
Answers to Check Your Progress (A, B, C, D & E) Terminal Questions
Suggested for Further Readings
After reading this unit, you should be able to:
(1) understand how HRD philosophy is translated into the various systems
(2) appreciate how the HRD sub-systems are developed and how some of the existin
(3) need to get modified in the process of aligning themselves with the developm
(4) understand the importance of right attitude and issues in attitude developme
nt and
(5) appreciate the importance and need for career path planning and self-develop
The perspective of managing people in the organization over a period of time has
become matured to include the totality of human beings. As such, it now encompas
all aspects of dealing with people and is today termed as Human Resource
Management (HRM). Originating as a mere set of activities, HRM today has acquire
the status of a crucial function in the organization. This has happened as a res
ult of the
realization that people cannot be treated as just another factor of production b
ut are an
important resource in determining the overall success of the organization. Resea
and practicing managers have tried to evolve strategies to answer the human rela
ted issues. They certainly have accepted the linkage between the individual's sa
and the organization's growth. Time and again systems have been developed to att
this congruence. In this context, new systems have been developed and a few

traditional ones have been modified. Since this happened at different points in
there is a need to view these systems and their linkages with a conscious and cr
outlook, with a view to guarding against contradictions in their implementations
. In this
unit, we will be focusing on the developmental subsystems of HRM.
The industrial revolution with its emphasis on quantity output and the prevalent
understanding of how people could be made to produce more (work), had led to the
dehumanization of the workplace. People were viewed as mere substitutes for machin
and the important components of human beings, namely, emotions, needs, aspiratio
expectations, values, feelings, etc., had no place. This realization had given w
ay to
various optional human focused strategies. Primarily, they were related to motiv
ation in
the context of work. In other words, efforts were directed to make the work more
interesting, valuable, and meaningful to people so that they were involved in do
ing the
activities beyond a mechanical perspective. For this, one approach was to recogn
ize the
emotions and needs of human beings, and the other was to change the 'content' of
activity so that the individual is motivated, and looks forward to doing this ac
willingly. Both the aspects, that is, the feelings and the job content, are inte
rlinked and
therefore, organizations sometimes tinkered with the job content and sometimes p
attention to human feelings and needs. These approaches had roots in the earlier
theories which either focused on how the jobs should be organized or how to make
people do what they are supposed to do.
At this juncture, it is pertinent to understand the linkage of individual develo
pment and
organizational development/growth. Every organization sets certain goals towards
which their entire efforts are directed. The goal may be in terms of productivit
y, better
work culture and the like, with the ultimate objective of satisfying business go
als besides
the needs of the society at large. To achieve these goals, the organizations hav
systems for production, finance, sale, control and monitoring and the people emp
fit in the entire gamut of systems to produce what is intended. The organization
has a
to manage the entire process. There is differentiation in u
structure, a pattern
hierarchical and horizontal, with given sets of relationship and interdependence
between these units. The success of the organization depends on effective perfor
of these units/levels which, in turn, is the performance of people occupying var

ious roles
in the organizational structure. Thus the structure can be viewed as the edifice
which processes are built. Each unit (job or role) of this edifice requires cert
knowledge, skills and attitude in an individual, without which the individual ma
y not be
able to give the expected level of performance. Therefore, to make sure that the
organizational goals are achieved, it is necessary to ensure performance of indi
at all levels in the organization and that the individuals have the required kno
skills, temperament and attitude.
There can be various means by which this can be examined and achieved. For
instance, whether the individuals have the required knowledge or skills could be
checked prior to putting them on the tasks or even before recruiting them. When
jobs change (technology change), a new set of individuals, with new skills, coul
d be recruited or the existing one could be retrained. There would be another sc
enario where
individuals may be required to be shifted to another job in which case one has t
o search
for a job that needs the skills the individual possesses. In other words, assess
ment of
employee is essential. The Performance/Potential appraisal is an essential compo
and the training can play an important role in ensuring performance. Primarily t
here are
two ways the organization can ensure that people have the required skills, that
is, either
upgrade the skills of the existing people or get new people with the required sk
Historically, these questions have been dealt with by organizations in a differe
nt manner
perhaps on the basis of the then situational context. Let us examine how this is
sue was
tackled by organizations over the time.
As Nadler (1984) puts it, Human Resource Development defined as the 'organized
learning experience in a definite time period to increase the possibility of imp
roving job
performance growth'. While tracing the history of HRD as 'organized learning' as
by him, he notes that during the early twentieth century which was a period of i
new and old.
revolution, employers provided the necessary learning for employees
During this period, learning programmes were also developed by unions: as they
needed a specific group to become their members. Many unions were craft-oriented
and to be able to become their member, individuals would have to attain a certai
n level
of job skills. It was the first realization of what training could contribute to
the workplace.
The period 1920-40 saw some development in this trend. For making production mor
profitable companies began tenting in outside people (researchers) to consider v
ways in which the workplace could be manipulated to increase production. The fam

Howthrone studies conducted at Western Electric Company in Chicago were a pointe
to new directions. However, the impact of the Great Depression of 1930's that fo
left many experienced workers unemployed and as a result since the companies cou
now get skilled workforce, the need for training was not felt. They could get th
e skills
they needed by hiring new employees and firing the old ones.
The Second World War brought up new issues with respect to developing people. In
private sector, there was need to expand but as young men were drafted for war,
only alternate source available was the women and the old men and a few ethnic
groups. Women were so far not trained in this matter and the old were viewed as
suitable. However, ultimately this period revealed that 'most of the people in t
groups could learn and could become productive members of the organization.' Thi
realization culminated in the establishment of the American Society for Training
The 1960s primarily witnessed enhancement in technology and application of
behavioural science to workplace. This development was in a way a reaction to th
earlier feeling that HRD training has not been showing the desired impact on
organizations. Attention was then shifted to 'efforts to change the workplace as
one way
of improving performance. It was accompanied by increased interest in people, as
as in the technical aspects of organization.'
Several significant changes came through in the 1970s and 1980s and HRD went
beyond mere training activity. In the 1990s, there was a continued surge for ind
democracy. Workers demanded a larger, more autonomous role in decision-making,
market selection, product identification, work planning and even supervisor sele
ction. As a result of this 'managers needed continual training in participative
leadership, conflict
resolution, interpersonal communication and matrix/task force management.
The 1990s focused on massive computerization of work place mainly to improve
operational efficiency and cost reduction. The PC revolution during the period c
totally the work processes and required Computer literacy at all operating level
s without
any loss of time. This has put a lot of pressure on the training system. The sen
iors who
could not pick up the computer skills started feeling powerless and developed fe
ar and
anxiety. This period also saw a massive outsourcing initiative by the organizati
ons to
Curtail costs.
The present decade, that is, the first decade of the twenty first century saw ex
competition due to liberalization, privatization and globalization of Indian eco
nomy. The
organizations mainly focused on improving customer service by meeting customers'
expectations through customization of products and services in a highly competit

environment. The focus was again on training to equip the work force for inter-p
and customer relations skills. The customers are now dictating their terms as th
ey have
wider choice and their brand loyalties are diminishing.
The traditional Indian banks both public sector and old private sector faced cha
in the form of competitive pressures and changing customer demands from foreign
banks and new private sector banks. Most of the public sector and old private se
banks had their existence for more than a century with a number of legacy issues
tackle. While the new private sector banks could adopt the best practices,
organizational culture: and could implement latest technology in their operation
s, the
foreign hanks acquired the practices and technology akin to their host countries
the regulatory framework of India. Faced with the threat of competition from the
and new private sector banks the banks employed a number of measures like going
fully automated systems (Core Banking Solution based operations) preceded with
business process reengineering (BPR), offering VRS to its employees, training an
retraining, of staff, lateral recruitment of specialists, emphasis on marketing,
customer relationship management and improving brand image, diversification of
activities, introduction of electronic based multiple service delivery channels,
setting up
of back offices and data centres, business process outsourcing, etc, to improve
operational efficiency, meeting customer expectations and reduction in operating
Productivity is the real test of performance in any organization. Some of these
have undergone restructuring exercise with the involvement of international cons
agencies to adopt best practices and remove bottlenecks in their operations. The
changes needed well thought of HR policies to attune the existing staff to adapt
to the
changes and to train them to learn new skills.
HRM is now being called upon to become a strategic initiative to make its effort
s more
effective and performance-oriented. Thus, strategic HRM is gaining its significa
While imparting new technology based training, the organizations have to focus o
development of behavioural and inter-personal skills. HRM initiatives can be ini
through involvement of line managers.
HRD today is a process by which the employees of an organization are helped in a
continuous and planned way to:
(1) Acquire or sharpen capabilities required to perform various functions associ
ated with
their present or expected future jobs;(2) Develop their general capabilities as
individuals and discover and exploit their own
inner potential for their own and/or organizational development purpose; and

(3) Develop an organizational culture in which supervisor-subordinate relationsh

teamwork and collaboration among subunits are strong and contribute to the
professional well-being, motivation and pride of employees (Rao and Pereira, 198
This definition highlights that HRD is not only a training for operational skill
s but also
includes behavioural skills as it ultimately aims to create an enabling culture
wherein the
capabilities are 'acquired, sharpened and used'.
In this context the specific goals of HRD (as pointed out by Rao and Pereira) ar
e to
(1) capabilities of each employee as an individual;
(2) capabilities of each individual in relation to his or her present role;
(3) capabilities of each employee in relation to his or her expected future role
(4) dyadic relationship between each employee and his or her supervisor;
(5) team spirit and functioning in every organizational unit (department, group,
(6) collaboration among different units of the organization; and
(7) organization's overall health and self-renewing capabilities, which, in turn
, increase
the enabling capabilities of individuals, dyads teams, and the entire organizati
The typical systems developed to enhance achievement of these HRD goals include:
(1) Training and Development
(2) Performance Appraisal, Feedback and Counselling
(3) Potential Appraisal, Career Planning and Counselling
(4) Organizational Development
(5) Human Resource Information System
Let us now briefly examine the linkages between and amongst these sub-systems.
The HRM broadly has three sub-systems, viz., administrative, developmental and
maintenance. There are strong inter-linkages between these three. However, for t
purpose of discussion and detailed study we are focusing only on developmental
subsystems in this unit.
It must be highlighted, in this context, that since work is the pivotal point fo
development of individuals, the job analysis is fundamental to any of the sub-sy
mentioned above. We may therefore, understand various aspects of Job or Role
Job or Role Analysis
Job Analysis is a technique which facilitates the listing of what is required to
perform a
task or a job. A typical job analysis comprises three parts - job description, j
specification and job evaluation.
Job Description: This simply records each and every component of the job which a
individual has to perform in a given set-up. For example: for a job of a stenogr
apher or a
private secretary, the job description may include taking dictation, typing the
keeping the record of boss's engagements, dealing with and taking care of visito
record keeping of inward and outgoing cases, preparing travel plan of boss, fili
ng letters,

Job Specifications: On the basis of the job description a list of requirements i

prepared in terms of educational qualification, age, work experience, specific
knowledge, skills, expertise, temperament, etc. Again in the example of a stenog
rapher or a private secretary, a certain temperament and skills are required. Fo
r example,
besides the shorthand and typing skills, the person need to have a good knowledg
e of
language (English or Hindi or both), maturity, charming personality, sharp
understanding, patience, etc.
Job evaluation: This is primarily used to compare similarity between jobs within
organization or between organizations or even in an industry. Thus, this is ofte
n the
base for wage settlements and is used for comparison of two or more jobs in term
s of
their complexities and competence. If we compare a stenographer with a private
secretary attached to a senior executive, we may observe that the technical skil
required, viz., taking dictation, typing, etc., may be similar but the complexit
y of job of a
private secretary to a senior executive will be much more hence he may deserve a
higher compensation package compared to a stenographer who just takes dictation
It may be noticed that the first two aspects can provide the basic data for trai
ning, need
identification as well as for performance appraisal in order to get the right ma
n for the
right job. Having listed out all specifications, a few crucial ones can be ident
ified for
decisions related to training and appraisal.
It is relevant to note that there are various terms which are used to describe t
he work
people do in an organization. Terms like task, job, position, role, and work are
used interchangeably but in academics these have a certain relationship with eac
other. Pareek and Rao (1986) have explained the relationship as follows:
Task: This is a basic element of a job and as such requires a person to achieve
specific product. In the process the individual is isolated from others.
Job: This is a complex system of tasks requiring an individual to achieve an ove
product and still making the relationship irrelevant.
Position: Puts an individual in a hierarchical pattern, expecting those below to
report or
surrender to higher positions and conform to their expectations while those high
er up
may be led to exploit the relationship and demand conformity.
Role: Emphasizes on the pattern of (mutual) expectations.
Work: Involves a more complex pattern as it goes a step further to encompass soc
iopsychological relationship.
The traditional concept of task and Job has the problem of treating individuals
as the
means to achieve the product as an isolated machine. Perhaps, it is such a persp
that alienates the individuals from what they do. The concept of position too, m

akes one
person powerful in relation to others and is likely to have a de-humanizing effe
ct like the
earlier two. It is the concept of role or work which takes an individual out of
traditional framework and puts in a complex relationship involving job-self othe
rs. In the
HRD perspective, role is a very relevant and imperative concept.
Like a job analysis technique, the roles can be analyzed by using the Role Analy
Technique (RAT) of which job analysis is a significant component. In addition to
listing the activities, expectations of the counterparts - all those related to
the given role
- (role set) are also considered. In the framework of role, the Key Performance
(KPA) are identified and the critical attributes that an individual needs to per
effectively are listed.
Check Your Progress (A)State whether the following statements are True or False:
(1) Even though the focus on people management underwent change, the systems
which were developed in the past could continue and need not change. ---- False.
(2) Performance Appraisal, Training and Development are critical elements
(subsystems) in the entire Human Resource Development System of HRM. ---- True.
(3) For HR functionaries, major challenge in training is to keep the workforce u
with current knowledge; what is not significant now can be forgotten. ---- False
(4) New skills can be easily blended with the old ones. ---- False.
(5) Job Analysis is the basic framework for most of the HRD systems. ---- True.
(6) Performance Appraisal is one system which has qualitatively got modified. --- True.
(7) Performance and Potential Appraisal systems have lot in common. ---- False.
(8) Career Planning is a motivational exercise. ---- True.
(9) When an organization develops in size and its business, it is called organiz
development. ---- False.
In the earlier approaches related to employees and their utilization, an individ
ual was
hired for a specific job and he continued doing it all through his work-life, on
e was
discarded when he was not able to do it due to his age or due to change in techn
It has subsequently, been realized that the individual has also a basic need to
Individuals are not static and they change by acquiring new knowledge, skills, a
and beliefs. They also tend to demonstrate certain capabilities which may not ge
adequate opportunity for expression in the normal course. Some critical event br
forth the capability. It appears as if individuals have a lot more in store. Mas
explanation of the need hierarchy highlighted the point that it is as natural a
need for an
individual to realize his potential, self-actualization, as satisfying the physi
cal need. It is
recognition of the fact that 'Individuals change over time'. They find new capac

within themselves and learn to interact with each other more productively. They
learn to
cope with stress, or to help others to do so. The problem of managing developmen
within organizations is to understand how one may hasten and channelise this pro
of 'learning and discovery' (Handy, 1976).
The rationale of training and development is to comprehend how this concept of
learning could be applied in the organizational context. What aspect of this lea
could be made a part of the formal system, what could be left to the specific in
and how the organization can enhance the process of individuals' becoming mature
effective in their environment, are its prime concern. We will examine the detai
ls of
establishing Training and Development system as part of the HRD efforts and this
(1) identification of training needs;
(2) conducting the training;
(3) evaluation of training; and
(4) selection and development of trainers.
These aspects have adequately been covered in Systematic Approach to training in
subsequent section.Purpose of Training and Development
HRD as an approach to management of HR and as also a function, is based on the
premise that employees should be provided with learning opportunities to enable
individual and the organizations to achieve their goals. The organizations on th
eir part
have to consciously analyze their requirements, define them, specify the time an
d level
at which these are required so that the system can take care of them. This need
of the
organization can be linked to the career progress of individuals so that it may
satisfy the growth need of individual. The activities which relate to this area
(1) improved performance of individual on his present job;
(2) his preparation for an identified job in a not-too-distant future; and
(3) his general growth (development) not related to any specific job.
According to Nadler (1984) if these activities are not identified or separated,
the learning
can be less effective. For the purpose of facilitating communication, a label ca
n be
applied to each of these levels:
(1) Training is for learning related to present job;
(2) Education is for learning to prepare the individual for a different but iden
tified job;
(3) Development is learning for growth of the individual not related to a specif
ic present
or future job.
There could be different categorization available for these three activities. So
me experts
may call futuristic learning as development and general (non-work-specific) lear
ning as
'education'. Some authors classify training as specific to a given job whereas

management development as 'attempts to instill sound reasoning processes - to

enhance one's ability to understand and interpret knowledge - rather than impart
ing a
body of serial facts or teaching a specific set of motor skills'. Development, i
n this
perspective focuses more on the employee's personal growth and organizational
development initiatives. Whether one uses Nadler's classification or any differe
categorization, it does not make a difference so long as it is understood unifor
mly in the
organization but some kind of segregation is necessary.
Such segregation helps in differentiating objectives for these three activities.
objectives are qualitatively different. First, when the goal is to improve perfo
training should be conducted and evaluated to check on the improvements. If the
goal is
futuristic, then one cannot evaluate performance until the individual moves to a
new job.
But if the objective is development then it has to be remembered that no direct
may be seen on the performance. Secondly, the differentiation helps clarifying m
expectations. Both the parties - the individual and the organization (the superi
or) - are
clear about what should be the outcome; the chances of misunderstanding are redu
Thirdly, and most importantly, the differentiation helps in identifying who is r
for what activity, for example, for training, the responsibility of identifying
the need and
ensuring that opportunity is given, has to be with the immediate superior but fo
education and development, it could be the central department or the overall HR
functionary who decides when and how to conduct the activity.
Imperatives of Adult Learning
It is interesting to note that though most of the people think that Adult Educat
ion is a
recent phenomenon, but it is not so. In ancient times great teachers like Confuc
ius, Lao
Tse, Hebrew Prophets, Jesus, Socrates, Plato, Aristotle - were 'teachers of adul
ts'. To these teachers 'learning was a process of active inquiry on the part of
the learners'; they
invented 'techniques for involving the learners in active inquiry.' In case of c
hild learning
the teacher has full responsibility for making all decisions about what should b
e learned,
how it should be learned, when it should be learned and if it had been learned .
.. the
student was left passive ... when adult education is organized with the model av
for children known as Pedagogy it does not give the desired results.
Ultimately, in and around the 1920s-30s, some thought was given to adult learnin
g. It
was Lindeman's work which can be cited as the first instance of defining the per
of adult learning. He explains his idea of adult education as, 'a cooperative ve
nture in
non-authoritarian, informal learning, the chief purpose of which is to discover

meaning of experience, a quest of mind which digs down to the roots of the
preconceptions which formulate our conduct; a technique of learning for adults w
makes education coterminous with life and hence elevates living itself to the le
vel of
adventurous experiment'. The special efforts to define and understand adult lear
includes Thorndike's early explanation that ability to learn diminishes with age
subsequently was modified to that it is the speed to learn that diminishes and n
ot the
power to learn. These efforts were then substantiated by the experience of teach
involved in adult teaching, and most of the social sciences like sociology, soci
psychology, also contributed their bit. Thus, a new term Andragogy was coined to
differentiate adult learning process from that of child learning. Today, what we
understand commonly is that learning is concerned with bringing about relatively
permanent change as a result of experiences. There are, indeed, a number of theo
to explain 'how' we learn. Knowles (Nadler, 1984) categorizes them in three sets
Mechanistic or Behaviourist Theories: These theories hold that the learner is pa
in the process of learning. If one introduces an input (stimulus) into a human b
eing, you
will get a predetermined response. In other words, learning occurs only when a l
is conditioned to give the 'right' response to a given stimulus.
Cognitive Theories: These theories equate man with his brain, based on the
proposition that one thing that distinguishes human beings from other living thi
ngs is
that they possess brains that are capable of critical thinking and problem solvi
ng. The
purpose of learning therefore is to teach the brain to engage in such critical t
hinking and
problem solving.
Organismic or Humanistic Theories: These theories hold that learning occurs only
when learners have the 'freedom to learn' what is particularly relevant to their
life situation. The purpose of learning is to encourage each individual to devel
op his or
her full, unique potential.
When we examine the training and development function in the organizational cont
ext, it
becomes apparent that all the three sets are relevant as all the three types of
exist in the organization.
Besides the specific framework of the theories, most of them have certain common
assumptions, there are theories related to the variables associated with the act
Teaching-Learning situation. Decenzo and Robbins (1995) list some as:
(1) Learning is enhanced when the learner is motivated: This means that the
learning experience must be so organized that it should create desire to learn.(

2) Learning requires feedback: Knowledge of results is necessary for learner to

improve upon his mistakes. The feedback also tends to act as motivator when the
learner knows that he is proceeding in the right direction.
(3) Reinforcement increases the likelihood that a learned behavior will be
repeated: Behavior that is positively reinforced are encouraged and therefore
(4) Practice increases a learner s performance: Learners need to practice what the
(5) Learning must be transferable to the job: Learning a skill just for the sake
of it will
not work; it must be possible to apply what is learnt.
While establishing an effective training sub-system, all the aspects related to
learning should be considered and kept as backdrop, namely, who needs training?
different groups could be: (1) young recruits, (2) Specialists, (3) middle level
(4) senior and top executives, etc. The contents and nature of training for the
groups will
vary. For the young one's it may be modem management techniques, for those with
experience, it may centre around to their being enabled to take up more responsi
positions. For specialists, the training should keep them abreast with the lates
developments in their field of specialization. For the senior and top management
, it
could relate to development of vision, entrepreneurship and business strategy.
Systematic Approach to Training (SAT)
With the developmental emphasis accepted by the organization, it becomes imperat
that organizations establish training systems. There needs to be a systematic ap
to manage training which has to answer a few basic queries like:
(1) Will the training to be done internally or externally? Does the organization
have or
intend to develop an in-house training centre?
(2) How much and what kind of training will be done externally and is this also
essential part?
(3) Who are the functionaries responsible for administering the training system?
It is a fact that majority of the organizations today have some kind of in-house
establishment which primarily caters to the training of operational knowledge an
d skill
requirements specific to the organization. This implies that the need for certai
advanced, specialized training is met by sending people to other (external) inst
The most common among these are specialized institutes which impart training in
management, finance or behavioural skills.
Whether the actual training is done internally or externally, organizations have
to follow
certain logical processes for enhancing knowledge, skills, and attitudes of thei
personnel. These are:
Step 1: Training Need Analysis (TNA) and Identification of Training Needs
Step 2: Preparation of a Training Plan;
Step 3: Conduct of the training which includes designing the programme in terms
of the time, duration, target group, sequence of inputs and methodology;

Step 4: Evaluation of the Training Programmes and the Plan; and

Step 5: Selection and Development of Trainers.
Let us examine each one of these a bit more in detail.
Step 1: Training Need Analysis (TNA) and Identification of Training NeedsIdentif
ication of training needs through the TNA (training need analysis) is the first
for successful implementation of any training initiative. One has to consider th
at the
training needs are perceived in the present as well as future context. The prese
context refers to the level of skills the existing employees have and in what di
they need to be upgraded. The information for such gap can come from their
performance appraisals done by their superiors, the productivity measure (norm)
set by
the organization, the larger rejects for the job done by an employee or a depart
ment, the
number of accidents, the inspection reports, etc. In other words, the level of a
individual's performance and the errors that he/she makes can be indicative of t
he gap
in his knowledge, skills and attitude which can be bridged through training. It
however be noted that all performance problems cannot be tackled through trainin
intervention. The poor performance on account of poor technology, outdated proce
poor working conditions, etcetera, cannot be solved by training.
The future needs of an organization also indicate the gaps to be filled by train
ing. The
organization's future business plan may include expansion in new or old business
domains. The organization needs to take a look at the skill levels of the existi
workforce and compare it against the requirement, to determine the total trainin
g efforts
required by the organization. Sometimes, organizations may have some specific fo
in the training as an offshoot of change in technology or a business strategy ad
opted by
the organization.
The training needs can be identified in formal or informal ways. Formal processe
s are
part of the administration of the training system. They are obvious, explicit li
nks and
processes. For example, the training needs identified as offshoot of the busines
consideration would be the result of conscious deliberations between the busines
s plan
and the HR functionaries. There should be an accepted mechanism or forum for thi
s to
happen at a given point in time.
Another formal way for identifying present needs would be to gather data from th
e micro
level from different stakeholders. Either the mechanism of performance appraisal
or an
independent exercise by an individual may spell out what, in his opinion, are hi
s training
needs to perform better on the job he is assigned. This statement is then qualif
ied by his

superior. Such data is collected from all levels and an analysis can be carried
out to find
out if there is any particular trend. It may happen that a specific department o
r a
particular geographical area is indicating specific needs. Thus, the analysis ca
highlight the major-minor specific groups of employees which can be considered w
preparing the annual training plan.
TNA requires collection of data systematically. It should include data to: (a) d
efine the
need; (b) identify solution; (c) specify those needing training; and (d) provide
planning details of the delivery of training (Rao, 1995). TNA can stem from diff
objectives, that is, it can be for employee development concern, personnel and s
concern, administrative and management concern or organization development
concern. It is possible to determine this with a set of questions to identify wh
at concerns
are being focused upon.
Step 2: Preparation of a Training Plan
The training need identification process provides the basic data for preparing t
he Annual
Training Plan. The primary focus at this stage is to prioritize the various issu
es thrown up by the data and seek an appropriate balance between meeting the nee
ds and
resources required. The training plan is expected to specify:
Internal External.
(1) Number of training programmes to be conducted
(2) Level of employees what will be the coverage of employees through the plan?
(3) What will be the subject areas that will be highlighted and what will be lef
t out of the
plan for future?
(4) What will be the plan for allocation of resources
what are the contingencies
(5) What arrangements are made to accommodate something that emerges beyond the
Rao (1995) has suggested a framework to facilitate the process of deciding prior
ities. Of
the factors mentioned by him, organizational policy and priorities is a vital fact
Without a favourable and committed policy for training and development the entir
exercise of collecting data, analyzing it and prioritizing will be a waste of ef
Another related aspect is to decide whether training should be given on the job
or in a
formal classroom set-up. There are situations where certain knowledge or skill b
training can be given on the job. Apprenticeship programmes, Job instruction tra
Understudy assignment (Mentor-prototype relationship), Programmed instruments (s
elflearning), Job rotation are commonly used on the job training methods. As may be
observed, very often organizations use this channel to train employees in the ro
procedural, operational aspects. The advantages are to the extent that the indiv
idual is

actually contributing to the events in the organization and secondly, the indivi
dual sees
the relevance and gets the 'feel of things' of what is to be done. This has its
significance in the initial period of joining the organization. An individual is
likely to be
motivated as he is on the scene of the work and not in the classroom.
Step 3: Conduct of the Training Programmes
In most cases the first two steps are handled by the training department of corp
office and this third step is specific to the actual delivery system, that is, t
raining centre.
When there is an in-house training setup available, this is their responsibility
. But in
cases where such an arrangement is not available and the organization out-source
s this
facility, the organization could specify their concern vis-a-vis the contents, e
methodology and output expected from conducting the training programmes.
The logical beginning for any training programme is to spell out the objectives
of the
programme. This facilitates the decision regarding the inputs in the training pr
For instance, if the objective is to impart a particular skill, then it is obvio
us that enough
time should be allocated to practice the skill after the participants have been
given the
specifics of the skill.
The objectives also indicate what methodology could be adopted to communicate th
ideas. Of course, the profile of the participants/target group influences the me
too. For instance, if the target group has no work experience then work related
discussions may not serve any fruitful purpose as they may have nothing in parti
cular to
share. The teaching methodology may include: Readings, Lecturetts, Experimental
Lectures, Discussion, Participative Training, Case Studies, Role Plays,
Instrumentations (use of tests and instruments), Simulation Games, Structured
Experiences, Intensive Small Groups and Intensive Growth Groups, etc.As is appar
ent when the involvement is the lowest, the meaning of what the learner is
exposed to is external to him - which means that the learning process is aimed a
making him or her aware of it. While on the other extreme of involvement, the me
of what the learner is exposed to is internal to him and the learning process is
facilitate the learner to be responsible for his learning. It is his or her expe
rience that he
is analyzing and drawing conclusions about. The selection of the methodology fro
m this
continuum among other things is based on the objectives, subject matter to be co
target group, profile, trainer's skills and capabilities.
It must be observed that the more one moves towards interactive side of the cont
the trainer's ability to deal with the data generated becomes crucial factors in
learning. The trainer needs to have clarity of the concepts he is dealing with i
n the
training sessions and should be able to draw and summarize learning points.

Step 4: Evaluation of Training

The primary purpose of evaluation is to improve training by discovering whether
training processes have been successful in achieving their objectives. Some expe
choose to make a distinction between `validation' and 'evaluation'. Validation m
assessment of whether the training has achieved its laid down objectives and eva
means the measurement of the total effect of the training programme. However, in
practice it is difficult to obtain information on the total effects of training.
Most commonly evaluation is done at four levels as the processes that occur as a
of successful training, are at these levels. The levels are:
(1) Reaction Level: Participants form opinions about the content, the method, th
trainers, the usefulness, the relevance and their enjoyment, etcetera. In other
these are the reactions of the trainees.
(2) Learning Level: Trainees learn-knowledge, skills and attitudes about the sub
matter which are acceptable for translating into behaviour ... what is learnt. T
his can be
measure through some type of tests conducted before and after the training.
(3) The behavior Level: Trainees apply the learning to actual situations, and th
is can
be observed in terms of change in behaviour at work, that is, transfer of learni
ng to
workplace. This may reflect in the work performance after the training which can
assessed with the help of their superior.
(4) Functioning Level: The changes in behaviour on the job affect the functionin
g of
the organization. This can be measured by indices which generally are expressed
terms of financial benefits or return on training investment. The modern organiz
view the raining expenditure as an investment so they look for the return on inv
It is quite difficult to segregate the financial benefits on account of training
Step 5: Selection and Development of Trainers
When there is an in-house training set-up, selection and development of the trai
ners is
another important activity. Both the aspects need to be consciously looked at if
training has to be effective.
The first question that arises is that: should the trainers be practicing
managers/operational people or should they be recruited specially as 'core facul
ty' from
academics? Both the options have their own merits. The advantage of having
operational people lies in the fact that they can relate to the actual work situ
ations while
communicating in the classroom. They can speak the same language that trainees
understand. The disadvantage can be the danger of adopting a narrow approach. It
is like in-breeding; new ideas may not emerge. The advantage of professional tr
ainers is
their ability to view matters from a different outlook and the professional know

about the concepts, teaching, methodology, etc. The disadvantage will be seen if
trainer is unable to relate to the work situations. He may remain an alien and b
perceived as a mere theoretician. In in-house training programmes, often a combi
of the two has proved to be effective. Whichever mode of selecting trainers is a
development of their skill is imperative.
In case of the operational personnel, the selection process should ensure their
willingness, communication skills, and concern for others (trainees). The specif
knowledge and skills that they may be required to teach can be checked or develo
in the second stage. Having ensured this the first developmental step for them w
ould be
the exposure to a course on Teaching Methodology which, by and large, covers the
issues discussed earlier about designing and delivering the training. In case of
recruitment of professional trainers, the teaching skills are available but the
need to be oriented towards organizational issues. They could be placed in the a
work situations for a couple of months so that they are in a position to relate
to the
organizational scenario.
Support Systems for Training and Development
Since HRM is a commitment to philosophy, the linkages and congruence among the
sub- systems is significant for its success, more so with training and developme
nt. Its
most important link is to the Performance and, therefore, how the performance
appraisal system functions and how far there is information flow from it to the
and development system is a significant determinant. In the absence of such
information, the training system has a danger of becoming a mechanical process a
not a developmental one.
The Human Resource Information System (HRIS) is another support system for
effective training. Since the data regarding the on-the-job experience, placemen
ts, and
skills acquired by way of professional qualifications or training attended is st
ored here,
this serves as a useful database for training. A comprehensive updated HRIS enha
the developmental efforts.
The most critical support is in terms of the organizational culture. As we under
stand, it
refers to the shared beliefs and values of the people at various levels. The sup
erior who
sends his subordinate for training, the HR functionary, the top management are t
he key
players in emphasizing the importance of training. If their actions give a contr
message, the purpose of training for development will be wiped out. If the super
hesitates to nominate or to relieve an employee for attending training or placem
elsewhere, if the top management itself gives a passive treatment to the trainin

subsystem by way of not sanctioning enough budget or flexibility, one can imagin
e what
level of motivation can exist among those who deliver and those who receive the
training. In one of the Indian companies, in the case of a covenanted staff, at
the time of
the performance appraisal, the DGM (training) acts as the mentor and an undertak
from the appraiser is taken for training the appraises in certain agreed areas.
undertaking is incorporated in the key result area for the superior for the foll
owing year.
It is important, therefore, that certain positive notion or beliefs should exist
in the
organization culture about usefulness of training. It is relevant to look at the
consciously and make sure that these are again and again talked about explicitly
within the organization. Top management's commitment to the following beliefs (
Rao, 1988)
and their reiterating them, is significant.
(1) Human resources are the most important assets in the organization.
(2) Unlike other resources, human resources can be developed and increased to an
unlimited extent.
(3) A healthy climate, characterized by the values of openness, enthusiasm, trus
mutuality, and collaboration, is essential for developing human resources.
(4) HRD can be planned and monitored in ways that are beneficial both to the ind
and to the organization.
(5) Employees feel committed to their work and the organization if the organizat
generates a feeling of 'belonging'.
(6) Employees are likely to have this feeling if the organization provides for t
heir basic
needs and for their higher needs through appropriate management styles and syste
(7) Employee commitment is increased with the opportunity to discover and use on
capabilities and potential in one's work.
(8) It is every manager's responsibility to ensure the development and utilizati
on of the
capabilities of subordinates, to create a healthy and motivating work climate, a
nd to set
examples for subordinates to follow.
(9) Higher the level of manager, in the hierarchy, the more attention should be
paid to
the HRD function in order to ensure its effectiveness.
(10) The maintenance of a healthy working climate and development of its human
resources are the responsibility of every organization.
Check Your Progress (B)
State whether the following statements are True or False:
(1) Training should be given in the organization because people like to learn ne
w things.
---- False.
(2) Employees can learn anything that they want for their development. ---- Fals
(3) Training, education and development have different meanings, they need to be
differentiated. ---- True.
(4) Pedagogy and androgogy mean the same thing. ---- False.

(5) Learning will not take place if there is no motivation. ---- True.
(6) It is better to do all the training in-house. ---- False.
(7) Training need analysis is a systematic process of looking into the gaps betw
what is there and what is desired. ---- True.
(8) Training plan is a summary of all training needs identified. ---- False.
(9) The methodologies adopted in training situations are decided by the trainer'
s skill.
---- False.
(10) Evaluation of training is an important step but it may not be possible to q
uantify all
the aspects. ---- True.
(11) Operational personnel do not need training in teaching methodology. ---- Fa
(12) Primary purpose of training is learning related to present job. ---- True.
(13) The purpose of development is learning for growth and not related to any sp
job. ---- True.21.4 ATTITUDE DEVELOPMENT
The term 'attitude' is frequently used to describe people in terms of their beha
viour and
its impact on behaviour. More precisely, an attitude can be defined as a persist
tendency to feel and behave in a particular way towards some object. For example
Ram does not like a job involving touring. Attitude can be characterized in thre
e ways.
First, attitude tends to persist unless something is done to changes. Second, at
can fall anywhere along a continuum from very favourable to very unfavourable or
positive to negative. Third, the attitude is directed towards some object about
which a
person has perception, feelings and beliefs, which in many cases may result into
emotionally charged opinion and prejudices.
Components of Attitudes
Attitude can be broken down into three basic components, viz., emotional, inform
and behavioural. The emotional component involves the person's feelings or their
positive, neutral or negative about an object. Emotions play a very important role
organizational behaviour of employees. The expression of emotions, either positi
ve or
negative, is also important to work behaviour.
The information component consists of beliefs and the information that an indivi
dual has
about that object. Generally, the beliefs or the information are founded on insu
observations or opinions which may not be empirically correct. A manager may bel
that 2 week's training is sufficient for an employee to effectively work as syst
administrator. In reality, minimum 4 weeks training may be required. The belief
of the
manager represents his attitude about the training.
The behavioural component consists of a person's tendency to behave in a particu
way towards the object. For example, the manager in the above example may assign

only 2 weeks for the Systems Administration training to an employee which may no
t be
sufficient for the employee to perform his job effectively. Thus, the attitudes
significant impact on workplace for achieving the organizational objectives.
Significance of Attitude at Workplace
An understanding of the role of attitudes is important to study and understand i
ts impact
on human behaviour at work for a number of reasons. Attitudes help predict work
behaviour. For instance, if an attitude survey shows that workers are upset by a
in the work rules, it may have an impact on their work behaviour. It may result
absenteeism. The management may conclude that the negative attitude towards work
rule has resulted into absenteeism. Another reason why an understanding of attit
ude is
important is that attitudes help people adapt to their work environment. Attitud
es serve
four important functions in the process. These are: (1) The Adjustment Function,
(2) The
Ego-Defensive Function, (3) The Value-Expression Function, and (4) The Knowledge
The Adjustment Function
Attitudes often help people adjust to their work environment. When the employees
properly treated by their boss, they are likely to develop a positive attitude t
supervision and the organization. These attitudes therefore help employees to ad
just to
their environment and area basis for future behaviour.
The Ego-Defensive FunctionBesides helping employees to adjust, attitudes also he
lp them defend their self-image.
For example, an older manager whose decisions are continually challenged by a
younger subordinate may feel that the latter is brash, cocky, immature and
inexperienced. May be the younger subordinate is right in challenging the decisi
The older manager may not be effective and may be taking poor decisions but he i
s not
going to admit this and will try to protect his ego. As a result, the older mana
ger will
have a negative attitude towards the younger officers.
The Value-Expression Function
Attitudes provide people with a basis for expressing their values. For example,
manager who believes strongly in the work ethic will tend to voice attitudes tow
specific individuals or work practices as a means to reflect this value. A super
visor who
wants a subordinate to work harder might put in this way:
`You have to work harder. That has been the tradition of the company since it ha
s been
founded'. This also helps to subscribe the ethics.
The Knowledge Function
Attitudes help supply standards and frames of reference that allow people to org
and explain the world around them. For example, a union office bearer may have a

negative attitude toward management. This attitude may not be based on facts, bu
t it
does help the individual to relate to management. As a result, everything that
management says is regarded by the unions as a pack of lies, a distortion of tru
th, or an
attempt to manipulate. Regardless of how accurate a person's view of reality is,
attitudes toward people, event and objects impact the individual make sense out
of what
is going on.
Changing Attitudes
As we have seen the attitudes of employees have significant impact on their beha
at workplace. It is therefore necessary to develop the right attitude of the emp
loyees for
the benefit of both, the organization as well as the employees. A positive attit
ude helps
a person in all spheres of life including his organizational life. Though it may
be difficult,
it is possible to change the attitudes of people. The level of difficulty depend
s upon
various factors including to what extent a particular attitude about a particula
r object is
deep routed and emotionally charged. The major barriers for attitude change are
commitment and lack of information. A prior commitment occurs when a person feel
s a
commitment to a particular course of action and is unwilling to change. The insu
information can distort the attitude about some object. For example, someone goe
s to
meet his old friend. The friend could not devote much time to his old friend bec
ause of
his other urgent commitments. Because of one incidence he may develop a negative
attitude about the behaviour of his friend who otherwise was considered as a ver
y good
There are ways in which the barriers can be overcome and attitudes can be change
One of these is by providing new information. Sometimes this information will ch
ange a
person's beliefs and, in the process, can change his or her attitudes. The secon
d way of
changing the attitude is through the use of fear. Researchers have found that fe
ar can
cause some people to change their attitudes. However, the degree of fear seems t
o be
important to the final outcome. If low levels of fear arousal are used, people o
ften ignore
them. The warnings are not strong enough to warrant attention. If moderate level
s of
fear arousal are used, people often become aware of the situation and are likely
to change the attitudes. However, if high degrees of fear arousal are used, peo
ple often
reject the message because it is too threatening and thus not believable. A good
example is provided in the case of anticigarette smoking campaigns. When the
department of health runs ads using patients who are dying of cancer, the messag
e is

so threatening to smokers that many of them shut it out. They refuse to listen.
The third
way of changing the attitude is by resolving the discrepancies between attitude
behaviour. For example, when a job seeker has more than one job offer and is for
ced to
choose one, he often feels that his final choice may go wrong. However, once he
chosen a particular job he will start feeling that he has taken a right decision
. He will
start to have negative feeling toward the job that was not chosen and positive f
toward the company that was chosen.
Influence of friends, peers and opinion leaders also has a great role on attitud
e change.
Thus, the role of leaders becomes very crucial for changing and developing right
attitudes of the followers. The leaders have to develop interpersonal trust and
themselves as rational persons interested in other's wellbeing. Additionally, wh
en a
particular matter is of personal interest to people, they are likely to reject e
discrepancies between their current behaviour and that of others. This is why un
behaviour is so difficult to combat because of other motives.
The managers are the formal leaders of an organization. Their attention is focus
ed on
organizational objectives and performance of employee. If a person intends to im
the attitude of an individual employee he needs to be friendly with him. Then on
ly, in
due course, he will know the employee and what motivates him. He will also know
employee's potential and shortcomings. In this process the manager can identify
learning needs of individual employees and can decide how to help the employee f
acquiring deficient skills. For this to happen, the manager will have to know th
employee and should be genuinely interested in the development of the employee.
A final way in which attitude changes often take place is by co-opting, which me
taking people who are dissatisfied with a situation and getting them involved in
improving things. For example, John is not satisfied with the present welfare sc
as a result the company appoints him as a member of the employee welfare committ
Once he begins realizing how these benefits are determined and how long and hard
committee works to ensure that the people are given the best benefits possible,
he is
likely to change his attitude.
Check Your Progress (C)
State whether the following statements are True or False:
(1) Attitude is directed towards some object about which a person has feelings a
beliefs. ---- True.
(2) Attitudes do not have any impact on the emotions of a person. ---- False.

(3) Attitudes of employees have significant impact on their work performance. --- True.
(4) Attitudes are formed based on facts and objective criteria. ---- False.
(5) Changing attitude is not possible for most of the people. ---- False.
(6) There are ways in which the barriers can be overcome and attitudes can be
changed. ---- True.
21.5 CAREER PATH PLANNINGIt is not uncommon to find that after the initial excit
ement in the job, individuals tend to
lose interest or get 'disillusioned' and feel that they have no `career' in a pa
organization or a profession. What is implied in such a feeling is that things h
ave not
happened as expected. In other words, individuals expect certain
changes/advancements to take place
time-bound or as a result of certain behaviou
When these changes do not occur it leads to the feeling of frustration or aliena
tion. The
mismatch between expectations and actual events could be in terms of the time fo
results being too long, or the absence of result itself. Sometimes there may hav
e been
irrationality in expectations leading to wrong perceptions. Organizational exper
ts have
tried to identify the variables responsible for this and explained the process i
n the
context of organizational realities and expectations about careers.
It is relevant therefore, to examine the underlying concepts in the generic obse
(1) individuals desire and expect change at certain stages in life:
(2) there is a (predictable) pattern in these changes; and
(3) there is a feeling of frustration if things do not happen as desired or expe
There area number of explanations available about the career in general and the
in organizational context. They refer to different aspects of career like the st
ages, the
movements, the perspectives at the stages, etc. We will take a look at the caree
r in
general and also elaborate the same in the organizational context.
The most commonly used framework for understanding the Life Stages is the one
given by Erik Erikson. He has divided the life into eight stages of which four a
re in the
childhood and four in the adulthood. The adulthood stages are relevant to unders
what individuals expect in organizational careers. According to Erikson the firs
t stage in
adulthood is:
Adolescence: In this stage individual's development is to achieve an ego identit
Individual is involved in reconciliation process of what he perceives himself to
be, what
he thinks others perceive him to be and make an adjusted assessment to form his
Young Adulthood: It is the next stage where he/she starts developing relationshi
with individuals, group or occupation. This could be establishing a close relati
developing an interest group or a work group.
Adulthood: The stage is that of guiding the next generation and during this stag

e one is
passing on the knowledge, values or sponsoring the younger colleagues and in the
Maturity: A stage when person attempts to achieve ego integrity by examining whe
life has been meaningful or satisfying.
Levinson and his colleagues have offered explanation about Career Transitions on
basis of the study of careers of a group of 40 individuals from different occupa
groups. He maintains that every five to seven years the individuals have to pass
some kind of personal or career related crisis with apparently a fairly predicti
sequence. The transitions are from early adulthood to late adulthood and as such
similar to Erikson's four stages.
Levinson's age-specific transitions correspond to Erikson's four adult stages. E
perspective is more generic and do not spell out specific age per se. It is rele
vant to
notice that similar stages are perceived in relation to the careers within the
organizations in the concept of CAREER ROLES given by Dalton, Thompson and Price
( 1977). They have emphasized on the sequence of roles and relationships an ind
Apprentice, Colleague, Mento
may experience in the four career roles labelled as
r and
Sponsor. At each of these stages, the tasks are different; relationships are dif
requiring personal adjustments:
Apprentice: This is the beginning of the career. An individual does routine work
the supervision of the mentor, who helps to learn. At this stage the individual
needs to
accommodate himself to a certain degree of dependency.
Colleague: This is the beginning of making an independent contribution though st
ill in a
subordinate role. There is less dependence on superiors for advice and direction
Mentors: This stage signifies the beginning of complex functions. The individual
develops ideas, manages others, and must learn to assume responsibility for his
subordinates' work.
Sponsors: At this stage the individual needs to broaden his perspective and thin
k longterm as he is now a part of the top management. He is required to define the dir
ection in
which the entire organization or at least a major segment of it would develop. H
e needs
to develop the capability to choose the right people in the organization who can
the process of influencing.
Career Patterns
The expected changes emerge as the pattern of movements that occur in the life
related to work. Driver (1985) has listed these patterns as Carver Concepts. He
there are some individuals who enter into an occupation and develop a plan for u
movement within the same profession using organizational hierarchy. This is Line
Career concept. In another pattern, individuals choose a profession, acquire hig

skills but do not choose to go higher up in the hierarchy. This is a Steady Stat
e Career.
In the Transitory pattern individuals shift from one job to another not necessar
ily related
to the previous one without acquiring any excellence. Lastly, in Spiral Career i
take on a new job, work hard, perform well, move up in status and rank, then mov
e on
to another type of work and follow the same pattern of development and performan
They tend to be geared up to take on new challenges at regular intervals and as
can be viewed as motivated by personal growth. In addition to the four patterns
described by Driver, one can observe a Plateau career which indicates reaching a
higher than where one started but then continuing on the same level
a plateau.
Schein has given another comprehensive framework of Three Dimensional Movement.,
viz., Vertical, Circumferential, and Radial. Vertical movement is along the hier
archy of
the organization, Circumferential movement is along the different divisions and
while Radial is towards the centre of the organization. He then explains the con
career movement which incorporates sequential movements in all the three dimensi
Schein has visualised all the three dimensional movements to occur in the career
pattern aiming to reach the top level of the hierarchy.
When these movements are predetermined in a logical sequence to enable an
individual to have knowledge of all activities of the organization (horizontal m
different perspectives of management (field and controlling) and different level
s of
management (hierarchical) it could be said that the organization has developed a
Career Path.
In practice, this means that after an individual joins a bank, he/she will have
to go
through the assignments that are along the horizontal plane, i.e. branches with
different business focus. This also being his apprentice stage, these assignment
s can be viewed
as teaming opportunities. Only after he has passed through some testing grounds,
becomes eligible to try for higher levels. At this level he may enter in the col
league role
and make his independent contribution to the organization. It may be that as he
up with promotion he is allowed to have exposure to the activities associated wi
th the
centre, that is, the controlling function and after a specified period he again
moves along
the peripheral assignment in the branch with more and complex business mix. The
level puts him in the mentor's role. As a regional manager he will be responsibl
e for the
development of the region, the business, and the people internal (employees) as
as external (the customers).

The concept of career path thus, relates to the sequencing of movements, decidin
g the
time period for each one, and so on. It implies that there is a destination to r
each either
at the hierarchical level or at the level of expertise. It denotes the distance
one has to
cover, the crossroads and the turns one has to encounter. It requires the indivi
dual to
take decisions and for that there has to be a signboard indicating direction and
It is logical to realize that in an organization, the movement will be decided b
y its
structure and the signboards are the criteria laid down for the eligibility to m
ove on.
Individuals will have to travel through these, while acquiring knowledge and ski
lls and
learn to face issues of higher/different levels. This process is expected to ena
ble the
organization to have competent personnel at all levels and at all times enhancin
simultaneously the growth and development of the individuals. In the context of
organizational career this implies that the organization can provide opportuniti
es for
individuals through a defined career path to develop, and individuals will have
to live up
to those challenges to satisfy the implicit need for growth. With an established
Path Planning subsystem, the organization can have a continuous supply of indivi
with required capabilities for future roles.
A word of caution is needed here. Career Development does not take place merely
having a path and a desire to go in a direction. On this path there are benchmar
which the individuals must cross in terms of achievements, skills, attitudes, et
Moreover, the organizational structures are pyramidcal in shape, that is, lesser
lesser positions are available at higher levels thus the career path does not en
sure a
smooth movement for everyone. The competitive environment in the organizations h
adversely affected the smooth movements in the ladder of hierarchy.
There are some more factors to remember. The employees including executives at
every level are likely to face frustration. Circumstances may be created by the
management to enable them to get over the frustration. Every one cannot reach th
e top,
people should be made to realize and accept the ground realities. There may be
supersession due to performance, appraisal system and bottlenecks. These may als
create great degree of frustration.
Career Anchors
Schein's concept of Career Anchor provides one explanation why individuals try t
follow a particular pattern. The concept of career anchor refers to a personal s
ense of
type of work individual wants to pursue and what that work or career means to an
individual. These anchors start developing early in the career as an individual

through various types of assignments. It is a mutual discovery of the individual
and the organization with respect to developing occupational self-concept. This
has three
(1) Self-perception of talents and abilities based on one's performance;
(2) Self-perceived motives and needs based on self-diagnosis and feedback; and
(3) Self-perceived attitudes and values based on interactions with the norms and
implicit in the organization.
Schein maintains that an individual needs to work in organizations for a conside
period to develop these meet anchors. On the basis of his research, he has found
such career anchors:
1. Technical or Functional Competence: Some individuals 'fall in love' with a
particular field or function. They desire to be outstanding in the field; their
self-concept is
associated with their skills in that area.
2. Managerial Competence: Some individuals like to manage. Their early career
experiences indicate to them that they will be able to rise in the management hi
3. Security: Some individuals seek a secure work environment and career by tying
themselves to a particular organization or geographical location.
4. Creativity: There are some individuals who want to create something new. They
to start something and make it a success.
5. Autonomy: Another group of individuals finds organizational life unpleasant o
difficult. They prefer to maintain their freedom.
Schein has sought to explain the matching between the opportunities and the
individual's inclination through the concept of external and internal careers. I
n his
perspective the opportunities are available externally in the education system,
society, in organizations. The internal career refers to the individual's career
that is, an individual's self-concept about what he is good at and has proved to
be so.
Career Path Planning: A System
The Career Planning in an organization is primarily an HRD sub-system. It establ
the linkages between and amongst other subsystems like manpower planning, job
rotations, transfer, placement, training and performance appraisal. It is essent
directed towards structuring employees' aspirations for upward movement through
organization and moderating these aspirations if they are found unrealistic (Par
eek and
Rao, 1986). As such, it need not mean any commitment on part of the management t
promote an employee. It only implies that the individual, after becoming aware o
f some
of his capabilities and career advancement opportunities, chooses to develop him
self in
that direction. The prime responsibility of the organization for developing and
implementing the career plan is to see that:
1. The policy of career planning is made explicit. It lays down the benchmarks f

performance at critical stages which the employees must attain.

2. It is made clear that career path is a facility for growth and not a right fo
3. The career path - a sequence of job assignments, training requirements and
promotion to higher level - is made known to the employees from the time of entr
Performance feedback is a part of the career path.
4. The career path is followed uniformly for all employees without any bias/ pre
5. It should be flexible to accommodate variations which may be needed to deal w
ith the
given circumstances.Besides working out the general policy guidelines, the HR fu
nctionaries will have to
chalk out the career path. For this purpose knowledge of all the activities perf
ormed in
the organization is a definite requirement. It is only with such knowledge that
sequencing of assignments is possible. The specific steps that follow then are:
1. For instance, if we take the concept of Career Roles then up to what level th
'apprentice' role would continue? At what level would it be considered as a coll
eague or
mentor or sponsor?
2. Identify the Core Jobs at Each Level: At each level, the jobs that are compar
able in
terms of the knowledge, skill required can be identified and categorized as a gr
These identified clusters are called 'Job Families'. It is necessary to have suc
h job
families because all units may not have identical jobs or assignments. The ratio
nale is
that an individual must be assigned at least one job from such job family.
3. Define and Spell out the Criteria for Each Successive level: The mechanism to
on to the next level (promotion) should be transparent in terms of the criteria,
weightages, and the measurements. In a way, an open appraisal system makes it
explicit as to what is expected and how it is to be measured. It must be mention
ed that
sometimes promotions may take place within a career stage, that is, in the appre
stage itself.
4. Placement is the Next Career Role: It is to be ensured that only those who cl
these criteria can move on to next level. And when the career stage changes, the
transition is facilitated by training and counselling. This is to highlight the
change in
orientation that is associated with changing career role. This is particularly s
when one moves from the role of colleague to mentor. The entire emphasis is on
shifting to a developmental role. The transition from mentor to sponsor is cruci
al too as
these calls for conceptual skills like visioning, planning, creative problem-sol
The experiences and practices in the organizations speak of more than one career
a choice for individuals to opt. Conventionally, in any industry, the topmost po
sition is

looked as the ultimate of the career aspiration and, therefore, logically one th
ought of
only one career. However, there are reasons to visualize multiple careers (discu
below) even within a given organization having single business focus.
Multiple Careers within Organization
Traditionally, organizations were simple and smaller. They were engaged in singl
business and their activities were focused. The other activities like finance, p
marketing, planning, etcetera, were together clubbed in the administrative funct
ions and
these were perceived as not requiring much heterogeneity in skills. However, as
organizations visualized the wider canvas and as management science grew, it was
realized that many of the aforesaid activities need special attention and skills
. Today,
these are clearly understood as separate independent functions, which require
expertise. Thus, in the manufacturing industry, one can see specialization at th
e top
management level for finance, personnel, marketing, planning, and quality beside
s the
traditional focus on production and maintenance. In this scenario it is feasible
perceive and develop multiple careers within the organization.
Individuals may join the organization with basic technical knowledge required fo
r the
given job but during his work life he could become expert in any, other than cor
technical area. For instance, a few decades ago we did not have financial manage
rs as experts as we have today. Financial Management has achieved a status of ex
function which a technical person can strive for. That has emerged as a career w
Currently, Information Technology (IT) has emerged as an area of specialization.
the potential of IT in any industry is tremendous; it is almost impossible to ha
ve a
readymade expertise. An otherwise technical person like engineer, medical
professional, artist, accountant can with a little bit of effort, develop expert
ise in IT within
the boundary of the organizational activities. The same holds good in service
organizations too.
In fact, in the larger context, even the management profession is getting into
specialization for different industrial sectors as well as industries. Therefore
, we have
specialization in poultry management, hotel management, hospital management and
Thus, a majority of the functions in the organizations are offering specific car
eers. In
view of this, career plans could be drawn up to ensure that attention is given i
n an
organized way to develop specific competencies required for these functions. In
traditional context, the practice was to recruit specialists but now one can thi
nk of
creating experts within the organization by using the system of career planning.
implies that the general career path drawn up must ensure that the core assignme

nts of
these specialized functions are also incorporated in that path. HR professionals
must be
careful to find out whether the employee/executive has a detailed understanding
of the
new job, insight into the culture, technology and the social atmosphere in the n
Schein has talked about career counselling workshops at different stages of care
wherein the individual is facilitated to understand his/her career anchors in th
e light of
his/her performance and introspection. Counselling is seen as a process to facil
itate the
individual in realizing his strengths and weakness vis-a-vis the competencies li
sted for
various career options. Career Workshops can be the forum for making the individ
aware of his career anchors and giving him opportunity to express his desire to
follow a
particular direction.
The concept of multiple careers is becoming more and more relevant as we are mov
towards flatter organizations. The emphasis and the chances of aiming at the ape
x level
position do not exist in such an organization. In flatter organizations, hierarc
hy is neither
desired nor available and what is needed is to develop expertise in different ar
Expertise building in one or more areas is crucial and challenging. In a way, th
e spiral
career concept given by Driver is becoming an ideal one for meeting the emerging
situation. This makes the multiple-career concept more relevant for the future.
Check Your Progress (D)
State whether the following statements are True or False:
1. Organizations cannot take responsibility of individual's career. ---- False.
2. Career Planning is not one time exercise, plans have to change. ---- True.
3. Career Planning is sequencing events for development. ---- True.
4. Career Progression is the right of the individual. ---- False.
5. Career Planning is a new concept for Indian organizations. ---- False.
6. Career Planning can become successful when the HR functionaries, the individu
and the immediate supervisor perceive this as a joint responsibility. ---- True.
The Concept of Self-development: Personal Efficacy
Before discussing about the self-development and personal efficacy, it may be
worthwhile to understand the concept of self. Self can be categorized into two p
namely,. the 'patent self' and the 'inner self'. The patent self can also be cal
led the
external self which normally comprise individual's identity and physical feature
s. On the
other hand the 'inner self' signifies the behaviour patterns, values and other
psychological factors including strengths and weaknesses. Before coming in close
contact with someone, we normally identify a person from his patent self, that i
s, a tall
man or a fair complexioned women, etcetera. Once we come into close contact with

someone the identifying parameters change. Now, we start identifying a person as

very kind man or very helpful woman or very emotionally strong person or very se
person, etcetera.
The self-development essentially refers to developing a mature personality who c
handle different tasks and situations with comparative ease. And in this directi
seeking self improvement becomes an ongoing process. It is the process of discov
and utilizing the tremendous potential within one's individual personality.
Presently organizations are experiencing much uncertainty vis-a-vis their human
resource. They are forced to bring about strategic changes involving business
diversification, expansion, and structural changes in response to the emerging d
in a liberalized and globalised environment. There are two challenges to be met
viz. (1)
keep and improve the existing things and (2) look for new opportunities in a cha
world. This is where we find it difficult to change people, i.e. their mindset.
Most of the
organizations need to do that since their strategies can bring result only if th
e 'true spirit'
behind those changes is understood and appreciated by the people involved in the
tasks. As Pareek (1994) states, 'structures are modified and new reporting relat
are put down on paper but unless the individuals' mindsets are altered to this e
ffect the
change would be deceptive. While addressing issues one cannot avoid looking at '
is to be changed but must also address simultaneously 'how' individuals can be
facilitated to change. In other words, organizational renewal implies similar re
newal at
the level of the individual and organizations must address this.' As a part of t
organizational development, the organizations need to make individuals understan
d this
and accordingly initiate their development process in line with the organization
expectations and vision.
With a view to creating learning organizations, individuals in the organization
should be
perceived as the `focal' point. Unless they are sensitized to the need for selfrenewal,
the organizational efforts for change may remain only at the cosmetic level. To
a lasting effect, they now have to concentrate on how the Human Resource could b
oriented towards such a self-renewal. The attempt could be specific to those hav
problems in adjusting but more generic effort would be to give an emphasis on 'b
learning individuals' throughout the organization. This is related to the proces
dimension of change and can be achieved through an appropriate focus on 'Persona
The factors that contribute to personal efficiency are motivation, self-awarenes

proactive behaviour and action-orientation (Pareek, 1997). This includes the per
of an individual with respect to his suitability to the activity he is doing pre
sently, how much he values that activity, how much he thinks others value the ac
tivity, and how
much scope for improvement he perceives in it. Thus, it includes awareness about
capabilities the desire to do well, belief that improvements are possible and ef
made to enhance the capabilities and competencies.
It is not merely for the benefit of the organization that the individual needs t
o develop, in
his own interests he must do so. Individuals need to be sensitized to the fact t
hat unless
they change and develop, they would not survive and grow. The change can come
about if and when the individual senses the changes occurring, evaluates them an
then decides to take corrective steps so that he does not become a misfit.
`Of primary importance at the personal level is the process of self-awareness, i
.e. to
what extent the person is aware, of what is happening to him, of social reality,
of his
relationship with others and so on. This process also relates to his awareness o
f the
various aspects of his personal life which are primarily concerned with self-act
that is, achieving those goals which are important to him in his life' (Pareek,
[994). Thus
personal efficacy is not only in relation to his job but in the process of explo
ring himself.
This would include the motivational processes, such as how the individual copes
the problems he faces, and the creative processes which are important aspects of
actualization. Such processes are important for the integration of the individua
ls with the
The prerequisite for introspection and learning is to understand the fundamental
s of
human behaviour. There area number of aspects one needs to understand about
oneself. However, in the context of our discussion on self- development in relat
ion to the
organization, the following aspects will be discussed.
At Individual level Motivational Pattern, Locus of Control,
Power Bases
At Interpersonal level Interpersonal Needs, Transactional
At Group level Being effective member in the Work
At Individual Level
The needs and expectations of employees have drastically changed during recent
years. They have a better exposure to the outside world; the environment has bec
quite competitive, and the opportunities have also increased. Technology has pla
yed a
major role in influencing the needs and expectations. Organizational loyalties a
nd long
term association with a single organization are disappearing.
Motivational Pattern

An individual has to make conscious efforts to be aware of what his life goals a
Awareness of one's own need bases can enhance an individual's acceptance of self
concept. How the individual attempts to balance self-concept with what he feels
think of him. Many a time, at a superficial level an individual may feel he is a
ware of
what he wants but that may not be the reality. Individuals have to be actively h
with some questionnaires and discussions to assess their orientation; to develop
a more
reliable and meaningful understanding. Individuals could become aware about what
motivates them, whether it is individual achievements or contribution to the gro
activities or in exerting influence. Such analysis can reveal that for job satis
faction one can look for those opportunities. It would facilitate creating aware
ness about career
anchor and then deciding what is the most suitable action for development and fo
increasing effectiveness. It is important to realize that people work for a vari
ety of
reasons like money, status, appreciation, work satisfaction, self-growth etc. an
d the
emphasis on a given goal keeps changing. HR Policy has to remain sensitive to th
changing needs & enable people to give their best.
Locus of Control
Personal efficacy is also related to an individual's ability to take the initiat
ive which
closely relates to his belief that he can change things. The concept of locus of
given by Leftcourt (1969) and Levenson (1972) explains that individuals have bel
about who is responsible for what happens in life. Some believe that events are
determined by external forces like other influential persons in society, luck, d
estiny and
so on. Whereas some others believe that the individuals can determine events. Th
we have individuals with more external locus of control and some with more inter
locus of control. These beliefs definitely have impact on the action orientation
individuals. For instance, it is logical to expect a person with internal Locus
of Control to
be generally geared up to look for resources around him, anticipate events and d
o not
wait for things to happen. On the contrary, individuals who believe that there i
s not
much they can do, will wait for external forces to push and exhibit a general
dependency. Conscious examination of one's orientation about 'who controls', can
reveal areas of development. Specific strategies could then be given or suggeste
d to
individuals to bring about change in the orientations in the desired direction.
instance, to reorient a person with more external locus of control to internalit
y, he could
be facilitated to realize that it was his efforts or his ideas which have contri

buted to his
success in an assignment and not the ease of the task or the luck. A feedback of
type can enhance the process of his conscious thinking about his contribution to
outcome of his actions. It is obvious that organizations would like to have mana
who have belief in their capabilities.
Power Bases
Another important concept related to influencing others is Power, Kotter (1979)
defined power as 'a measure of person's potential to get others to do what he or
wants them to do, as well as avoid being forced to do what he or she does not wa
nt to
do.' Distinction is also made in terms of fear or love being used as base of exe
this power. Flanders (1970), Hersey and Blanchard (1982) and Pareek ( 1997) have
contributed to the present understanding that coercive bases include organizatio
position, punishment, charisma, personal relationship, (emotional power), closen
ess to
a source of power and withholding information on resources. The persuasive bases
include expertise, competence, and modelling (example set by behaviour). In usin
g the
power bases concept, a person becomes aware of the power he/ she has and how
much more is needed which is quite relevant. Perception of having and using powe
empowers a person. After all, the exercise of authority (power) is essential for
functioning of any organization. This is the power dimension of working. From th
is, one
develops the power dimension of rewarding employees by deciding as to who should
get what differential compensation.
Interpersonal Interactions: Dyadic RelationshipIn organizations most of the situ
ations imply interacting and influencing others. While
certain roles it may be more specifically labeled, so the process is common to a
transactions that take place in the organization. It is therefore advantageous f
individuals robe aware of the process of influence through interpersonal interac
tion and
about the various influencing styles that lead to the desired effect.
In the focus of influencing others we need to understand our interpersonal inter
pattern. Here we will discuss the concept of Interpersonal Needs and Interperson
Interactions (through transactional analysis).
Interpersonal Needs
Schutz (1958, 66) drew attention to three basic interpersonal needs implied in
interaction among people; viz., inclusion, control and affection. As Schutz defi
ned, 'The
interpersonal need for inclusion is defined behaviourally as the need to establi
sh and
maintain a satisfactory relationship with people with respect to interaction and
association. Satisfactory relationship includes: (a) a psychologically comfortab

relationship with people somewhere on a dimension of initiating interaction, and
(b) a
psychologically comfortable relationship with people with respect to eliciting t
behaviour from others. On the level of feeling, the need for inclusion means nee
d to
establish and maintain a feeling of mutual interest' (Pareek, 1996).
The interpersonal need to control is to establish and maintain satisfactory rela
including: (a) a psychological comfortable relationship in controlling all behav
iour of
other people, and (b) eliciting behaviour from them which controls one's own beh
It may be understood that these concepts are to be examined in the framework of
oneto-one relationship and not in a group situation. They facilitate the process of
awareness about one's tendency to be wanted to be loved, acknowledged, belonged
controlled. It is educative for individuals to learn about themselves as they ca
n observe
and analyse their own interactions with their colleagues, subordinates, superior
s and
other work related people external to the organization.
Transactional Analysis
Another framework available to understand interpersonal relationship and interac
tion is
a concept developed by Eric Berne and in term
in terms of Transactional Analysis
s of
existential positions conceptualized by Harries (1969). A transaction is a combi
nation of
a stimulus and its response in an interpersonal interaction. The personality of
individual comprises collection of behaviour patterns developed over a period of
These behaviour patterns are evoked in different degrees from three ego states,
namely, Parent, Adult and Child. As Berne states, 'although we cannot directly o
these ego states, we can observe behaviour while individuals are interacting or
transacting and from this we can infer which of the three ego states is operatin
g at that
moment.' The three ego states are discussed below:
An individual's personality has a combination of these three ego states which co
uld be
unique to an individual. It would also not have a direct relation to the age or
any other
demographic parameter of an individual. Thus, we may have an individual who is
proportionately more adult (orientation) at the age of sixteen and have another
individual who is more child (orientation) at the age of sixty. This profile of
the ego
states of an individual determines his interaction with another individual. Thus
one could
behave in a more regulatory or analytical or a very casual orientation while dea
ling with others. In the context of influencing others in the organization an ap
propriate behaviour
suited to the situation is required.
Eric Berne defined the ego states as 'consistent pattern of feeling and experien
directly related to a corresponding consistent pattern of behaviour.' The terms

adult, child are related to orientations an individual has. For instance,
1. The parent ego state regulates behaviour and nurtures it, More of ethical,
conscientious behaviour and influenced by preaching's from parents and elders
2. The adult ego state collects information and processes it. More of a analytic
rational and practical orientation
3. The child is concerned with creativity, curiosity, reactions to others and ad
behaviour. More of instinctive behaviour with motive of enjoyment.
The parent ego state is a result of the messages (conditioning) people receive f
rom their
parents, elders, teachers and others during their childhood. These messages are
recorded in people's heads. These messages help in regulating one's behaviour by
telling what is right, what is wrong, what is desirable and what is undesirable.
There are
two kinds of Parent ego: (1) Nurturing parent and (2) Critical parent. Nurturing
parent is
that part of a person which is understanding and caring about other people. Crit
parent behaviour criticizes others for their undesirable behaviour. When a perso
n is in
critical parent ego state he is very much evaluative and judgmental and makes ot
hers to
feel that they are not OK.
The adult ego state evokes behaviour that could be described simply as logical,
reasonable, rationale and unemotional. Behaviour from the adult ego state is
characterized by problem solving, analytical and rationale decision making. Thes
people examine alternatives based on facts and figures and probabilities prior t
engaging in behaviour.
The child ego state is associated with the behaviour that appears when a person
responding emotionally. A person's Child contains the 'natural' impulses and att
learned from experiences. The child ego state can be classified into Adopted chi
Natural child and Little Professor. The part of child state which adapts to what
must be
done to others to get along. A natural child tries to enjoy every bit and take t
he things as
they come. The little professor is the 'thinking' part of child. It is creative,
imaginative and does experimentation. He dreams up new ideas. The compatibility
people largely depends on the ego states of interacting people. If the transacti
on is
complementary, namely, from Parent to Child and back from Child to Parent or Adu
lt to
Adult, situation is classified as desirable. But, if the transaction is crossed,
i.e. Parent to
Child and again from Parent to Child, it is not a desirable situation, the trans
action is
blocked. In an organizational situation for improving the effectiveness through
interpersonal relations and interactions it is desirable to avoid any crossed tr
People make basic assumptions about their own self-worth as well as about the

significant people in their environment. Harris called these combinations as Lif

Positions. These life positions are described in terms of Okayness. Thus the
individuals are either OK or NOT OK. Four life positions can be described as:
1. I am OK you are OK (both have value)
2. I am OK you are NOT OK (I have value but you don't have value)
3. I am NOT OK you are OK (You have value but I don't have value)
4. I am NOT OK you are NOT OK (neither person have value)Subsequently expanding
on the work of Avary (1980), James (1975), Pareek (1984) has
developed twelve influencing style, six of them in the OK states and six in the
states. Pareek's application of this to the organizational role in the form of S
tyles Profile
of Interaction Roles provides relevant framework.
The purpose of understanding the Ego State (personality orientation) profile is
to make
necessary modifications in one's behaviour. Behaviour scientists have suggested
certain behavioural patterns in the framework of Ego State Profile and Life Posi
('OK' and 'NOT OK') as desired while certain others as undesirable and therefore
to be
avoided. Awareness of one's own pattern and intensity in these styles can be a s
towards developing healthy influencing relationships.
Working in Teams
Synergy is the highest activity of life, it creates new untapped alternatives; i
t values and
exploits the mental, emotional and psychological differences between people. In
situation requiring the real time combination of multiple skills, experiences, a
judgments, a team inevitably gets better results than a collection of individual
s operating
within confined job roles and responsibilities.
A group of people with high degree of interdependence geared towards the
achievement of a goal or the completion of task is known as a team. 'Group' and
are used interchangeably, though there are some differences. The term 'Group
Dynamics' was coined in 1930s by Kurt Lewin It refers to the:
1. internal nature of groups
2. how they form
3. their structure and processes
4. how they function and affect individuals and organization
An individual's interactions do not stop at one to one situation
they exist in t
he context
of work groups. How effectively one performs the role as a member, can be meanin
information for self-development. To this effect, understanding group dynamics a
nd the
roles in the group is a necessary input for increasing effectiveness. Individual
s must
understand that the members have two major sets of roles to play. One set is gea
towards the task of the group. The other one is to maintain the cohesiveness of
group. It is the second set which is crucial and has a long-term perspective. Th
e issues
involved here are about listening to other members, respecting them and their vi
contributing meaningfully to the group activities and understanding the appropri

meaning of consensus and group decision-making process. Consensus is often
mistaken for compromise, or majority view. There is a kind of negative emotion i
for those who compromise or those who are in minority. Such feelings are not hea
for the group in the long-term. It is necessary that members understand that con
means debating over the pros and cons with full respect for each other.
It is useful to understand the stages in group formation and group behaviour nam
1. Forming (Awareness): Members with varied experience get acquainted, Understan
the Team's goal and its role
2. Storming (Conflict): Conflict among the members, through this conflict team a
to define itself
3. Norming (Cooperation): Norms are laid as to how the task will be accomplished
, the
manner in which the team will behave, and the rules and regulations it will foll
4. Conforming (Adjustment): Adjusting one with the team expectations and norms5.
Performing (Productivity): Members behave in mature fashion and focus on
accomplishing their goal. Members can devote full energy to work
Understanding self helps in self-development and using one's potential better. I
t is
always useful to do the SWOT analysis of self to understand the Strength, Weakne
Opportunities and Threats. This may help in better use of strengths, overcoming
weaknesses, capitalizing the opportunities and safeguarding against threats. It
relevant to refer to the concept of Johari Window given by Loft and Ingham (1973
which explains what is meant by self-awareness. The authors refer to the two
dimensions, namely, (1) how much of one's behaviour is known to him or her, and
how much he feels others know him or her. These two dimensions give four windows
called Arena, Blind, Closed, Dark. The diagram below explains the model. As can
seen the area which is known to self and others is the Arena (open) aspect of on
personality and one which is not known to both is the Dark aspect. The Blind sec
tion is
known to others but not the self and the Closed section is closed to others so t
o say.
The closed window is also referred as Private, being private to self.
Known to self Not known to self
Known to others ARENA is known to
others and known to self
BLIND is known to others
but not known to self.
Not known to others CLOSED is not known to
others but known to self
DARK is neither known to
others nor to self.
In this, the size of arena or open space is critical for improving effectiveness

. It is
implied that he more the person feels, the others know him or her; more and bett
conducive the environment becomes and the stronger the self-concept. As we
deliberated, the more one knows about oneself, the better equipped he is to face
challenges. The strategy to increase the Arena (open-self) implies that the indi
sensitizes himself to receive feedback from others and by making more and more
disclosures. Thus, the receiving feedback and self disclosures help in increasin
g the
Arena (open-self). Such persons are more trustworthy, open to other's ideas and
suggestions, have better self awareness.
Emotional Intelligence
The contemporary research by experts has revealed that for success in life the
traditional concept of IQ is not enough as a predictor. Daniel Goleman has cited
number of recent researches indicating that `link between IQ test scores and the
achievements in life is dwarfed by the totality of other characteristics that on
e brings to
life' (Goleman. 1995). He has visualized these other characteristics as 'Emotion
Intelligence: abilities such as being able to motivate oneself and persist in th
e face of
frustration; to control impulse and delay gratification; to regulate one's moods
and keep
away distress from swamping the ability to think; to empathize and to hope'. Gol
has drawn on the understanding developed by Gardner in his 1983 work on "intelli
and success in life". Goleman states that unlike the IQ, which is stable from ch
ildhood, Emotional Intelligence grows throughout adulthood. It can be learnt as
one matures with
proper awareness assessment and efforts to correct.
The five components of Emotional Intelligence which relate to how we manage
ourselves and manage others are:
1. Self Awareness: Ability to recognize, understand one's mood, emotions and dri
as well as their effects on others.
2. Sell Regulation: Ability to control or redirect disruptive impulses and moods
propensity to suspend judgment
to think before acting.
3. Self Motivation: Passion to work for reasons that go beyond money or status a
propensity to pursue goals with energy and persistence.
4. Empathy: Ability to understand the emotional make-up of others and skill to t
people according to their emotional reactions.
5. Social skills: Proficiency in managing relationships and building networks an
d ability
to find common ground and build rapport.
Self Awareness includes ability to recognizing one's emotions and their effects,
Assessment i.e. knowing one's strengths and limits and Self Confidence, that is,
strong sense of one's self worth and capabilities
Self Regulation includes self Control i.e. Keeping disruptive emotions and impul
ses in
check, Trustworthiness i.e. Maintaining standards of honesty and integrity,

Conscientiousness i.e. Taking responsibility for personal performance, Adaptabil

ity, i.e.
Flexibility in handling changes and innovation, i.e. Being comfortable with nove
l ideas,
approaches and new information
Self Motivation includes achievement Drive i.e. striving to improve or meet a st
of excellence, Commitment, that is, aligning with the goals of the group or orga
Initiative, that is, readiness to act on opportunities and Optimism, that is, pe
rsistence in
pursuing goals despite obstacles and setbacks
Empathy signifies: understanding Others i.e. sensing others' feelings and perspe
and taking an active interest in their concerns, Developing Others i.e. sensing
development needs and bolstering their abilities, Service Orientation i.e. antic
recognizing and meeting other's needs, Leveraging Diversity, i.e. Cultivating
opportunities through different kinds of people and Political Awareness, i.e. re
ading a
group's emotional currents and power relationships
Social Skills (Handling Relationships) cover: influencing, that is, wielding eff
tactics for persuasion, Communication, that is, listening openly and sending con
messages, Conflict Management, that is, negotiating and resolving disagreements,
Leadership, that is, inspiring and guiding individuals and groups, Change Cataly
st, that
is, Initiating or managing change, Building Bonds, that is, nurturing relationsh
Collaboration and Cooperation: working with others toward shared goals, Team
Capabilities, that is, creating group synergy in pursuing collective goals. In t
he arena of
management of human relationships it is wise to remember that no single style of
management is likely to hold good all the time. One, therefore, has to be adapti
ve to
different types of style to suit the given situation.
Check Your Progress (E)
State whether the following statements are True or False:
1. Organizational changes are not effective unless the people also change their
way of
thinking accordingly. ---- True.2. Individuals can accept only those changes tha
t relate to the work. ---- False.
3. Organizations need to make the individual change. ---- False.
4. Self-perceptions are enough to bring about improvements. ---- False.
5. Personal efficacy is how efficiently one is doing his job. ---- False.
6. 'Locus of Control' refers to one's belief about who is responsible for the ev
ents in
one's life. ---- True.
7. People have different motivational bases. Some receive satisfaction in achiev
ing by
themselves, some others by working in groups while some others by exerting influ
---- True.
8. With experience, age and hierarchy in the organization, the Child component o
f the
personality should be eliminated. ---- False.

9. The Adult ego state is mainly responsible for creativity, curiosity and react
ions to
others. ---- False.
10. The Parent ego state mainly regulates behaviour and nurtures it. ---- True.
11. ARENA refers to the part of personality known to 'self' but not known to oth
ers. ---False.
12. BLIND refers to the part of personality known to self but not known to other
s. ---False.
13. CLOSED refers to the part of personality known to self but not known to othe
rs. ---True.
14. DARK refers to the part of personality not known to self or known to others.
15. Emotional Intelligence refers to being emotional. ---- False.
16. Emotional Intelligence refers to being empathetic. ---- True.
17. Emotional Intelligence refers to being self-motivated. ---- True.
18. Emotional Intelligence refers to being self- regulated. ---- True.
Morale is an important mental state and the spirit of a person or group which is
dependent on a number of intangible factors within the organization. High morale
of an
individual or a group contributes significantly to the achievement of organizati
onal goals.
Morale is generally exhibited by confidence, cheerfulness, discipline, and willi
ngness to
perform assigned tasks. The morale denotes a spirit, as of dedication to a commo
n goal
that unites a group: the high morale of the troops; the esprit of an orchestra;
the esprit
de corps of the swim team; the morale of the troops. It also displays the emotio
nal or
mental condition with respect to cheerfulness, confidence, zeal, etc., especiall
y in the
face of opposition, hardship, etc. The spirit and the desire of a group that mak
es the
members of the group succeed is influenced by the level of morale.
Positive employee morale is highly dependent on employee motivation; and also on
rewards and recognition. Organizations want a workplace in which high morale
translates into positive motivation, increased productivity, exceeding expectati
ons for
performance and happy employees. Like a disease, poor morale can infect every
aspect of a business. It can lead to reduced productivity, reduced revenue, high
turnover and more. According to Sirota Consulting, the share price of low morale
companies saw only a 3 per cent increase in price versus an industry average of
cent.Employee Morale Booster
Welcome Ideas: Employee morale improves when staff feels they are valued. Share
and implement their innovations and ideas.
Keep Score: Mount a large score board in the office to recognize top performers
and to
motivate those on the bottom of the list.
Inspect: The old management adage, inspect what you expect is true. Companies wi

a lack of focus can confuse staff and lead to less morale.

Thank You Note: Send a special 'thank you' letter to your staff's family or spou
praising their good work and efforts.
Huddle: Have a daily morning huddle to highlight tasks for the day and to cheer
yesterday's wins.
Open Up: Provide an open forum or one-on-one time to allow employees to express
their concerns and feelings can be an easy means to boost morale.
Have Fun: Special events and outside work activities can take the pressure off t
he dayto-day grind in the office.
Show Charity: Get your staff involved in a bigger cause to help them see there i
s more
to life than work.
Add Perks: Use low cost perks such as a Foosball table in the lunch room.
Fire Staff: Sometimes the root cause of low employee morale can be a staff membe
whose negativity brings down the group. Even a top performer can bring down staf
behind your back.
Measure It: Keep tabs on the levels of morale in your business by regularly meas
employee satisfaction.
The backbone of business success resides in the productivity and output of emplo
Those companies who remain vigilant to the signs of low morale and who focus on
improving morale can thwart off the impact of a low morale workplace.
This is a best case scenario. You have received feedback about negative rumors a
you know that the underlying cause of the negativity is based on faulty informat
incorrect assumptions, or deliberate misinformation. You may receive feedback th
at a
new policy or procedure is not understood correctly. People may be misinterpreti
ng a
corporate memo. An industry newsletter might have referenced an industry problem
your company does not share. You may have fired an individual who is circulating
information about the company. In each of these circumstances, you have some con
over the information, the situation, and the communication. You can solve the pr
and communicate well to overcome the negativity.
When you can control or influence the situation, use a systematic problem-solvin
process with the affected employees to improve the identified areas of negativit
y. Do
this as quickly as you determine that negativity exists. (Many Human Resources o
launch a complete investigation, and by the time the facts are gathered, the neg
ativity is
out of control). Include the employees who are closest to the negative situation
in the
problem-solving process. Do a good cause analysis so that all possible causes of
negativity are identified. It is not enough to say, 'We have low morale.' You ne
ed to
identify exactly what is causing the low morale to have any chance of improving

Solicit widespread input to each step of the action plan you develop so that sol
are 'owned' across your organization. Involve as many people as you can in its
development and particularly in its implementation. Implement the chosen solutio
ns quickly. Then, periodically assess that the plan is working. At each step of
the problemsolving process, communicate as much information as you have about the negativit
and the solutions. When the solutions selected in the action plan are rolled out
, people
in the organization are not surprised. They have participated in the information
exchange as each step or opportunity was discussed.
Let Us Sum Up
In this unit we examined how the present HRD perspective aims at integration of
individual needs and growth with the satisfaction of organizational needs and gr
This understanding being fundamental to developing human resource, we considered
few important subsystems that relate to the developmental aspect. These are trai
and development, attitude development, career path planning, and self-developmen
We also focused on the training and development as a specific subsystem of HRD.
appreciate the importance of the system per se, we initially examined the presen
understanding of 'Training', `Development' and 'Education'. We examined the conc
ept of
adult learning and why it is different from what we commonly understand by teach
We, then, elaborated on the systemic issues of training and development. Specifi
we studied the various steps involved in the introduction and maintenance of a f
training system in an organization. We also discussed the importance of attitude
s at
workplace and the need methods of attitudinal change.
We examined the relevance of the concept of career with its implications in
organizations. We reviewed the terms Career Stages, Career Transitions, Career
Movements, Career Roles, and Career Anchors. In the organizational context, Care
planning as a system plays an enhancing role in the Human Resource Development.
We discussed the steps in establishing this HR sub-system and the emerging need
develop multiple careers.
We focused on the individual's role and responsibility vis-a-vis the development
al efforts
initiated by the organization for self-development. As such we examined the conc
underlying human behaviour which can be appreciated by the individuals in the pr
of development. The 'Personal Efficacy' is the process intervention to substanti
ate some
of the HRD systems that aim at individual's growth and development. In the emerg
profile of organizations, interpersonal styles, group behaviour, facilitating le
adership and
empowerment of subordinates are going to be behavioural benchmarks. In this cont

we also discussed the concepts, role and application of Transactional Analysis a

s tool
of inter-personal skills/behaviour. The concept and content of Johan window as a
framework to improve personal efficacy though the mechanism of feedback and
disclosure have also been discussed. The factors associated with improving emoti
Intelligence viz. Self Awareness, Self Regulation, Self Motivation, Empathy and
Skills for improving personal and inter-personal effectiveness have also been
discussed. We also discussed the concept of employee and group morale and its
impact on organizational productivity. The impact of motivation, reward and reco
on employee morale has been identified. The morale boosters are also discussed.
Case Study 1
Mr. Mansorie has been working on the Pension Desk of Establishment Section in th
Zonal Office of a Public Sector Bank for last eight years and is now due for int
departmental transfer. He has been very sincere, hardworking and knowledgeable w
orker. His boss Mr. Natrajan, Assistant Manager was having full confidence in hi
sincerity and ability, therefore, he was not worried about this aspect of work a
nd was
concentrating on other establishment matters like payment of salary in time, pre
of PF statement, payment of bills etc. Mr. Mansorie was rarely taking leave and
was not
considered for training for a long time. Mr. Natrajan received a communication f
rom the
training department nominating Mr. Mansorie for a week's training to the Staff T
Centre (STC) on 'Public Relation' in the last week of month. The communication w
received from the training department in time. The STC is located in the same bu
Three days before the commencement of training Mr. Natrajan approached the Chief
Manager pleading for not relieving Mr. Mansorie for the training on the plea tha
t the
disbursement of the pension is a time-bound activity, if he is relieved for the
training the
work will suffer. The other clerks were not very much conversant with the work b
performed by Shri Mansorie.
Case Study 2
A large public sector bank having an apex training college and 10 Staff Training
(STCs) at different locations across the country runs regular courses on differe
aspects of banking, IT and HRM. While the apex training college caters to the ne
eds of
middle and senior management, the STCs are mainly training to award staff and ju
management officers. The top management of the bank is not satisfied with the tr
system as a whole because it is not producing the right type of trained staff to
meet the
emerging challenges. Training initiatives are implemented as rituals. The syllab
i of the

courses are not periodically revised. The course coverage is decided by the trai
themselves based on their own knowledge and exposure, training infrastructure is
inadequate, selection of trainees is based on adhocism resulting into uneven tra
opportunities to employees, there is also gap between the type of skills require
d and
available and this gap is widening due to ageing profile of the employees, train
opportunities are underutilized mainly because of lack of motivation and also no
cooperation of line managers to spare the right staff for the training. The trai
department is playing a passive role. It has become hard to increase the trainin
budget, as there is wide feeling that training is a wasteful expenditure, people
are not
taking training seriously and the trainers are not competent. Training job was
considered as risk free and comfortable. Training is considered as a cost centre
and line
managers perceive no visible benefits out of training. No evaluation is taking p
except a reaction level at the time of conclusion of training. There is lack of
between different stakeholders of training system.
Human Resource Development; Training and Development, Education; Job Analysis,
Job Description, Job Specification, Job Evaluation Attitude and Attitudinal Chan
Career Development, Career Path Planning, Career Counselling; Life Career Stages
Liners, Spiral, Steady, Transitory; Career
Career Transitions, Career Concepts
Anchors, Career Paths, External-Internal Career Path; Career Roles: Apprentice,
Colleague, Mentor, Sponsor; Personal Efficacy; Self-awareness; Johari Window;
Motivational Base; Power Bases; Locus of Control; Interpersonal Interaction: Nee
Interpersonal Interaction: Styles; Transactional Analysis; Working in Teams;
Consensus; Emotional Answers to Check Your Progress
1. False; 2. True; 3. False; 4. False; 5. True; 6. True; 7. False; 8. True; 9. F
1. False; 2. False; 3. True; 4. False; 5. True; 6. False; 7. True; 8. False; 9.
False; 10.
True; 11. False; 12. True; 13. True
1. True; 2. False; 3. True; 4. False; 5. False, 6. True.
D 1. False; 2. True; 3. True; 4. False; 5. False; 6. True.
1. True; 2. False; 3. False; 4. False; 5. False; 6. True; 7. True, 8 False; 9. F
alse; 10.
True; 11. False; 12. False; 13. True; 14. True; 15. False; 16. True; 17. True; 1
8. True.
Terminal Questions
1. What is HRD? How did the concept develop?
2. Examine the rationale why special focus is needed to be given to Human Resour
Development as a subsystem.
3. What were the events that lead the organizations to learn that the existing w
can be developed to do new things?
4. Explain the linkage between the individual performance and organizational
performance and HRD system.

5. What are the HRD subsystems? How do they connect with each others? Explain an
one of them in detail with its linkages to others.
6. Human Beings are learning beings - Discuss.
7 Organizations must provide learning opportunities because human beings have a
desire to learn. Do you agree?
8. Why is Pedagogy not suitable for adults?
9. What is the difference between adult and child learning?
10. Describe the various stages in establishing Training and Development system.
11. State the reasons for having a systematic approach to organise training.
12. What is Training Need Analysis?
13. Discuss the various teaching methodologies.
14. What is the purpose of training, development and education? How are they
different? Should organizations have emphasis on all of them?
15. What is the significance of having right attitudes? Discuss in the context o
f bank's
efficiency and productivity.
16. How can we change the attitude of dissatisfied staff?
17. The organizational career is the responsibility of the organization and the
individual Discuss.
18. All the concepts that have been developed around 'Life Stages and Transition
' can
be applied to organizational careers - Elaborate this statement.
19. Write short notes on:
Career Movements/Patterns
Career Roles
Career Path
Career Anchors
20. What is meant by multiple careers?
21. Why is there a need for individuals to appreciate that they need to change?
Explain.22. What are the aspects that individuals need to understand about thems
Explain any two aspects discussed in the unit on self-development.
23. What is the relevance of understanding interpersonal interactions in the
organizational context?
24. Write short notes on:
Personal Efficacy
Locus of Control
Working in Teams
Suggested for Further Reading
1, David, Decenzo A and Stephen Robbins P; Personnel/Human Resource
Management, Prentice-Hall of India, 1995.
2. Luthans, Fred, Organizational Behaviour, McGraw-Hill International Edition, 1
3. Mankidy, J; Human Resource Management in Banks: Contemporary Issues, National
Institute of Bank Management, 1998.
4. Nadler, L; The Handbook of Human Resource Development, A Wiley-Interscience
Publication, 1984.
5. Pareek, U and Rao, T V; Designing and Managing Human Resources Systems,
Oxford & IBH, 1986.
6. Rao, P L; HRD Through In-house Training, ISTD and Vikas Publishing House, 199
7. Rao, T V; Pereira D F, Recent Experiences in Human Resources Development,
Oxford & IBH Publishing, 1988.
8. Sahani, A; 'Career Planning for HRD and Utilization', Indian Management, June
9. Schein, E; 'Career Development: Issues for Organizations', B Taylore and G Li

(ed). Management Development and Training, Handbook, McGraw Hill Co., 1983.
10. Stoner, J; and Wankel, E; Organizational Careers and Individual Development
Management, Prentice-Hall India, 1987.
PAPER 1Advanced Bank Management
UNIT 22 Human Implications of Organizations
22.0 Objectives
22.1 Human Behaviour and Individual Differences
22.2 Employees Behaviour at Work
Check Your Progress (A, B and C)
22.3 Diversity and Gender Issues
2'.4 Theories of Motivation and their Practical Implications
Check Your Progress (D, E and F)
22.4 Role Concept and Analysis
Check Your Progress (G)
Let Us Sum Up
Answers to Check Your Progress (A, B, C, D, E, F and G) Terminal Questions
Suggested for Further Reading
1 29
After reading this unit, you should be able to:
1. understand the various facets of human behaviour and individual differences,
2. understand the various aspects of employees behaviour at work and its signific
in organizational performance,
3. appreciate the diversity and gender issues at workplace, and
4. appreciate the motivational aspects and their practical implications at work,
5. appreciate and analyze the significance of role in the context of organizatio
Understanding and appreciating the importance of individual differences and its
on human behaviour is a most crucial aspect of human resource management. As eac
individual is different from the other in his/her physical appearance, he or she
is also
different from other person in his/her behaviour and other psychological paramet
viz., feelings, perception, values, etc. One finds striking differences in intel
physical features and personality traits, etc., among people. From the day of bi
rth, each
person is unique; individual experiences after birth, make people even more diff
Human behaviour is a complex phenomenon. It is most difficult to define in absol
terms. It is primarily a combination of originating and responding behaviour. Th
behaviour reflects the psychological structure of a person. It is also the resul
t of
biological, psychological and social processes.
According to psychologist Kurt Lewin, behaviour is a function of the person and
environment around him. These two factors are linked with each other. Any one of
these individually cannot explain fully the behavioural characteristics. Thus,
different people
behave differently in the same or similar environment.


After explaining the foundations of human behaviour, the individual differences

examined in this Unit. Various personality theories have also been discussed in
The Unit also brings out the connection between the employee and the organizatio
The employees' motivation and its practical implications at work have also been
out in this unit.
The behaviour of an individual is influenced by several factors. These can be gr
under the following heads:
1. Environmental Factors: (a) Economic, (b) Social (norms and cultural values),
(c) Political;
2. Personal Factors: (a) Age, (b) Sex, (c) Education, (d) Abilities, (e) Marital
Status, (f)
No. of dependants, etcetera;
3. Organizational Factors: (a) Physical Facilities, (b) Organization Structure a
Design, (c) Leadership, (d) Compensation and Reward System, etcetera.; and
4. Psychological Factors: (a) Personality, (b) Perception, (c) Attitudes, (d) Va
lues. (e)
Learning, etcetera.
Environmental Factors: These factors are mainly external and they influence
individual's behaviour. These, broadly include the social, cultural, political a
nd economic
environments. Among these, economic environment determines the behaviour of an
individual to a great extent. Economic environment consists of the level of empl
wage rates, economic outlook, etcetera. Cultural factors such as work ethic,
achievement needs, values, etcetera., form part of the environmental factors. Th
political climate also influences individual behaviour. The stability of the gov
ernment can
contribute to employment opportunities. The quality of the political system also
has a
bearing on individual behaviour. The social environment, which includes societal
and the family atmosphere, also influences to some extent the individual behavio
Personal Factors: Every individual brings to his workplace several personal
characteristics such as age, sex, education, knowledge, intelligence, abilities,
dependents and similar other related factors. Performance of an individual depen
ds on
these factors to a great extent.
Organizational Factors: The structure of the organization, the availability of p
facilities, the existence of reward and compensation system, the personnel polic
ies, the
organizational culture, etc influence the behaviour of an individual in an organ
The quality of leadership also influences individual behaviour.
Psychological Factors: The individual behaviour is determined to a great extent
by the
physical and mental personalities of that individual. The values, perceptions an
attitudes also contribute to the individual behaviour.
Since each person is individually different implying that in order to motivate t

employees they have to be treated differently keeping in view the needs and moti
ves of
the employees. If the needs and motives of two persons are different they must b
treated differently. If it were not for individual differences, some standards c
ould have
been adopted for dealing with employees and minimum judgment would have been
required thereafter. There might have not been any difference in dealing with me
n and
machines.From the organizational angle, managers usually view their employees as
human beings who are primarily motivated by money. Accordingly, they adopt
'economic man' and the 'rational man' approach to understand and predict human
behaviour. However, it has also been realized that man is also a social being. H
e wants
to belong to a group, and his behaviour at the workplace emanate from his social
as well. One of the well-known studies (Hawthorne studies) has made it clear tha
economic motives alone do not explain human behaviour. Social interactions at
workplace, especially how they are treated, and how their contributions are
acknowledged, make a big difference in their attitude to perform. Thus the idea
of 'social
man' was developed.
However, as time passed by, the 'social man' approach was also considered somewh
simplistic. This approach does not pay adequate attention to work, its intrinsic
and its organization. Nor does it concern itself with the economic functions and
responsibilities of the enterprise. And at times, it is plainly manipulative. Or
behaviour theorists such as Argris G C, Likert R, and McGregor D argued that peo
ple in
organizations need opportunities to use their creativity and this growth need sh
ould be
met to enable them to contribute effectively.
At the same time, all employees may not want to develop and grow on their job; t
may have their preference elsewhere. Hence, the current thinking is to accept ma
n as a
complex being and to recognize that personalities always differ. An understandin
g of the
concept of personality and the influence of its components on the behaviour at w
ork is
necessary to provide a congenial environment in which employees can perform. Suc
an understanding may help managers to adjust their own behaviour also and contri
to organizational cohesiveness. Besides, this may enable them to predict employe
ebehaviour at work (absenteeism, turnover, work involvement, etc.) and take timel
preventive measures.
The behaviour of people at workplace plays an important role in organizational s
The behaviour of an employee as an individual as well as his behaviour in a grou

makes a difference in achievement of organizational and group objectives. The

technical competence of an individual is important but beyond that his behaviour
interpersonal skills are extremely important. The people in the organizations do
not work
in isolation, their role and performance is interdependent. They work in teams w
contribution of each member is important and significant. The team-building skil
ls which
are founded on individual behaviour and interpersonal skills can help in getting
at workplace where the cooperation and collaboration can improve the group
performance and output beyond the individual contributions. Synergy is the highe
activity of life, it creates new untapped alternatives; it values and exploits t
he mental,
emotional and psychological differences between people.
There are some basic assumptions about human behaviour at work:
1. There are differences between individuals.
2. Concept of a whole person.
3. Behaviour of an individual is caused.
4. An individual has dignity.
5. Organizations are social systems.6. There is mutuality of interest among orga
nizational members.
7. Organization behaviour is holistic.
While the first four concepts centred around people, the next two are concerned
organizations. The last one is a combination of the first six assumptions.
Persons differ and again, there are certain 'commonalities' in the persons. Ever
y person
is, in certain respects,
1. like all other persons,
2. like some other persons, and
3. like no other person.
This position indicates that an individual possesses some common characteristics
most of the people. He may have some features of some other people. He may also
have some characteristics which other persons do not have, i.e. the features uni
que to
an individual. Human personality is thus a complex and multidimensional phenomen
There is indeed no simple definition of what personality is. However, personalit
y can be
examined in terms of certain stable characteristics, tendencies and behaviour pa
Salvotore Maddi defined personality as a stable set of characteristics and tende
that determine those commonalities and differences in the psychological behaviou
(thoughts, feelings, and actions) of people that have continuity in time and tha
t may not
be easily understood as the sole result of the social and biological pressures o
f the
moment. This definition does not imply that people do not ever change. It simply
indicates that individuals do not change drastically overnight and their thought
feelings, values and actions remain relatively stable over time. Changes in pers
behaviour pattern that take place in individuals occur slowly over an extended p

eriod of
time. Thus by understanding certain dimensions of personality and behaviour,
managers can, to a great extent, predict the likely behaviour in terms of action
s and
outcomes of actions in respect of employees.
There are several theories to explain the concept of personality.
One dimension of personality which is getting attention both from organizational
as well
as medical researchers is the Type A and Type B behaviour profiles.
A person exhibiting Type A behaviour is generally restless, impatient with a des
ire for
quick achievement and perfectionism.
Type 'B' personality people are much more easy going, relaxed about time pressur
less competitive and more philosophical in nature.
Friedman, Meyer and Ray Roseman have mentioned the following characteristics of
Type W personality:
1. Restless by nature, so that he always moves, walks and eats rapidly.
2. Is impatient with the pace of things, dislikes waiting and is impatient with
those who
are not impatient.
3. Multitasker
does several things at once.
4. Tries to schedule more and more in less and less time, irrespective of whethe
everything is done or not.
5. Usually does not complete one thing before starting on another.
6. Often displays nervous gestures such as clenched fist and banging on a table.
7. Does not have time to relax and enjoy life.
Type B personality exhibits just the opposite characteristics and is more relaxe
sociable and has a balanced outlook on life.We come across both Type A and Type
B Managers in banks. Usually Type A
Manager's cabin is untidy, and gives a Messy appearance. Further, his table is f
ull of
papers and many a time, it is difficult to trace important papers kept on his ta
ble. He has
a tendency even to lose some papers and to blame others for such a loss.
Type B personality, however, is systematic and methodical in his day-to-day work
. He
has full control over time and does not complain of lack of time even due to pre
ssure of
work. This is because he plans the work in such a way that urgent and important
matters are disposed of in time. Although he is busy like many other managers, h
appears to take things easy and normally does not get disturbed.
A development model of personality described by E H Erikson also helps us to
understand the concept of personality. Erikson has identified eight developmenta
stages in explaining the personality. These stages which are based on a person's
of mind at a given point of time are mentioned below:
Stage 1: Trust versus Mistrust
As children we depend on others for our various needs. In the process we develop
feelings of trust or mistrust towards others depending on our experience about t
fulfillment of our needs. Similarly, in the workplace, we may not know everythin
g about
the job and therefore, we are dependent on others for guidance. In the process w
e also

develop feelings of trust or mistrust towards others in the organization dependi

ng upon
how well they respond to our needs and help us to find our place in the system.
Stage 2: Autonomy versus Shame and Doubt
As children we experienced a great need to be on our own and whenever we
succeeded, we felt we are independent and autonomous. When we failed in such
attempts, we experienced a sense of shame and doubt. Similarly, in the workplace
induction and initial training, we feel happy when we can function independently
. But
when we commit mistakes we start doubting our own competence and experience a
sense of shame for not doing things right.
Stage 3: Initiative versus Guilt
This stage indicates the child's efforts at trying to do things on its own initi
ative and
feeling guilty if mistakes are committed. Similarly as employees we take initiat
ive and
use our talents to settle down in the jobs; if things go wrong, we may experienc
e a
sense of guilt that we have wasted our energy and the resources of the organizat
Stale 4: lndustry versus Inferiority
As we grow up we become diligent and industrious. We want to pursue our goals an
manage our life. If we are successful in these efforts, we feel good about ourse
lves; if
we fail, we develop a sense of inferiority. Similarly, in the workplace we try t
o work hard
to find a place in the organization; if we are not successful, we tend to suffer
from a
feeling of low self-concept and low self-esteem.
Stage 5: Identity versus Role Diffusion
As we grow, we experience conflict due to the socially imposed requirement of
becoming an independent and effective adult. This, at times, becomes difficult.
In the
workplace also, we are expected to prove ourselves as high, performing members.
Obviously, this is not always easy for everybody. In the process some may find t
role identity diffused rather than identified and distinguished.
Stage 6: Intimacy versus IsolationAs a youth, one feels the need to develop inti
mate relationship with others. However,
there may be impediments to develop such relationship and hence some might feel
isolated. Same is the experience in the workplace also. We may develop close con
with others and we may also feel a sense of isolation.
Stage 7: Growth versus Stagnation
In middle adulthood, there are compulsions to forego one's immediate needs in fa
of developing one's children. If this is not effectively resolved within the ind
ividual, a
sense of stagnation creeps in. Similarly, in an organization as one reaches midcareer,
there is an expectation and need to develop others in the system and help them t
grow. If this is not done properly, the person senses a feeling of stagnation.
Stage 8: Integrity versus Despair
During the later part of life, there is a natural decline of social and biologic
al roles due to
the ageing process. As a result one may experience a sense of uselessness. If he
is in

a position to accept reality, he may resolve the conflict and feel happy about h
is lifelong
achievements. Likewise, in an organization, as one approaches retirement age, he
experience either a high sense of self-worth due to his perceived accomplishment
s in
the career or he may withdraw himself with a sense of purposelessness and despai
The two theories (Type A and B) and Erikson's model of personality bring out dif
aspects of the concept. While Type A and B focus on certain personality features
Erikson's model narrates different stages of an individual's growth and their ef
fects on
his mental personality.
Check Your Progress (A)
Answer the following
True or False:
1. Type A person feels a chronic of time urgency. ----,, True.
2. Type B is an easy going individual. ----,, True.
3. Type A person is not achievement oriented. ----,, True.
4. Type B person does not experience any competitive drive in his activity. ----,,
5. Erikson's model of personality has eight stages. ----,, True.
6. During youth, according to Erikson, one develops a need for intimate relation
ship with
others. ----,, True.
7. There is mutuality of interest among organizational members. ----,, True.
8. Type B person does several things at a time. ----,, False.
There are certain common patterns and variables which determine the personality
of the
people. The patterns of behaviour can be to some extent predicted if we can iden
tify the
type of personality. People with similar attributes can be classified in one cat
egory and
their behaviour can be predicted. Accordingly, experts have developed certain
personality theories.
Psycho-analytical Theory (PT)
PT is based primarily on the Freudian concept of unconscious, subconscious and
conscious nature of personality. Freud noted that his patient's behaviour could
always be explained. This led to him believe that the personality structure is p
founded on unconscious framework and that human behaviour and motivation are the
outcome of psychoanalytic elements, namely, id, the ego, and the super ego. Id i
s the
foundation of the unconscious. It strives for sexual pleasure and other biologic
pleasures and has animal instincts of aggression, power and domination. Ego is c
onscious in nature and relates our conscious urges to the outside world. It keep
s the id
in check through the realities of the external environment. While id demands imm
pleasure, whatever the cost, ego controls it so that these pleasures are granted
at an
appropriate time and in an acceptable manner. Because of difficulty of keeping t
he id
under control, ego is supported by super ego. The super ego is the higher level
restraining force and can be described as the conscience of the person. The cons

creates standards of what is wrong and what is right and is generally subconscio
developed by the absorption of cultural and ethical values of the social environ
ment. All
these three Freudian elements are interrelated and each cannot exist in isolatio
n from
others. In order to create a 'normal' personality, there must be a balance in th
relationship among these three forces. For example, an overdeveloped super ego w
make the person highly moral and make him feel guilty for every little thing tha
t slightly
deviates from the norm. This would not be considered practical or rational. Simi
larly, an
underdeveloped super ego would let id urges loose and would characterize the per
as one having weak morals and values. This psychoanalytical approach to personal
structure analysis has made some impact on organizational behaviour. For example
stages of creative process are unconscious in nature and can be brought out by
psychoanalysis. Similarly, such employee behaviour as daydreaming, forgetfulness
absenteeism, tardiness, sabotage, alcoholism and drug abuse, can be analysed thr
psychoanalytical studies and analysis.
Trait Theory
Trait theory believes that the traits of a person which determine his personalit
y and
behaviour are basically inherent to a person, that is, more of a heredity impact
than the
environment .Trait theory explains personality as a demonstration of certain tra
its of the
individual. While there are many traits common to most people, there are many ot
traits that are unique to a person and are not shared by other individuals. On t
he basis
of Trait theory, people can be described as aggressive, loyal, pleasant, flexibl
humorous, sentimental, impulsive, cool and so on. Traits are the basic elements
personality and can be used to explain their behaviour. People behaving in a for
manner in most situations could be described as aggressive. Similarly, if a pers
allows others to take the initiative, he is 'submissive'.
Self-Concept Theory
This theory believes that personality and behaviour are to a great extent determ
ined by
the individual himself. We have an image of our own and our actions would be
consistent with that image. Carl Rogers is closely associated with this theory.
to him, the best vantage point for understanding behaviour is from the internal
frame of
reference of the individual himself. An individual himself is the centre of expe
rience. His
self-image is an integral of how he views himself and his perception of how othe
rs view
him. This self-concept is a result of a person's interaction with his environmen
t. This

interaction in the form of learning

modify our self-concept as a result
feedback from others in response to
reinforced. On the other hand, when

experience helps us to grow and mature, and

of these experiences. When we get positive
our behaviour, our self-concept is positivel
we get negative feedback, our self-regard is

lowered, resulting in tension and anxiety. Thus, an employee with a self-concept

of high
intelligence, independence, and confidence may not look for such reinforcement
techniques as monetary rewards, job security or directive supervision. He may lo
ok for a challenging environment where he gets recognition, responsibility and a
chievement. On
the other hand, the monetary rewards and job security may be more effective on
employees who have a self-concept of dependence, insecurity and who lack confide
in themselves.
Social Learning Theory
This theory believes that personality development is more a result of social var
than biological factors. Much of human behaviour is either learnt or modified by
learning. Through learning, one acquires knowledge, attitudes, values skills, et
Further motives can be traced to known and conscious needs of the individuals.
Personality is the sum total of all that a person has learned. The social learni
ng theory
uses 'reinforcement and punishment' approach in understanding personality. For
example, frustration caused by external environment, causes and reinforces aggre
as a personality trait. Also, good behaviour is rewarded by the society in terms
of praise
which further reinforces good behaviour. Thus, behaviour and external environmen
have mutual interaction. Behaviour partly creates the person's environment and t
environment affects the person's behaviour as well.
Check Your Progress (B)
True or False:
Answer the following
1. Id is the foundation of the unconscious. . True.
2. In order to create a normal personality there should be a balance in the rela
among the id, the ego and the super ego. . True.
3. People behaving in a forceful manner in most situations could be described as
sentimental. . False.
4. We have an image of our own and our actions are consistent with that image. .
5. Personality is a sum total of all that a person has learnt. . True.
Personality and Brain (Left and Right Brain)
An important biological factor which influences personality is the role of brain
of an
individual. Two types of contribution can be found in this area: Electrical stim
ulation of
the brain (ESB) and split brain psychology. Human brain is believed to contain c
definite pleasurable and painful areas. Accordingly it may be possible physicall
y to
manipulate personality through ESB. It may also be possible to use ESB as a meth
od of

reducing stress and tension and stimulate creative thinking. Split brain, right
versus left,
psychology is closely related to ESB and is probably more popular. The character
and dimensions attributed to the left and right hemispheres of the brain are ind
icated in
the following table:
Left Hemisphere
Controls Right side of body
Right Hemisphere
Controls Left side of body
1. Speech and Verbal 1. Spatial and musical
2. Logical and Mathematical 2. Holistic
3. Linear and Detailed 3. Artistic and symbolic
4. Sequential 4. Simultaneous
5. Controlled 5. Emotional6. Intellectual 6. Intuitive, creative
7. Dominant 7. Minor (quiet)
8. Active 8. Spiritual
9. Analytic 9. Synthetic, gesalt-oriented
10. Reading, writing, naming 10. Facial recognition
11. Sequential ordering 11. Simultaneous
12. Perception of significant order 12. perception of abstract
13. Complex motor sequence patterns 13. Recognition of complex figures
Note: Adapted from Freed Luthans, Organizational Behaviour, 6th Ed.
The Left and Right hemispheres of the brain are attributed with some specific
dimensions and characteristics as shown in this table. These areas are, however,
open for further research.
Matching Personality with Jobs
John Holland's personality job fit theory is of late receiving increasing attent
ion. The
theory is based on the match of personalities with jobs. Holland presents six pe
types and proposes that satisfaction and dissatisfaction with the job depends on
individuals successfully match their personality with their occupations. Table d
the six types, their personality characteristics, and gives examples of congruen
TABLE 22.1 Holland's Typology of' Personality and Congruent
Type Personality
Congruent Occupation
1. Realistic: Prefers
physical activities that
require skill, strength and
1. Shy, genuine,
persistent, stable,
conforming, practical.
1. Mechanic, drill press
operator, assembly-line
worker, farmer.
2. Investigative: Prefers
activities that involve
thinking, organizing and
2. Analytical, original,

curious, independent.
2. Biologist, economist,
mathematician, news
3. Social: Prefers
activities that involve
helping and developing
3. Sociable, friendly,
3. Social worker, teacher,
counseller, clinical
4. Conventional: Prefers
rule-regulated, orderly,
and unambiguous
activities, flexible file
4. Conforming, efficient,
practical, unimaginative,
bank teller.
4. Accountant, corporate
5. Enterprising: Prefers
verbal activities where
there are opportunities to
5. Self-confident,
ambitious, energetic,
5. Lawyer, real-estate
agent, public relations
specialist, small business influence others and
attain power.
6. Artistic: Prefers
ambiguous and
unsystematic activities
that allow creative
6. Imaginative, disorderly,
idealistic, emotional,
6. Painter, musician,
writer, interior-decorator
Check Your Progress (C)
Answer the following statements in True or False:
1. Human brain is believed to contain definite pleasurable and painful areas. . T
2. Extroverts are quiet, reflective people. . False.
3. Successful people have high tolerance for ambiguity. . True.
4. Individuals with low self-esteem take more risk in their career. . False.
5. Personality job fit theory was developed by John Holland. . True.
6. Right brain controls intuitive and creative behaviour. . True.
7. Left brain controls analytical behaviour. . True.
8. Right brain controls Speech and Verbal ability. . False.
Diversity and Diversity Management
Many organizations have acknowledged the importance of the increasing diversity
in the

workforce. They have begun to question the effectiveness of the human resource (
systems that are largely designed for a more homogeneous workforce. There is a n
to consider the implications of diversity for the development and synthesis of s
HR policy areas. There is also need to study the degree to which the current the
and practice have incorporated issues of diversity management. While race/ ethni
and gender are the most recognized forms of diversity, there are other types wit
important implications for HR systems and management. They include disability, f
background, age, lifestyle and culture. Each of these identity group memberships
affect an employee's attitudes and behaviour at workplace as well as influence h
is or
her ability to work well with other organizational members.
Organizations have traditionally HR systems based on models of homogeneity. They
promote similarity not diversity, provide a number of examples illustrating how
HR management models foster workforce homogenization, viz., recruiting practices
emphasise people from sources that have historically been reliable or selecting
candidates similar to those who have been successful. Similarly, decision-makers
tempted to hire, promote and evaluate people in terms of the degree to which the
y are
like their own image. Such an approach has been coined 'homogeneous reproduction
referring to the tendency of selection and promotion systems to allow only those
employees to pass through who fit with the characteristics of the dominant coali
The aptitude tests used for mass selections and recruitment are also designed in
such a
way that it selects the candidates with similar abilities and competence. Once t
hat ability
or the competence becomes obsolete the entire work group becomes redundant. For
example, in 1970s and 1980s the Indian banks had recruited a large workforce wit
h numerical ability to meet the growing demand of employees in the banking servi
ces due
to rapid branch expansion. With large scale computerization in banking sector in
and current decade of this century the numerical ability became an obsolete skil
l as the
reconciliation and all back office jobs have been taken over by the computers. W
growing competition between the banks, the selling and marketing skills have bec
more in demand and banks are facing a problem of re-skilling the staff into the
marketing skills. There is a drastic shift of orientation of people of back offi
ce work and
front office jobs requiring inter-personal skills. Thus, having people with hete
and complementary skills are always beneficial for the organizations. Too much
similarity in the work force in an organization can be detrimental to long-term

renewal, and ability to respond to important environmental changes such as dynam

market conditions, new technologies and ideas, societal shifts, or the expectati
ons. HR
policies supporting diversity can help the culture to continually adapt in respo
nse to new
environmental demands. Such systems are critical for attracting, selecting, moti
developing and retaining highly skilled diverse workforce.
Modern employers now encourage diversity at workplace. When workgroup diversity
managed effectively, groups develop processes that can enhance creativity, probl
solving, workgroup cohesiveness and communication. At organizational level,
performance, and the quality of product and service may improve. Diverse group o
employees who possess the key success factors are needed to compete in today's
changing marketplace. Despite these reported benefits, their realization has rem
elusive for most of organizations. This is because traditional HR strategies man
diversity, which has largely been introduced in piece meal, without taking a hol
istic view,
lacking integration with other systems. For example, in most of the countries,
legislations have been enacted for equal pay for similar work irrespective of ge
race, etc. without changing the culture and human beliefs. The three predominant
traditional HR approaches for managing diversity are: diversity enlargement, div
sensitivity and cultural audits.
Diversity enlargement approach increases the representation of individuals of di
ethnic and cultural backgrounds in an organization. The goal of this strategy is
to create
diversity by changing an organization's demographic composition. Employers seem
assume that increasing diversity and exposure to minority employees will result
improved individual and organizational performance. The employers have wider cho
from diversified groups.
Diversity sensitivity approach acknowledges the existence of cultural distance a
attempts to teach individual members about cultural differences via training. Of
training sessions are held to help sensitize employees to stereotyped difference
s of
various employee racial, ethnic and gender groups. The purpose is to promote
communication and understanding, and to build relationships among members of
different backgrounds.
A third strategy, the cultural audit, generally tries to determine what is block
ing the
progress of nontraditional employees. Data is collected through surveys to asses
various demographic groups' identification of major obstacles they face in the c
culture. This helps in bringing out their feelings about the predominant culture
and the
dominant ethnic groups. Conducting cultural assessment as an isolated strategy i

s likely
to fail unless it is linked to HR systems. Managing diversity is a mutual proces
s and the new culture and HR strategies must be designed to be inclusive to allo
w all members to
contribute to their potential. Cultural audit not only needs to focus on the dif
between groups but also identify the similarities between groups that the cultur
e and
supportive HR systems can reinforce to achieve organizational objectives.
There are several issues and problems associated with achieving objectives in te
rms of
hiring and managing diverse employees. One problem that emerges is the issue of
'critical mass'. Organizations planning for diversity often find themselves 'spi
nning their
wheels' because of inability to bring enough diverse workers into the organizati
on. The
problem here is that it may need a critical mass of diverse workers in order for
employees to feel welcome and accepted. Entrance of few diverse workers into the
organization may fall flat because of sense of isolation and/or overexposure in
the role
as 'token' (Kanter.1977). Another problem with achieving diversity objective is
that it
takes considerable time before the organization with best of intentions begins t
o show a
complete demographic profile which reflects their objectives and efforts. Finall
y, the
nature of underlying business conditions may limit achieving business objectives
. When
the organization is growing/expending and hiring with greater frequency, it allo
ws faster
achievement of diversity goals. However, when the expansion is slow or nonexiste
nt or
during downsizing, it becomes difficult to achieve the diversity objective.
Gender Issues
The major factors for diversity are gender and race differentiation. Many jobs h
preference for a particular gender both from employer's and worker's points of v
This differentiation is basically on account of physical, social, psychological
emotional considerations. For jobs requiring greater physical strength, men are
preferred, whereas for the jobs requiring hospitality and emotional aspects, wom
en are
preferred. Gradually the difference is getting blunted. Now, women are willing t
o accept
all sorts of jobs and have proved themselves successful in the jobs which were
predominantly being occupied by men. The jobs like aero plane pilot, police, etc
are successfully being handled by women. The women, however, also have the
responsibility of managing their household affairs in addition to their jobs.
Powel (1987) conducted a major review of the empirical literature on gender as i
t relates
to recruitment and selection decisions in the organizations. He found that gende
r did not
significantly affect the selection decisions. The greater the amount and relevan
ce of
information (namely past performance) about the job and applicant received by th

evaluator, the lesser gender biased the decisions. Research also suggests that
attributes of success and failures may explain the relationship between gender a
personnel decisions.
There has been whole host of initiatives by the governments worldwide to remove
discriminations in employment and employment conditions based on gender. The
initiatives have been generally in the nature of legislations. The employment
opportunities for women have considerably improved in recent years in almost all
sectors and areas of specializations. The employment rate of women has gone up
considerably in recent times. Lots of opportunities for part-time employments fo
r women
have emerged. Women are disproportionately represented in secretarial occupation
whereas the men are highly represented in machine operative works and craft rela
occupations. In spite of government policies, there has been large number of ins
of pay disparities to the disadvantage of women employees for similar jobs. In a
survey conducted in UK (Labour Market Trend
2001) women got 82 per cent of the
hourly earnings as compared to male counterparts in full time employment. The pa
y gap
varies between sector to sector and job to job.
In India, the representation of women in employment is still quite poor. The rec
ent years
have seen some significant improvement in the proportion of women representation
Women workers are visible almost in all sectors and all occupations. A large num
ber of
women workers are seen in manual work like construction activities. Banking, tea
and health care have traditionally been seen as the preferred occupations for wo
As women are generally required to shoulder dual responsibility, they prefer a j
ob with
regulated working hours so that they can devote sufficient time to their family
household affairs. There are avenues for women in almost every job. Government
policies and legislations also do not permit any gender discrimination in pay or
any other
service conditions. The Equal Remuneration Act, 1976 has provided for the paymen
t of
equal remuneration to men and women employees and for prevention of discriminati
on the grounds of gender against women. The act also seeks to provide for more
opportunities to women in specialized employments. However, keeping in view the
vulnerability of women at workplace, jobs requiring odd hours of work require
permission under the Factories Act, 1948: to allow women workers to work during
hours and shift duties under special circumstances and proper protection.
The preference for a male child is predominant in Indian society. Recent Census
conducted by the Government of India indicated that there has been a significant
imbalance in many of the states. There is also significant gap in the literacy l
between male and female. To improve the literacy level of women and girl child f
or the
purpose of making them self-reliant, government is encouraging literacy by provi

various incentives, concessions and encouragements. To improve the status of wom
in society, the government has recently amended the Hindu Succession Act 1956 to
give equal rights to female successors at par with their male counterparts in an
property. There has been significant representation of women in village panchaya
state legislations and the parliament but the number is disproportionately low c
to their ratio in the population. The proposed legislation giving 33 per cent
representation to women in parliament is pending for a long period. It could not
passed due to vested interests and lack of will on the part of male counterparts
occupying power centres.
The security of women at workplace has always been a major concern. A number of
cases are being reported of exploitation, sexual harassment and discrimination a
workplace. The Supreme Court of India has taken a serious view of the matter and
issued a comprehensive directive to avoid such incidences. It has defined what
constitutes sexual harassment and the manner it should be dealt in the organizat
ions. In
spite of Supreme Court's directive, a number of cases of sexual harassment still
continue and there is under-reporting of such cases because of job insecurity an
d social
What is Motivation?
To begin with, we will define the term motivation. The word motivation is derive
d from
Latin word movere (to move). Accordingly, it attempts to account for the 'drives'
and 'wants' of an individual rather than just focusing on the individual's actio
ns. The term
motivation is commonly used and understood by everyone but there is no uniform
definition of the term. One can find as many definitions as number of books on t
subject. In its simplest form motivation in an organizational context is referre
d as 'the
extent of willingness of an employee to respond to the organizational requiremen
Motivation is generally directed, consciously or unconsciously, towards satisfac
tion of
needs (motives). Motivation has direct impact on the job performance of individu
Motivation is a process beginning from inner state of a person and ending with n
fulfillment. For example, when an employee works hard, his level of motivation m
ay be
considered as high and if he avoids work, his motivation level may be considered
low. The level of motivation of an employee can be judged by his actual work beh
The managers are, therefore, interested in knowing the factors which motivate
employees to work hard and also the factors which contribute to 'de-motivation'.

human being has a given level of satisfaction at a given point of time.

Motivation as a behavioural concept is of great interest to the executives and m
in organizations today. One of the biggest problems a manager faces is how to mo
the people working under him. What is motivation and how can employees be motiva
to work'? What is the relationship between motivation and performance? Whether a
highly motivated employee is necessarily a good performer or an employee whose
performance is not good can be considered as de-motivated? These are some of the
issues which are drawing the attention of the organizations.
Theories of Motivation
The various theories of motivation are:
1. Scientific Management or Rational Economic View
2. Human Relations Model
3. Abraham Maslow's Need Hierarchy Theory
4. Frederick Herzberg's Two-Factor Theory
5. Clayton Alderfer's ERG Theory
6. Achievement Motivation Theory
7. Victor H Vroom's Expectancy Model
8. James Stacy Adams' Equity Theory
9. Lyman W. Porter and Edward E Lawler - Performance Satisfaction Model.
10. Reinforcement Theory
Scientific Management or Rational Economic View
F W Taylor, who is known as the Father of Scientific Management, has contributed
much to the theory of motivation. Scientific Management is a set of methods and
techniques applied to organization of work at the operational level for the purp
ose of
increasing efficiency. He believed that the best way to increase output was to i
the techniques and methods used by workers. Workers had to adjust to the
management and not the management to the people.
Taylor's logical and rational approach to management explained that people are
primarily motivated by economic considerations and will exert more if offered
opportunity to improve their economic gains. Put simply, Taylor's theory stated
1. Physical work could be scientifically studied to determine the optimal method
performing a job.2. Workers could thereafter be made more efficient by giving pr
escriptions for how they
were to do their jobs.
3. Workers would be willing to adhere to these prescriptions if paid on a differ
piece work basis.
Scientific approach to motivation based on rational economic view has however be
criticized severally. In particular, behavioural scientists have argued that Tay
lor and his
colleagues de-humanized workers by treating them as mere factors of production,
could be manipulated completely through economic incentives.
The most fundamental problem with Taylor's approach from a motivational viewpoin
t is
concerned with his rather simplistic assumption about human behaviour. Taylor
believed that workers would be motivated more by the need for money (this assump
is called 'rabble hypothesis'). He thought that the primary interest of the work

er is
economic gain in the form of higher wages. Contrary to this rabble hypothesis, w
seek satisfaction of a variety of needs in the workplace like need for security,
fulfillment, and a challenging job, including pay.
Human Relations Model
Elton Mayo in 1920s and early 1930s conducted Hawthorne Studies at Western Elect
Company. He found that in addition to finding the best technological methods to
improve output, management needs to look into human affairs. The real power cent
within an organization were the interpersonal relations that developed within th
e working
unit. The organizations were to be developed around the workers and had to take
consideration human feelings and attitudes. The leader was to facilitate co-oper
ation for
attainment of goals by followers. Leader was to provide opportunity for the pers
growth and development of workers. The main focus was on individual needs rather
than the organizational needs
Eventually it became clear that the assumption that workers are primarily motiva
ted by
money, may not be correct. Elton Mayo and his team found that the social contact
which the workers have at workplaces are also important. Mayo and others also
believed that the managers could motivate employees by acknowledging their socia
needs and by making them feel useful and important.
As a result, employees were given some freedom to make their own decisions on th
jobs. Greater attention was paid to the organization's informal work groups. Mor
information was provided to employees about the manager's intentions and about t
operations of the organization.
In the Scientific Management Model the workers were expected to accept
management's authority in return for higher wages. In the Human Relations Model,
workers were expected to accept management's authority because supervisors treat
them with consideration and were attentive to their needs.
The problem with the Human Relations Model is its undue reliance on social conta
cts at
work situation for motivating employees. Social contacts, though desirable, by
themselves do not always help motivate workers.
Check Your Progress (D)
Answer the following statements in Yes or No:1. The term Motivation has been der
ived from the Latin word 'movere' (to move). .
2. Taylor's Scientific Management theory belongs to Content Theories of Motivati
on. .
3. Human Relations Model is one of the early theories of Motivation. . Yes
4. Elton Mayo contributed to a great extent to Human Relation Model. . Yes
Maslow's Hierarchy of Needs
Abraham Maslow, a clinical Psychologist from USA submitted (1954, 1968) that peo

have the following five basic levels of needs. He identified five needs in an or
der of
hierarchy, namely, Physiological Needs, Safety and Security Needs, Social Needs,
Self-esteem Needs, Self-actualization Needs. The prominence of these needs
generally follow a hierarchy i.e. when a need is satisfied then only the next ne
becomes prominent in that hierarchal order. But there have been found exceptions
this order for certain persons. They are prepared to sacrifice a lower order nee
d for
achieving a higher need.
Physiological Needs
This group of need includes the needs for food, drink, shelter, oxygen, sleep, s
weather, etc. These physiological needs are required to maintain the physical en
tity of
the individual. These are the basic needs in the sense that they satisfy the ver
livelihood of the individual for survival.
Physiological needs dominate human desires and only when these needs are
reasonably satisfied, one's attention turns to other needs. In the organizationa
l context,
physiological needs are represented by the employee's concern for salaries and g
physical working conditions. The organization should therefore endeavour to sati
sfy the
physiological needs of the employee. Only then they will be motivated to perform
Safety and Security Needs
Safety needs become motivators after physiological needs are met. Maslow suggest
that the safety needs are most readily observed in infants and young children be
of their relative helplessness and dependence on adults.
Safety and security needs in the organizational context relate to such factors a
s job
security, salary increases, safe working conditions, unionization, and lobbying
protective legislation. Managerial practices to satisfy the safety needs of the
include pension scheme, group insurance, provident fund, gratuity, safe working
conditions, grievance procedure, etcetera. Arbitrary or unpredictable actions, w
create a feeling of uncertainty (particularly regarding continued employment),
favouritism, or discrimination on the part of the management do not create a fee
ling of
security in the employee's mind.
Social Needs
This need is expressed through the desire to belonging and affection in a social
In the organizational context, social needs represent the need for a compatible
group, peer acceptance, professional friendship, and friendly supervision. These
are the
needs one acquires, learns or adopts through experience and these needs are most
culturally determined. They are largely a manifestation of the desire to belong
and be
accepted by others. Managers would do well to encourage informal groups amongst

the employees so that this need is adequately met. Care should be taken that the
groups should not work contrary to the requirements of the organization. May be,
workers have the freedom to form their own work teams and decide upon the
distribution of work within the teams and to that effect organize the team, one
may be
able to see a productive outcome.
Self-esteem Needs
The esteem needs for self-respect and recognition and for respect of others are
referred to as ego or status needs. The satisfaction of this need generates a fe
eling of
self-confidence and of being useful and necessary in the world. In contrast, the
thwarting of this need leads to a feeling of inferiority, ineptness, weakness, a
helplessness. Maslow emphasized that the healthiest self-esteem is based on earn
respect from others rather than on fame, status or adulation.
In the context of workplace, self-esteem needs correspond to job title, merit, p
increase, peer and supervisory recognition, challenging work, responsibility, et
Managerial practices to fulfill these needs include challenging work assignments
performance feedback, performance recognition, personal encouragement and
involving employees in goal setting and decision-making.
Self-actualization Needs
In an organization, self-actualization needs correlate to the desire for excelli
ng in one's
job, advancing an important idea, successfully managing the unit and the like. T
his level
of needs encompasses the ability to accomplish and achieve something in life, i.
e. to
maximize one's potential and the desire to become what one is capable of becomin
gBy being aware of the self-actualization needs of subordinates, managers can use
variety of approaches to enable the former to achieve their personal as well as
organizational goals. The workers who operate at self-actualization need do pref
autonomy and do not require supervision.
While Maslow's needs classification theory makes good sense, problems arise with
contention that they are arranged in a hierarchical fashion and that the lower l
needs must be first satisfied before the higher level needs in the pyramid will
activated. Take for instance the case of teachers, poets, artists and musicians
all over
the world who have tried to self-actualize themselves by their immortal work wit
ever having satisfied their lower level needs. Thus, it is possible for some at
least, not to
go through every step in the hierarchy. Another problem with Maslow's theory is
operationalisation of some of his concepts which make it difficult for researche
rs to test

his theory. For instance, how does one measure self-actualization? Despite the
problems the theory has useful practical implications for managers. It is a fact
that the
vast majority of employees joining organization at lower levels, are by and larg
seeking to satisfy their physiological needs first and then move up the levels s
tep by
step. It thus offers a good conceptual scheme for managers to understand and dea
l with
issues of employee motivation at the workplace.
Herzberg's Two-Factor or Motivation-Hygiene Theory
Frederick Herzberg (1959) extended the work of Maslow and developed a specific
content theory of work motivation. He conducted a widely reported study on about
accountants and engineers from eleven industries in Pittsburg, USA. He used the
critical incident method of obtaining data for analysis. He asked them two quest
ions:1. When did you feel particularly good about your job
what turned you on?
2. When did you feel exceptionally bad about your job
what turned you off?
He then asked them to describe the conditions that led to these feelings.
Herzberg found that employees named different types of conditions for good and b
feelings. His study revealed that the factors responsible for job satisfaction a
re quite
different from the factors that led to dissatisfaction. Reported good feelings w
generally associated with job experiences and job content. Reported bad feelings
, on
the other hand, were generally associated with the surroundings, peripheral aspe
cts of
the job the job context. These two feelings were not adverse to each other. If a
was satisfied with a job in a particular condition, the absence of such conditio
n would
not mean job dissatisfaction, but it might be called no job satisfaction.
Similarly, opposite of job dissatisfaction is not job satisfaction but it might
be no job
Thus Herzberg suggested that the opposite of satisfaction is not dissatisfaction
, as was
traditionally believed. Removing dissatisfying characteristics from a job does n
necessarily make the job satisfying.
Herzberg's theory is based on a two-factor hypothesis, that is, factors leading
to job
satisfaction and the factors leading to job dissatisfaction. The factors so iden
tified were
classified by him into two categories:
1. Motivational Factors; and
2. Hygiene or Maintenance Factors.
Motivational Factors
These factors are related directly to the job itself. The presence of such facto
rs creates
a highly motivating situation, but their absence does not cause dissatisfaction.
tend to respond positively to the presence of such factors. Herzberg mentioned s
ix such
1. Recognition
2. Advancement
3. Responsibility

4. Achievement
5. Possibility of Growth
6. Work itself
Factors like achievement and responsibility are related to job itself and others
from it. This set of factors has been designated as motivators or satisfiers and
related to job contents.
Hygiene or Maintenance Factors
This set of factors is such that their presence does not significantly motivate
employees but their absence cause serious dissatisfaction. The non-availability
of such
factors is likely to affect motivation and bring down the level of performance.
Maintenance factors mostly are related to environment, outside the job.
Herzberg named ten such factors:
1. Company policy and administration
2. Technical supervision
3. Interpersonal relations with subordinates
4. Salary5. Job security
6. Personal life
7. Working conditions
8. Status
9. Interpersonal relations with supervisors
10. Interpersonal relations with peers and colleagues
Hygiene or maintenance factors are the context factors. They provide a backgroun
d on
which people work. They create an atmosphere for doing work, but there is nothin
g in
them that motivates them. According to Herzberg, they can dissatisfy by their ab
but cannot satisfy by their presence.
Check Your Progress (E)
Please mention whether the following statements are true or false:
1. There are five types of needs according to Maslow's theory. . True.
2. Self-esteem needs is the highest need in Maslow's Need Hierarchy. . False.
3. Herzberg theory is prescriptive in nature. . True.
4. Herzberg's theory is based on two factors namely motivators and hygiene. . Tru
ERG Theory
This theory is based on existence, relatedness and growth. These are the three s
ets of
needs in organization. ERG theory was advanced by Clayton Alderfer. Alderfer arg
on the same lines of Maslow that people have needs in a hierarchy and that these
needs are important determinants of human behaviour relating to work performance
These needs are related to survival and growth.
However, the ERG theory differs from the Maslow's theory in following respects:
First, instead of five levels of needs, the ERG theory indicates only three.
Second, Maslow's theory postulates a rigid step like progression. The ERG theory
instead, postulates that more than one need may be operative at the same time.
Third, Maslow argues that a person will stay at a certain level until that need
satisfied. The ERG counters by noting that when a higher level need is frustrate
d, the
individual's desire to increase a lower level need takes place.
Achievement Motivation Theory

This theory was developed by David C. McCelland and his associates. According to
theory, there are three needs, namely, need for achievement, need for power and
for affiliation.
Need for Achievement
Employees with high achievement motivation derive satisfaction from achieving go
Succeeding at a task is important to them. Although people with a high need for
achievement are often wealthy, their wealth comes from their ability to achieve
However, high achievers are not motivated by money per se; money is their indica
tor of
achievement. They prefer to work independently and dislike easy tasks which do n
throw any challenge or a competitive situation.
Need for PowerThe employees exhibiting the need for power derive satisfaction fr
ont the ability to
control others and having control over resources. Actual achievement of goals is
important to them than the means by which goals are achieved.
Individuals with a high need for power derive satisfaction from being in positio
ns of
influence and control. Organizations that foster the power motive tend to attrac
individuals with a high need for power (for example, military, civil services an
d political
Need for Affiliation
Individuals exhibiting this need as a dominant motive derive satisfaction from b
social with interpersonal activities. They have a strong need for interpersonal
ties and to
'get close' to people psychologically. If asked to choose between working at a t
ask with
those who are technically competent and those who are their friends, individuals
high need for affiliation will choose their friends.
Vroom s Expectancy Model
This theory has several names such as instrumentality theory, path-goal theory a
valence-instrumentality expectancy theory. The theory was developed by Victor H
Vroom. The expectancy model is based on the belief that motivation is determined
the nature of the reward people expect to get as a result of their job performan
ce. The
underlying assumption is that a man is a rational being and will try to maximize
perceived value of such rewards. He will choose an alternative that would give h
im the
maximum benefit. People are highly motivated if they believe that a certain type
behaviour will lead to a certain type of outcome and their extent of personal pr
for that type of outcome.
There are three important elements in the model. These are:
This is a person's perception of the likelihood that a particular outcome will r
esult from a
particular behaviour or action. This likelihood is probabilistic in nature and d

escribes the
relationship between an act and its outcome. For example, if a student works har
during the semester, he will expect to do well in the final examination though h
e cannot
be hundred per cent certain. There is some probability attached to this outcome.
This factor relates to a person's belief and expectation that his performance wi
ll lead to
a particular desired reward. It is the degree of association of first level outc
ome of a
particular effort to the second level outcome
which is the ultimate reward. For
example, working hard may lead to better performance which is the first-level
outcome, and it may result in a reward such as salary increase or promotion or b
which is the second-level outcome. If a person believes that his high performanc
e will
not be recognized or lead to expected and desired rewards, he will not be motiva
ted to
work hard. The instrumentality is the performance-reward relationship.
Valence is the value a person assigns to his desired reward- He may not be willi
ng to
work hard to improve performance if the reward for such improved performance is
what he desires. It is not the actual value of the reward but the perceptual val
ue of the
reward in the mind of the person that is important. An employee may be motivated
work hard not to get pay raise but to get recognition and status. Another employ
ee may
be more interested in job security than status.Adams' Equity Theory
Although several authors have contributed to this theory, it was James Stacy Ada
whose formulation became prominent. The following terms are relevant to this the
1. Person: The individual for whom equity or inequity exists.
2. Comparison: Any group or individual used by a person as a reference regarding
inputs and outcomes.
3. Inputs: Characteristics which individuals bring with them to the job, namely,
education, knowledge, skills, attitudes, experience, etc.
4. Outcomes: Salary, promotion, perquisites received from a job.
The theory proposes that the motivation to act develops after the person compare
inputs and outcomes with the identical ratio in comparison to the other person.
is defined as the perception that person's job inputs and outcomes ratio is not
equal to
the inputs and outcomes ratio in comparison to the other.
The basic equity proposal assumes that, upon feeling inequity, the person is mot
to reduce it. Further, the greater the felt inequity, the greater would be the m
otivation to
reduce it.
When attempting to reduce inequity, the person may try a number of alternatives.
He may alter his inputs or, alter his outcomes or, distort his inputs and outcom
cognitively or, leave the field or try to alter or cognitively distort input and

outcomes in
comparison to the other, or force him to leave the field.
Porter's Performance Satisfaction Model
This model starts with the premises that: (a) motivation (effort or force) does
not equal
satisfaction and, or, performance. Motivation, satisfaction and performance are
separate variables and related in different ways; (b) effort (force or motivatio
n) does not
directly lead to performance. It is mediated by abilities/ traits and role perce
ptions; and
(c) the rewards that follow and how these are perceived will determine satisfact
ion. The
model suggests that performance leads to satisfaction.
Reinforcement Theory
This theory assumes that the consequences of an individual's behaviour in one si
influence that individual's behaviour in a similar situation. Techniques based o
n this
principle have been developed to change human behaviour. Such a technique,
generally known as 'operant conditioning', has been advocated by B F Skinner. It
implication is that individual behaviour can be predicted, from a person's past
The operant conditioning approach to behaviour is based on the law of effect, wh
states that behaviour which has a rewarding consequence is likely to be repeated
There is positive reinforcement. On the other hand behaviour that leads to negat
ive or
punishing consequence, tends not to be repeated. There is negative reinforcement
When operant conditioning is used to control behaviour of employees in an
organization, it is called organizational behaviour modification or OB Mod in it
acronym. Many of the negative traits and behaviour pattern are developed because
earlier similar behaviour was rewarding or encouraged. For example, a thief has
been caught several times earlier; he will have courage to repeat his act and be
again and again. Similarly a ticket-less traveler in a Mumbai local train repeat
s his act
because he has not been caught.Check Your Progress (F)
State whether the following statements are True or Falw:
1. ERG theory was developed by Alderfer.
2. There are four needs as per Achievement Motivation theory.
3. Instrumentality theory is another name for Expectancy Model.
4. There are five items in Equity theory.
5. Reinforcement theory has positive and negative reinforcements.
6. Individual's behaviour in one situation does not influence that individual's
behaviour in
a similar situation.
Motivation and Behaviour
Behaviour of an individual is generally motivated by a desire to achieve some go
Sometimes goal may not always be known to the individual but still he may behave
in a
particular way. 'Why did I do that?' or 'Why did I not do that?' Answers to thes

questions will indicate the reason for a particular behaviour. Behaviour is eith
er an
'activity' or, 'a series of activities'. Each activity is supported by motivatio
n. To predict
behaviour, managers must know which motives or needs of people evoke a certain
action at a particular time.
Every individual carries a set of inner motivations and drives that influence th
e way he
behaves much more radically than he realizes. Individuals differ not only in the
ir ability
to do but also in their will to do, or motivation. Motives are sometimes defined
as needs,
wants, drives, or impulses within the individual. These are directed towards goa
ls, which
may be conscious or subconscious. Motives are the 'whys' of behaviour. They arou
and maintain activity and determine a general direction of the behaviour of an i
In essence, motives or needs are the mainsprings of action. When we use these tw
terms interchangeably
motives and needs
we refer to something within an individu
that prompts that person to action.
Goals are outside an individual. Goals are sometimes referred to as 'hoped for'
towards which motives are directed. Psychologists use the term 'incentives' for
goals. Incentives include tangible financial rewards such as increased pay and a
lso the
non-financial intangible rewards such as praise or power; and both tangible as w
ell as
intangible rewards are crucial in evoking behaviour.
Motivation to Work
A mere knowledge of theories of motivation is not sufficient for the manager. He
also know specific ways and techniques to motivate employees in the work situati
Most of these techniques are practical in nature and can be adopted by him in th
normal course. While there are several ways of motivating employees in the work
situation, some of the common incentives like money, appreciation, job enlargeme
job enrichment, job rotation, participative management, and quality of work are
frequently used in organizations.
MoneyMost of the motivational theories have indicated that money is an important
for several reasons. Money is capable of purchasing several things which in turn
several needs of a person. For example, Maslow's physiological needs like food,
clothing and shelter can be met through money. So in organizations the wage/sala
structure becomes an important and powerful motivator for the employees. The lev
els of
salary should not only satisfy all the basic needs of the employee but should al
so meet
his higher needs like entertainment, pleasure, etcetera.
Money has limited impact as a motivator. It has a diminishing return with regard

to its
utility. Employees look for something beyond salary and monetary benefits. The m
effective non-monetary benefit is the recognition and appreciation for a good jo
b. It
satisfies the self-esteem need and the employee feels important and tries to per
form still
better to be recognized as a distinct member of the work group. It also has an i
mpact on
other group members. They also try to improve their performance to get recogniti
The managers must use this incentive wherever possible to acknowledge the
contribution of the employees. However, it should be done in an objective and im
manner so that it does not have any adverse impact on the other members of the w
Job Enlargement
Job enlargement refers to assigning more and more jobs of same level to diversif
y the
skills of a person. For example, in IBM a machine operator was waiting fora mach
setter to come and set the machine. He started setting the machine himself. Late
r he
became an expert in setting the machine. Job enlargement helps both the organiza
and the individual. The individual gets the satisfaction of working on a variety
of jobs
and learns more and more skills whereas the organization gets a person who can
handle different jobs.
Job Enrichment
A job is enriched when it is exciting, challenging and creative and involves hig
responsibility. It should give the employee more decision-making, planning and
controlling powers. A few studies conducted in the United States demonstrated th
usefulness of job enrichment. For example, employees at AT&T showed improvement
in job performance after job enrichment. Another study with technicians, enginee
rs, and
sales representatives showed similar results. Job enrichment is generally effect
ed either
by promotion to a higher post or by delegation of authority.
Job Rotation
Job rotation means, shifting an employee from one job to another at a same level
different functionality. For example, somebody may be working in the dispatch se
at. He
maybe asked to do typing. Job rotations are quite common in banks. When employee
are rotated in different jobs, the manager will know what type of job suits whic
employee. Further, it removes boredom of the employee as he is not required to d
o the
same job for a long period. In spite of the advantage of job rotation a large nu
mber of
employees prefer to continue on the present job because of inertia and fear of u
The time duration required for job rotation depends upon the nature of job being
out and the nature of the learning curve of a job in relation to one's capabilit

ies. For
example, a highly qualified employee is placed on a routine job; he will reach t
o highest
level of efficiency in a shorter time and will start getting disinterested and o
ver confident resulting in a lowering of his performance. Before reaching such a
stage the person
should be rotated to some other job. On the other hand there are certain jobs wh
ich will
provide more and more challenges and will provide learning opportunities all the
Employee participation in management is one of the tools available to increase t
motivation levels of employees. Participative management refers to associating
representatives of employees at every stage of decision-making. Starting at the
participation may extend right to the board level. Participation encourages empl
contributions to managerial decisions, goals and plans along with suggestions on
these can be implemented. Employees feel their importance in the organization, a
their power need is satisfied to some extent. Such participation by the key empl
reduces the resistance to change. Many times it is used as a strategy by the
management before initiating any major change. Thus, participation fosters great
acceptance of change.
The motivational basis of participation is that employees like to be asked their
about the problems affecting them and feel happy when they know that their ideas
some influence in the ultimate management action taken. The underlying assumptio
are: people derive satisfaction from being a part of the decision-making process
, from
doing an effective job, and from having self-control rather than management cont
Most people readily agree more to what, in part, they have created than what is
alien to
them. Besides, participation fosters the feeling of belonging and being wanted.
It inflates
or at least recognizes a person's ego and provides a needed sense of importance.
addition, it encourages better decision-making, gets people to accept responsibi
promotes teamwork, and emphasizes the use of creativity.
Some feel that in the exercise of workers participation, the worker should be gi
ven some
well-defined authority so that he can make his own decision independently. When
has to make a decision, he acts with responsibility.
Quality of Work Life
The term 'quality of work life' means, different things to different persons. It
is a
combination of physical and emotional comforts. For example, to a clerk in dispa
seat, it may just mean a fair day's pay. To a mine worker, it means safe working
conditions. Shop floor workers want their supervisors to treat them with dignity

. A
probationary officer, who has just joined the bank, may look forward to opportun
ities for
promotion, creative tasks and a successful career. The following factors contrib
ute to
the quality of work life:
1. Adequate and fair compensation.
2. A safe and healthy environment.
3. Jobs aimed at developing and using employee's skills and abilities.
4. Growth and security; jobs aimed at expanding employees' capabilities rather t
leading to their obsolescence.
5. An environment in which employees develop self-esteem and a sense of identity
6. Protection and respect for employee's rights to privacy, dissent, equity. etc
7. A sensible integration of job career and family life and leisure time.
Role means a set of expected behaviour patterns attributed to someone occupying
given position in a social unit. The idea of 'role' comes from Sociology. It is
the pattern
of actions expected of a person in activities involving others. It includes both
rights and
obligation. It refers to the part that an individual is required to play as a re
sult of
occupying some position or status in life. Human beings, as a result of occupyin
various positions play such roles as father, mother, worker, manager, nurse, fri
end and
soldier. All these are separate and well defined roles. But every human being pl
many roles. Thus an individual may be a worker, a father, a son, a trade union l
and so on. All these constitute what is called the role space of that person. At
the centre
of the role space is the self.
Concepts and Analysis
Role and position are two sides of the same coin. But they are different concept
s. Role
is a position one occupies in a social system. It is defined by the functions on
e performs
in response to the expectations of the significant members of the social system.
is a relational and power-related concept, but role is an obligational concept.
concept of role is important for the integration of the individual with the orga
The organization has its own structure, systems and procedures and goals. Simila
rly the
individual or a person connected with the organization, has his own personality
needs. All these aspects interact with each other and get integrated into a role
The concept of role is central to an organization. Similarly, the concept of sel
f is central
to the several roles of a person. A person performs various roles that are centr
around the self and are at varying distances from the self (and from each other)
. These

relationships define the role space, which is then a dynamic interrelationship b

the self and the various roles an individual occupies.
Similarly, role set is a pattern of interrelationships between one role (called
a focal role)
among many others. For example, all the different persons with whom a supervisor
interacts have role expectations concerning the way in which the supervisor shou
ld act,
and these expectations collectively make up the role set for the job. In a role
set map,
the focal role is in the centre.
The concept of role widens the meaning of work and the relationship of the emplo
with other significant persons in the system. The concept of job is more prescri
ptive in
nature, while role includes more discretionary part of work. A job assumes relat
of the employee with his supervisor whereas the role emphasizes his relationship
all those who have expectations from him (as he has from them). Recently, much
emphasis has been given to the development of roles and making them more effecti
in organizational context. Certain important aspects of role are discussed now:
Role Stagnation
Most of the organizations have definite promotion policies. They promote persons
based on the appraisal of their performance. When a person gets a promotion, he
enters into a new role. The new role demands that an individual outgrow the prev
one and take charge of the new role effectively. But the person may fail in his
new role.
This is bound to produce role stress and he may experience role stagnation even
though he has occupied a new role in the organization. For example, a senior cle
rk, who
has put fifteen years of service in a bank, may be promoted as a junior officer.
from the changes in the position, he is now occupying a new role. The role expec
tations from the position of a junior officer in the bank are different from tha
t of a clerk. This
person may not be able to take charge of this new role effectively, he may there
experience role stagnation which in turn causes role stress.
Inter-Role Distance
When an individual occupies more than one role, there are bound to be conflicts
between them. For example, a bank manager quite often faces a conflict between h
organizational role as a manager and his role as a husband and a father. His wif
e and
children may place demands on his time. He may not be able to cope with their
expectations, if he has to perform his organizational role effectively. He may t
experience inter-role conflicts which in turn cause role stress.
Role Set Conflicts
The role set consists of important persons who have different expectations from
the role
that an individual occupies. The conflicts arise due to incompatibility among th
expectations of significant others and the individual himself. These role set co
nflicts take

the following forms:

1. Role ambiguity
Sometimes an individual may not be clear about the various expectations that peo
have from his role and this causes role ambiguity. It may be due to lack of info
available to a role occupant or may be due to lack of understanding of the cues
available to him. Role ambiguity may be in relation to activities, responsibilit
ies, priorities
or general expectations. Generally role ambiguity is experienced by persons occu
roles that are newly created or roles that are undergoing change. For example, a
has set up a branch computerization department. A new post of Deputy General
Manager (DGM) has been created to head this department. Somebody who is already
DGM has been posted to this department. Many computer professionals who have bee
recruited to work in this department are reporting to him. A doubt may arise reg
the eligibility of the DGM to head the department. Perhaps this DGM has been sel
on the basis of relatively better computer knowledge possessed by him than his
2. Role Expectation Conflict
When there are conflicting expectations or demand from a role, the role occupant
experiences conflict and stress. The conflicting expectations may come from the
subordinates, peers, customers, etc., and his role occupant is not sure how he s
act in such situations.
3. Role Overload
Sometimes a role occupant feels that there are too many expectations from the
significant others in his role set. For example, a bank branch accountant may fa
different types of problems. When the branch is set to commence business, he may
have to allocate duties to take care of vacant seats to his employees. At the sa
me time,
some customers may rush to him for certain clarifications. Simultaneously, the b
manager may call him for certain important discussions. In such situations, this
accountant may experience role overload. Role overload may also occur when the r
occupant lacks power or where there are large variations in the expected output
when there is no proper delegation.
4. Role ErosionSometimes a role occupant feels that certain functions which he w
ould like to perform
are being done by some other person having a different role. Role erosion is the
individual's subjective feeling that some important expectations that he has fro
m a role
are shared by other roles within the role set. Some organizations create new pos
as a part of their reorganization exercise. Such new positions, which also creat
e new
roles, may take away certain functions of the existing roles. In such situations

, the
existing role occupants may experience role erosion. Sometimes, the organization
s may
also redefine the existing roles and this may result in the present role occupan
experiencing role erosion. For example, in one small sized bank, the sole genera
manager was looking after both planning and operations. As the business of the b
increased, it created another post of a general manager and the planning was ass
to the new general manager. The existing general manager felt that his role has
eroded as he was now not connected with planning.
5. Resource Inadequacy
A role occupant may experience resource inadequacy when the resources required b
him to perform his role effectively are not available. Resources may include inf
people, material, finance, facilities. etc. For example, in these days of rapid
communication facilities, a bank official may experience resource inadequacy if
branch is not provided with certain latest communication equipment like fax, Int
6. Personal Inadequacy
When a role occupant feels that he does not have enough knowledge, skills or
experience to perform a role effectively, he may experience role stress. Sometim
persons who are given new roles without adequate training are likely to experien
personal inadequacy. The difference between role ambiguity and personal inadequa
is that: in the former, the role occupant has certain amount of knowledge of his
role, but he experiences some ambiguity whereas in case of personal inadequacy t
role occupant suffers from lack of knowledge or skills to perform his new role.
7. Role Isolation
In a role set, the role occupant may feel that certain roles are closer to him,
while other,
are at a greater distance. The main criterion of distance is the frequency and e
ase with
which he performs the role. When linkages are strong, the role isolation is low
and vice
versa. For example, when the branch accountant goes on leave in a bank, the bran
field officer, (person in charge of advances), may be asked to perform the accou
role as it is felt that the field officer's role can be kept in abeyance tempora
rily in small
branches. In such cases, the field officer may experience role isolation, if he
is unable to
perform the accountant's role effectively.
In organizations, generally roles are expected to be well-defined and set so tha
t one can
say that an employee has a given role. This is only partially true. In course of
time, he is
likely to experience a variety of incidents and develops expertise to deal with

situations even proactively. For example, a paying cashier may know the credenti
al of
the customer well and is likely to pay-out even before checking the balance avai
lable in
the account. A personnel manager, because of his closeness with certain governme
authorities may take decisions without consulting the union, etc. Thus, apart fr
om the
given role, the role may be person driven as well. Hence, we find differences in
the way
a predecessor and a successor handle the same function.Now, in this background,
the H.R. man has the role or duty to design the role of
employees, especially in today's turbulent times where technology, markets and
products are changing all the time, impacting the roles drastically. Hence, func
tions, the
need to decentralize control and decision-making, systems that operate at any gi
time, clarity of individual's task and position, economy of effort, vision for a
ttaining the
objective of the company and enable the employee to become more competent in his
field should be the criteria. For this purpose, knowledge must be built into pro
ducts and
services to get benefits of excellence. For example, a highly sophisticated comp
uter and
technology backed bank cannot have experts in manual systems managing branches.
The technology will not be used to the possible extent, if the manpower using th
technology is not competent and trained.
Check Your Progress (G)
Mention whether the following statements are True or False:
1. The role integrates an individual with an organization. . True.
2. Role and position are one and the same concept. . False.
3. Each individual occupies and plays several roles. . True.
4. Role ambiguity is caused due to personal inadequacy. . False.
5. Intra-role conflict leads to role isolation. . True.
6. Role set conflicts for a role occupant refers to erosion of role due to creat
ion of new
roles and positions. . False.
Let Us Sum Up
Organizations are social systems. They are composed of individuals. Each individ
behaviour in the organization is affected by several factors. These factors are
psychological, organizational and environmental. We have examined in this unit s
theories of personality and human behaviour. We also discussed certain critical
dimensions of personality that influence human behaviour at work. Personality an
d its
interaction with the environment help us to understand why employees behave as t
do. We also saw how managers can help employees by understanding the effects of
personality on behaviour and coping mechanisms. The connection between personali
and brain has been discussed with a view to examining the influence of biologica
factors on personality. The factors affecting employee behaviour have also been
in detail.
We have also studied the impact of diversity in the organizational context and t

he role of
HR policies in diversity management. One of the major factors of diversity is th
e gender
difference. We have studied the gender issues with reference to recruitment, ser
conditions and protection of interest of women at workplace.
We have surveyed different theories of motivation and their practical implicatio
ns on
human behaviour. While each theory is unique and has several interesting feature
s, no
single theory brings out clearly all the complexities of motivation and its impa
ct on
performance. However, all the theories put together contribute to our understand
ing the
concept of motivation and its applicability in organizational setting.
Role is a position one occupies in a social system. Role and position are, howev
separate concepts. They are two sides of the same coin. Concept of role is impor
tant for
the integration of an individual within an organization. The organization has it
s own structure and its goals. Similarly, the individual has its personality and
its needs. All
these aspects interact with each other and get integrated into a role.
Ego; Extroversion; Heredity; Introversion; Locus of Control; Machiavellianism;
Personality; Psychoanalysis; Self-Esteem; Behaviour Modification; Expectancy;
Hygiene Factors; Instrumentality; Job Enlargement; Job Enrichment; Motivation; M
Need for Affiliation; Need for Achievement; Need Hierarchy; Need for Power; Qual
ity of
Work Life; Role Ambiguity; Role-Coping; Role Distance; Role Efficacy; Role Erosi
Role Isolation; Role-Making; Role Stress.
Answers to Check Your Progress
1. True; 2. True; 3. True; 4. False; 5. True; 6. True; 7. True; 8. False R 1. Tr
ue; 2.
True; 3. False; 4. True; 5. True;
1. True; 2. False; 3. True; 4. False; 5. True; 6. True; 7. True; 8. False D, 1.
Yes; 2. No;
3. Yes; 4. Yes;
1 1. True; 2. False; 3. True; 4. True;
1 1. True; 2. False; 3. True; 4. False; 5. True: 6. False (1: 1. True; 2. False;
3. True;
4. False; 5. True; 6. False
Terminal Questions
1. What are Erikson's stages of Personality Development?
2. What are the advantages of employing Type A personality in organizations?
3. Write a note on factors affecting human behaviour.
4. What are the factors of diversity and their impact at workplace? How to manag
diversity through effective HR system?
5. What is motivation? Why is it a critical issue of interest to managers in org
6. Compare and contrast Maslow's Need Hierarchy Theory with Herzberg's Two-Facto
Theory of Motivation.
7. Write a brief note on the following:
(1) ERG theory of motivation
(2) Vroom's expectancy model of motivation
(3) Equity theory

(8) Write a note on Achievement Motivation theory advocated by David McCelland.

(9) How the concepts of job enlargement, enrichment and rotation can be applied
motivate the employees?
10. Explain the following:
(1) Role space conflicts
(2) Role set conflicts
Case 1
ABC Limited is a major manufacturer of refrigerators in India. While the main
components of the refrigerator are manufactured by the company, other parts of t
final product are produced by the subcontractors. The company employs around 300
hundred workers. It does not have state-of-the-art manufacturing facilities and
suffers from low productivity of the employees. Due to secured working condition
productivity was low. The employees' morale also remained low due to less market
share for its product.
The company decides to introduce a profit sharing plan in terms of which they wo
uld be
encouraged to improve upon productivity and quality of product. The company prom
ised share in the extra cost saved or extra profit earned. Initially the workers
were skeptical
about the programme. In due course workers started getting monetary benefits as
the company's promise. While their programme was successful, some workers were
unhappy due to sharing of gains by all workers equally.
1. Do you think gains-sharing programmes are considered to be motivators for wor
as individuals? Explain how the programme has motivated the workers at ABC Limit
2. Should the management continue with the current manufacturing facilities or s
hould it
invest capital in upgrading the technology of production? Which option would hel
p the
management more and why?
3. What can the management do about the unproductive workers who are getting the
same benefits as the productive workers?
Case 2
Mr. Satwant Singh joined a bank as a specialized officer as economist. He got fi
promotion quite early alongwith his batch mates and his performance as well as
motivation level was quite high. Being the youngest in his batch he was expectin
g to
reach the level of DGM to head the Research Department of the bank. He used to h
difference of opinion with his boss Mr. Mohanty, both on official and other issu
es. Mr.
Mohanty was not happy with the behaviour of Mr. Singh and used to criticise him
publicly. Mr. Singh was trying to ignore his comments and was concentrating on h
is job
performance. Since both Mr. Mohanty and Mr. Singh belonged to the specialised
department there was no chance of getting rid of each other. When the time for n
promotion came, Mr. Singh was hopeful to get the promotion because of his
performance. To his surprise, he was not selected. He came to know informally th
at his

Performance Appraisal Report (PAR) was not up to the mark. He was thoroughly
disappointed but continued to perform. He did not get the promotion next year al
Most of his batch mates have superceded him. He decided to leave the bank. He go
t an
opportunity in another bank and decided to join at the same level losing all the
of his seniority.
Discuss the above case with reference to different motivational theories.
Suggested for Further Reading
De, N R; Alternative Design of Human Organizations, Sage Publications, New Delhi
Dwivedi, R S; Human Relations and Organizational Behaviour. Oxford & IBH, 1993.
Ellen Ernst Kossek and Sharon A, Lobel, Human Resource Management
Transforming the Workplace, A Maya Blackwell Imprint, New Delhi, 2001.
Freidman, Meyer and Ray, Roseman; Type A behaviour and your heart, Alfred A Knop
Holland, J L; Making Vocational Choices: A Theory of Vocational Personalities an
Keith, Davis; Human Behaviour at Work: Organizational Behaviour McGraw-Hill, NY,
Lorsch, J W and Morse, J J; Organization and their Members: A Contingency Approa
Harper and Row, New York, 1974.
Luthans, Fred; Organizational Behaviour, New York: McGraw-Hill, 1989.
Pareek, Udai; Motivating Organizational Roles: Role Efficacy Approach, Rawat
Publications, 1984.Rogers, C R; The Concept of Fully Functioning Person, Mimeogr
aph Paper, 1955.
Stephen, P Robbins; Organizational Behaviour Concepts, Controversies and
Applications, Prentice-Hall of India, New Delhi, 1989.
Unit 23
Employees Feedback and Reward
4.0 Objectives
4.1 Employees' Feedback
Check Your Progress (A)
4.2 Reward and Compensation System
Check Your Progress (B)
Let Us Sum Up
Answers to Check Your Progress (A & B)
Terminal Questions
Suggested for Further Reading
After studying this Unit, you should be able to:
1. appreciate the use of employees feedback in formulating HR policies,
2. understand the process of getting employees feedback through surveys,
3. understand the process of reward and compensation, and
4. have an idea about the compensation system in the Indian Banking Industry.
Satisfaction of employees at workplace is considered an important parameter for
achieving organizational objectives. Progressive organizations always try to get
regular feedback from the employees on various human resource management
aspects, and new initiatives taken in this regard through some satisfaction or c

surveys. The information is gathered both formally and informally about the atti
tude and
satisfaction of employees. This information is used for refining and fine tuning
the policy
initiatives from time to time. At formal level the information and feedback is g
through well designed questionnaires, psychological instruments, suggestion sche
etc. The informal information is also gathered through discussions with the
representatives, observations of managers and superiors based on the behaviour
pattern of the employees. Vital information can also be gathered while conductin
appraisal interviews and also through exit interviews of employees particularly
who leave the organization unexpectedly. These interviews provide useful clues t
o the
management to understand the expectations of the employees and to fine tune the
personnel policies and human resource development initiatives.Many organizations
are attempting to use climate survey data and performance
data to measure and evaluate the quality of their management of human resources.
Research conducted by Schuster (1982) based on a survey called Human Resource
Index (H R I) provides some insight into current H R M practices. When several
thousand employees in a cross section of twenty-eight diverse organizations were
surveyed for fifteen factors in their work situations, they strongly expressed t
hat they
were least satisfied with the opportunities they had to participate in the decis
of the organization. They also voiced that they did not get enough information a
business objectives, goals, and plans of the organization. The employees were al
relatively dissatisfied with their reward systems and their relative distributio
n within their
Perhaps the most important conclusion that can be drawn from such surveys is
that how effectively an organization is managing its people. Moreover, the surve
y data
have proved helpful in diagnosing specific problems and in initiating organizati
development initiatives by opening up two-way communication about matters of
practical significance to the organization and its employees.Feedback Through Cl
imate Surveys;
Climate surveys are most popular and prevalent means to gather feedback from
the employees. If designed properly, these surveys can provide very useful infor
and clues to the management for effective human resource management. Organizatio
used to measuring employees' perceptions of the prevailing climate in an organiz
are called climate surveys. Although climate is usually measured for the organiz
ation as
a whole, scores are typically analyzed department/division wise so that the
management can assess the climate in different units and compare them with other
units. The Human Resources Development/Management department ordinarily
coordinates the entire exercise, from designing the questionnaire to administeri
ng the

questionnaire and tabulating and presenting the results. The assistance of line
managers is also sought in administering the questionnaire. The results of the s
are presented to the top management by the HR Department and the view of the
departmental heads/unit heads are obtained to analyze the position and finding o
viable solutions for improvement.
Although the content of the climate surveys may vary from organization to
organization, the coverage of a typical survey can be as follows:
1. Structure: The feeling that employees have about the constraints on the group
rules, regulations, procedures, communications channels (layers in decision maki
delegation and authority, etc.
2. Responsibility: The feeling of being your own boss, clarity of role and respo
vis-a-vis superior, subordinates and peers, etc.
3. Reward: The feeling of being rewarded for a job done well, perception about r
and punishment system, perception about pay and promotion, etc.
4. Risk: The sense of riskiness and challenge in the job and in the organization
, and
any emphasis on taking calculated risk (risk taking is encouraged and bona fide
are protected) or playing safe is encouraged and accepted.
5. Warmth: The general feeling of fellowship that prevails in the workgroup atmo
the prevalence of informal supporting culture and social groups.
6. Support: The perception about helpfulness of managers and other employees in
group, emphasis on mutual support from above and below in the heirarchy.
7. Standards: The perceived importance of implicit and explicit goals and perfor
standards, the emphasis on doing a good job, the challenge represented in person
and group goals.
8. Conflict: The feeling that the managers and other workers want to hear differ
opinions, the process of conflict resolution, opportunity to express the views,
9. Identity: The feeling of belonging to the organization and perceived value in
organization and work group, etc.
The survey should be conducted from time to time at reasonable intervals to
analyze trends in the matters of attitude, expectations, satisfaction, and frust
rations, if
any. The survey may be completed utilizing variety of instruments, both standard
(already available in published form) and/or custom-tailored to a particular org
anization.The consequences of unfavourable climate characteristics include using
job time
to confer with peers in order to cope, high stress, looking for another job, con
reporting sick, reduced communication with superiors and considerable job
dissatisfaction. In contrast, the likely advantages of favourable climate charac
are open problem solving, loyalty, cooperation, among peers and across groups,
enhanced motivation and satisfaction, and high quality customer service. We can
infer that the top management in the banks with the help of HRD department shoul

formulate a conscious strategy to create and maintain the favourable climate.
There are many pros and cons regarding employee survey, and if some bank
decides to conduct such survey, help of some expert may be taken especially in
designing the questionnaire, selection of sample respondents, interpretation of
and deciding strategy to overcome some genuine problems. If the survey is not do
scientifically and the employees are not prepared to voice their genuine opinion
in a
constructive way, employee survey can create more problems than they can solve.
It is
always desirable to communicate the results of the survey to the employees
may b
e in
a summarized form otherwise it will create more confusion.
Check Your Progress (A)
State whether the following statements are True or False:
1. Employees' feedback is useful for the organization. . True
2. Conducting climate surveys does not serve much purpose as employees do not
come out with their views freely. . False.
3. The surveys have to be designed well otherwise they can be counter productive
. .
4. The survey questionnaire should be customized for different organizations kee
ping in
view the peculiarity of the organization. . True
5. It is beneficial to take the help of a consultant for organizing a climate su
rvey. .
6. There is no need to develop a questionnaire for the organization as they are
in the marked which can be used across the organizations. . False.
The prime motive of a person to take up a job is to meet his basic needs first.
The basic needs are adequately met by the wages he gets for his contribution to
organization. The wages in the form of compensation is viewed as the main attrac
tion to
join or change a job. The compensation should be reasonable and justifiable to k
eep the
employee happy and committed to the organization. There should also be an inbuil
reward system for better performance. Thus, the basic goal of an individual in a
organization is to earn satisfactory wages or compensation and perform well to b
recognized for other financial and non-financial rewards. The salary and wage st
of any organization is an important part of its personnel policy. It is necessar
y that the
efforts of the employees are adequately compensated. If the compensation is disp
roportionate to the type of work and the industry trend, either the company will
attract only a poor quality of employee or there will be a very
tio. The
compensation should not be so meagre that employees do not feel
their best. In such cases all good employees will leave and the
l be left
only with mediocre performers. Too high a level of compensation

high turnover ra
motivated to put
organization wil
may also prove t

o be
counter-productive. Ideally, the compensation should be such that it continually
talent, it is a major source of retention of the existing manpower and has an ed
ge which
motivates them to give their best. This is, however, a sort of over simplificati
on of the
situation. At this stage let us note that there are different motivating factors
compensation is one of them. We will see how the compensation gets decided, theo
and philosophies behind it, and other related issues.
Types of Compensations
Let us first understand what 'compensation' means. It may be defined as money m
remuneration received for the performance of work plus the kinds of benefits pro
by the organization. If these benefits are quantifiable in terms of money they g
et added.
Compensation is expressed in terms of money. It would thus include: wages or sal
bonus, cash allowances and benefits such as accident, health insurance cover,
employer's contribution to the retirement funds, provision of accommodation, etc
. The
jobs are broadly classified in four groups and the compensation for them is comm
referred to as shown below:
1. Managerial (top, middle, junior) ... remuneration
2. Supervisory ... salary
3. Clerical or Administrative ... salary
4. Unskilled, semi-skilled, skilled and highly skilled ... wages
The words remuneration, salary and wages are generally used interchangeably
in different context and form part of compensation. The compensation can also be
grouped by the method of payment. Compensation could be payable to an individual
his contribution, to a team of a group for certain measurable results, a certain
component every month and a variable portion related directly to the performance
of an
individual or of the team.
Compensation Base
Compensation policy is an important element in personnel management. What is
the basis or factors on which compensation gets decided? It could be:
1. Company objectives
2. Market situation or prevailing market rate
3. Internal and external pressures.
Company objective is the main basis on which the level of compensation gets
determined. There are certain companies which aim to be the highest pay masters
try to attract people. The company philosophy in such cases could be to attract
the best
talent at a high salary but keep the size of the company very lean. Some compani
recruit people only from the prestigious professional institutions to gain profe
edge. To attract people from these sources will obviously take the compensation
quite high. The company objectives in turn will depend on its capacity to pay an
d its cost
benefit analysis.Market situation is another factor which will decide the compen

sation level. Certain

types of skilled people and certain kind of experienced candidates are very scar
available. For example. in banking, exposure in the area of foreign exchange tra
treasury or risk management is available to a very few candidates. Naturally, th
market demand and value is high. The market situation depends upon prevailing ma
rates for certain types of employees and expertise to be recruited and their dem
and and
supply situation. The requirement goes up if the new companies come into existen
The organization's policy of 'overall growth' or 'the right man on the right job
' also has an
impact on market condition. If the policy of overall growth is followed it may b
e possible
to develop from internal source a hand, to man such a position and the company m
not be totally at the mercy of the market situation.
Internal and external factors determine the levels of compensation. Internal fac
could be: capacity of the company to pay, bargaining power of the unions, attrac
tion and
retention pressures, the motivational factor, etc. External factors include: lab
our laws
governing the subject of wages, provisions of Companies Act in respect of remune
of managers, different wage concepts, compensation surveys, recommendations of
arbitrations, pay commissions, etc.
Compensation Theories
Let us now consider conceptual and theoretical aspects of compensation. A good
compensation package should cover factors like adequacy, societal considerations
supply and demand position, fairness, equal pay for equal work and job evaluatio
These concepts are explained briefly:
Adequacy of Wages
The Committee on Fair Wages pronounced certain wage concepts such as:
1. Minimum wages
2. Living wages
3. Fair wages
4. Need-based minimum wages
While the concept of minimum wages is wage level to sustain the worker, living
wages considers the aspect of satisfaction of social needs and insurance coverag
e. Fair
wages is the one between the minimum wages and the one which could be determined
on the capacity of the organization to pay, but covering the aspects of producti
vity of
worker, prevailing rates, economic scenario, etc. The need-based minimum wages a
aimed at satisfying the minimum human needs of the worker.
Societal Consideration and Legal Framework
The level of compensation in any industry, theoretically, gets decided by the
socio-economic considerations. Skewed distribution of wages will make the flow o
supply shift and with the application of basic principle of demand and supply th
equilibrium will be attained. This means that the compensation levels will, more

or less,
tend to be at par for the comparable work. In practice, however, this happens ve
rarely. In the free economy the Government does not control the aspect of wage
administration and normally the market forces determine the compensation level.
However, the administration is bound to protect the workforce from irrationally
wages. Taking this as the prime objective the Indian Government has enacted:1. T
he Payment of Wages Act, 1936,
2. The Minimum Wages Act, 1948
3. The Payment of Bonus Act, 1965, and
4. The Equal Remuneration Act, 1976.
These Acts ensure payment of wages at regular intervals, prohibit unauthorised
deductions from the wages, define a certain minimum level of wages for certain
industries which ought to be paid, provide for payment of bonus, in the form of
wages every year irrespective of the profit or loss of the organization, decide
minimum and maximum rates for payment of bonus and propound the principle of equ
remuneration for equal jobs to both men and women workers. Thus, the Government
has ensured a bare minimum level of compensation to the workers and ensures thro
its administrative arms and law-enforcing authorities that there is no exploitat
ion of
workers at the hands of employers.
Job Evaluation
This is one important measure to determine the level of compensation package.
A scientific job evaluation will ensure parity of compensation levels for simila
r or equal
jobs. It also helps in distinguishing jobs in the level of complexity, skills re
quired, the risk
involved and link compensations accordingly. Job evaluation is a method of appra
the value or worth of one job in comparison to other jobs in the organization. T
objectives are:
1. to determine the compensation rates
2. to link pay with the requirement of the job
3. to provide for pay differentials taking into account skills, efforts, hazards
required in
each job
4. to establish a compensation structure.
The process includes job analysis, job description and job specification. The jo
evaluation may also be useful for some other aspects in the organization, viz.,
manpower planning, performance appraisal, etc. The jobs are ranked according to
perceived difficulty and value addition they make. They are classified in groups
on skill intensity, difficulty, hazards, responsibility, experience required, et
c. Once the
jobs are ranked and classified it is easy to decide the level of pay for each jo
b. The jobs
which are considered more valuable to the organization than the one which are no
t so,
will obviously carry more pay. Similarly the higher level of responsibility will
higher pay. Following this doctrine the supervisors draw more pay than the worke

because the responsibility and experience required are of a higher order. Howeve
r, in
exceptional cases the supervisors may draw lower pay if the job to be performed
by the
workers is risky and requires higher skills or hard physical work.
Rewards Linked to Performance
We have so far seen the various types of compensation, compensation bases,
theories and concepts and legal framework. Let us now consider another concept o
compensation linked to performance. Compensation can be, from this point of view
three types: fixed, totally variable and mixed. However, let us see why there is
a need to
link compensation to performance.We have considered that job evaluation appraise
s the skills required in the job
and higher the level of skills, higher the level of compensation. But it is an a
dmitted fact
that individuals differ in their performance on job. Although the job analysis d
efines the
skills required, the degree of skills and the fineness with which the job is per
formed, is
different for each individual. There is a growing feeling that this finesse need
s to be
recognized and compensated for. It is argued that this not only motivates the hi
performer but also motivates others and their performance level will go up. Let
us now
examine how this is achieved.
Fixed level of compensation means that based on job analysis, or market
conditions or the collective bargaining power of the unions, the compensation is
fixed for
various jobs. It assures payment at that agreed rate to all the employees irresp
ective of
how they perform their jobs. This leads people to perform below their potential.
quality control systems are not well established, as in the service industry, fi
compensation levels may prove to be counter-productive, with no inducement to hi
performers and no compulsion for low performers to improve their contribution. F
level of compensation thus suffers from creating a low level of motivation and c
high performers to mediocre performers.
Variable level of compensation attempts to remove this drawback. It decides the
compensation solely on the performance level of the employee. In the manufacturi
unit it is a compatible system as the number of pieces produced and the quality
can be
measured against the benchmarks already decided. More the number of pieces of
acceptable quality, higher could be the compensation rate. This theory induces a
high level of production but also puts undue pressure on employees to perform un
der all
conditions. Their compensation level is directly linked to the level of their pe
But on many occasions the performance may come down because of reasons beyond
the employee's control. The system has therefore to take care of such eventualit
ies. The
other drawback of the theory is that in a service industry where the measurement

performance is a difficult task, it may be subject to human error in judging the
performance, which may lead to frustration.
The mixed compensation level tries to remove the drawbacks of both the above
systems and at the same time seeks to get the benefits of both of them. It assur
es a
fixed level of compensation and proposes additional compensation depending upon
level of performance. For example, a predetermined salary and reward linked to o
level of performance is one combination. The additional compensation may be in t
form of bonus, or additional wages, etc. Both the variable and mixed compensatio
theories presuppose a well established performance appraisal system. This system
followed in most of private sector organizations including new private sector an
d foreign
banks. However, the variable part of the compensation is kept secret and the
employees are prohibited to disclose it to other employees.
Compensation Structure
In a traditional system, wage structure includes basic pay, dearness allowance
linked to consumer price index, house rent allowance if no accommodation is prov
city compensatory allowance, conveyance allowance etc. But there has been a new
trend in keeping the structure flexible. Many companies in the private sector of
fer, what is known as a 'cafeteria' or 'menu' option to their employees. The emp
loyee decides
what he will draw as basic salary, what amount as house rent allowance, etc. Thi
s is of
course within the overall package level decided for the employee beforehand. The
to have a flexible structure is to allow the employee to plan his income under t
he various
heads of salary depending on his requirement for the particular year and to offe
r him the
permissible tax benefits to the maximum extent. There is a concept of cost to th
company and the flexible pay and allowances will form part of total cost to the
The cost to the company includes other costs, viz., Leave Fare Concession, Leave
Encashment, Medical Benefits and other benefits offered by an organization.
Practice in the Indian Banking Industry
The determination of salary level in the banking industry has undergone a
change during the last five decades. To trace the progress, in the initial days,
was decided solely at the discretion of the banks, when all the banks were in th
e private
sector. There was no union and association and as such there was no system of fi
of salary after discussion or negotiation. However, with the trade union movemen
taking shape in the banking industry, the first dispute was on the salary. The u
contended that the banks had the capacity to pay higher salary but they were den
the same and paying much lower salary, whereas banks argued that salaries cannot

determined on the only criterion of capacity to pay. The matter went finally for
adjudication to the tribunals. The Sastry Award and the Desai Award are examples
how the arguments were articulated for and against by the parties, and the salar
were decided by the tribunals for the bank-men across the country. Thus, fixatio
n of
salary through settlements by a third party, i.e. the tribunal, became an accept
thing. Since 1966, however, so far a "workman" staff is concerned, the wages are
settled through Bipartite Settlements between the Management of Banks (represent
by Indian Banks' Association) on the one hand, and their Workmen (represented by
various central trade unions in the industry) on the other. The settlement is bi
nding on
parties for the specified period of time. At present the settlement period is fo
r 5 years.
The settlement takes place for all the banks which are the members of IBA.
Currently a debate is going on proposing that each bank should have freedom to
decide its compensation package as the capacity to pay differs from bank to bank
. This
is on the grounds that many public sector banks are not performing up to the des
level, and revision of salary at a regular interval puts strain on weak banks. T
he other
argument in favour is that the banks would also like to have freedom in designin
certain policies which will recognize high performers and try to work out a rewa
system linked to performance so that good performers are motivated and the gener
efficiency level is raised. The Government has indicated that such freedom can b
granted. However, the recent settlement has been done industry-wide under the
pressure of trade unions.
Check Your Progress (B)
State whether the following statements are True or False:
1. People do not give much importance to the compensation in the organizations.
--False.2. Wage, salary and remuneration all mean the same. --- False.
3. The reward linked to the performance generally improves the motivation level
employees. ---- True.
4. It is not necessary to give market -linked wages to employees. They may other
continue because of job security. ---- False.
5. Uniform wage structure helps in improving the performance. ---- False.
6. Job Evaluation is necessary as it helps in distinguishing jobs in the level o
complexity, skills required and risk involved. ---- True.
7. Cafeteria or Menu option of compensation refers to providing cafeteria or canteen
facilities to the employees. ---- False.
8. The compensation paid to the managerial position is generally referred to as
---- False.Let us Sum up
The feedback from employees about various organizational policies serves a

great purpose in understanding the employees' perspectives about the personnel

policies and their level of satisfaction, or, dissatisfaction. Well designed cli
mate surveys
provide useful data to the management for fine tuning organization's personnel p
It also gives opportunity to the employees to air their views and feelings which
may be
quite valuable for the organization.
We studied different concepts, theories, legal aspects and the recent trend in
compensation packages. We also studied the practice followed in the Indian Banki
Industry in this regard. Compensation is a vital factor in the personnel managem
ent. We
have discussed various types of compensation packages with their merits and deme
A carefully designed compensation package and rewards system is likely to help t
organization to keep its people happy and satisfied which in turn may enable the
m to
give their best to the organization.
Climate survey; Employees' feedback; Designing questionnaire; Wage; Salary;
Compensation; Reward; Remuneration; Performance linked compensation.
Terminal Questions
1. What is the purpose of obtaining employees' feedback on various organizationa
2. How climate surveys can help organizations? How a systematic climate survey c
be designed and conducted? What are the benefits to the management?
3. What should be the coverage of climate survey?
4. Explain the different compensation bases.
5. Describe compensation theories and how the legal framework addresses this iss
6. Discuss the need of "rewards linked to performance".
7. Examine the present practice in the Indian banking industry in respect of
determination of salaries. Do you think there is scope to introduce performance
Suggested for Further Reading
Edwin B. Flippo, Principles of Personnel Management, McGraw-Hill Book Company, 6
edition, 1984.
Fredrick E, Schuster, Human Resource Management, Reston Publishing Company,
Virginia, 1985.Monappa and Saiyadain Mirza, S Arun, Personnel Management, Tata M
Publishing Company Ltd., Ilth edition, 1991.
Venkataratnam, C S and Srivastava, B K; Personnel Management and Human
Resources, Seventh Reprint, 1997, Tata. McGraw-Hill Publishing Co. Ltd.
UNIT 24 - Performance Management
Part 1 of 2
24.0 Objectives
24.1 Introduction
24.2 Appraisal Systems
Check Your Progress (A)
24.3 Performance Review
24.4 Counselling

Check Your Progress (B)

Let Us Sum Up
Answers to Check Your Progress (A and B), Terminal Questions
Suggested for Further Reading
After studying this unit, you should be able to:
1. Understand the objectives and uses of the performance appraisal system.
2. Gain familiarity with the different appraisal methods,
3. Learn the techniques of performance review,
4. Appreciate the counseling process and its importance in motivating people, an
characterize an effective performance appraisal system.
Performance of employees is the key to the success of any organization. The
main purpose of Human Resource Development is to develop people in the
organization and to ensure that an atmosphere is created and maintained in which
employees contribute their best. It is, therefore, logical that their performanc
e on the job
is measured so that what they have contributed is known and made known. If there
any areas of improvement, they have to be afforded an opportunity to do so. Flip
says, 'no company has a choice as to whether or not it should appraise its perso
and their performance it is inevitable that the performance of the hired person
will be evaluated by someone at some time. The choice is one of the methods.' He
describes the choices the organization has in this regard:
1. A casual, unsystematic and haphazard appraisal,
2. A traditional and systematic measurement of employee characteristics and empl
3. Mutual goal setting, i.e. Management by Objectives (MBO).
Performance appraisal is a process by which the management finds out how
effective it has been in hiring and placing the employees.
Heyel defines performance appraisal as 'a process of evaluating the performance
and qualifications of the employees in terms of requirements of the job for whic
h they
are employed, for the purposes of administration including placement, selection
promotions, providing financial rewards and other actions which require differen
treatment among the members of a group as distinguished from actions affecting a
members equally.'
Monappa and Mirza Saiyadain put it as 'a systematic evaluation of personnel by
supervisors or others familiar with their performance because employers are inte
in knowing about employee performance. Employees also wish to know their positio
n in
the organization.'
From these definitions it is clear that performance appraisal is an important to
by which the organizations review employee performance, take corrective steps th
training, interventions or placement decisions, reward good performance and atte
mpt to

take the employee performance to a higher level.

Performance appraisal is an organizational necessity. Various appraisal systems
have evolved over a period of time. These systems vary from simple to complex, f
vague to objective, from unstructured to structured and from confidential to ope
n. An
organization has the option to device its own system or can adopt, with certain
modifications, some other's system. What system one should choose will depend on
whether it fulfills the objectives the organization wants the system to serve. I
ndeed, the
system's success depends on the time it takes to carry out the appraisal exercis
e and
how easily people adopt the system. An informal appraisal system is possible in
a very
small organization where the employee's contribution is readily visible. However
, this is
not a scientific way. The organization may grow over a period of time and it may
be*necessary to have a record of one's achievements or failures. This emphasizes
need for having a systematic appraisal system.
Objectives of Performance Appraisal System
It is possible to achieve several objectives with a well designed performance
appraisals. As observed by McGregor the performance appraisal plans meet three
1. Judgemental - for salary increases, transfers and promotions;2. Developmental
- telling an employee how is he doing and suggesting changes in his
skills, attitudes, behaviour;
3. Counseling by superior - for giving feedback and understanding problems for p
Many of the experts, however, consider that it serves two needs, i.e. judgmental
and developmental; counseling being part of developmental need.
The overall objective of the performance appraisal is to improve the efficiency
the organization. The specific objectives the system achieves could be summarize
d as
1. to enable the organization to maintain an inventory of the quality and skills
of people
and identify and meet their training needs;
2. to determine the performance-linked increments and provide data for promotion
s and
3. to maintain individual and group development and fulfill their aspirations by
with them their standard of observed performance and help them reach the benchma
by skill up gradation programmes.
Performance appraisal is an important tool both for the organization and the
employee. If the objectives are well defined and understood by the parties conce
its implementation becomes easy and meaningful. It will then be in a position to
reach a
multi-useable level.
Uses of Performance Appraisal
Having seen the objectives of the performance appraisal system, it is relatively

easy to list down its various uses. It is a tool to evaluate objectively the per
formance of
the employees on the given job. While doing so, it also throws light on the
characteristics and traits of the employees. Data on these aspects of the employ
personality can be useful for certain personnel decisions. Viewed from this angl
e, the
wide range uses of the system are:
1. It rates all the employees in a unified manner by using the same rating scale
s and
thus making them comparable on a common footing.
2. It provides information which could be critical while deciding on promotion,
increases, transfers, training, etc.
3. It provides information about the areas of weaknesses of the employee to enab
initiation of corrective steps.
4. It improves the quality of supervision as the supervisor becomes a keen obser
5. The system, if implemented with openness and trust, ensures better interperso
relations between the employee and his supervisor.
However, in practice, the system is generally criticized by the employees due it
failure to meet one or the other objectives mentioned above.
Performance Appraisal MethodsTo achieve the objectives and to be in a position t
o use the system to the fullest
extent, the organization has to choose an appropriate method from the various
alternative methods. Depending on its requirements and objectives, the chosen me
can be modified suitably. However, before deciding upon which method to adopt, i
t is
necessary to understand the evaluation process. There are following steps in the
evaluation process:
1. The process begins with the organization setting the 'performance standards'
advance. These standards should be clear, realistic and measurable. It is advisa
ble to
involve the line managers in the exercise as they understand the nuances and nit
tygritty of the job.
2. The performance standards then are required to be communicated to the employe
3. The next stage is to measure the performance. It can be done through the data
available with the department, personal observations, and feedback from the appr
4. Performance level of the employee is then compared with the benchmark or stan
already established. Deviations are discussed and the reasons for deviations are
5. The outcome is discussed with the employee, emphasising the strong points and
counselling him on the weak points.
6. The last step is to initiate corrective measures and act on the positive perf
ormance by
deciding on various incentives like increments, promotions, training needed, etc

The above steps seem quite simple and logical to be followed. But there are only
few organizations that take the appraisal process seriously and observe all thes
stages. Apart from this, there are genuine difficulties in setting performance s
as many of the jobs involve sets of steps or actions which cannot be quantified
measured easily. Special attention needs to be paid to these steps as otherwise
the tool
loses its credibility and the employee loses his faith in the system. Many a pro
blem stem
from such dissatisfaction of the staff with respect to the appraisal system.
There are different methods of performance appraisal. They can be grouped as
traditional methods and modern methods. While the traditional methods emphasize
rating the individual's personality traits, the modern methods lay importance on
results - job achievement rather than on personality. It is believed that concen
more on the end results makes the process more objective. Following is the list
of the
traditional and modern methods:
Traditional Methods
1. Free Form Essay Method
2. Straight Ranking Method
3. Comparison Method
4. Grading Method
5. Graphic or Linear Rating Scales6. Forced Choice Description Method
7. Forced Distribution Method
8. Group Appraisal Method
Modern Methods
1. Assessment Centre Workshops
2. Management by Objectives
3. Human Asset Accounting Method
4. Behaviourally Anchored Rating Scales
5. 360 Degree Appraisal Method
Let us now discuss these methods with their merits and demerits:
Traditional Methods
Free Form Essay Method: It is totally unstructured method of appraisal. In this
the appraiser makes a free form, open-ended appraisal of the employee. The syste
thus gives absolute freedom to the superior to write about the job knowledge,
employee's attitudes, development needs, etc. The drawback of the system is that
could lead to a totally subjective evaluation and comparison between two employe
es is
difficult. This type of appraisal system is generally used to appraise the top
Straight Ranking Method: This is the oldest and simple method of performance
appraisal. The relative position of each employee is assessed. People are rated
in order
of merit and placed in a grouping. The system obviously suffers from numerous
drawbacks such as it is difficult to compare an individual with others having va
behaviour traits.
Comparison Method: This is a modification of the earlier method where each
employee is compared on certain selected factors such as leadership, initiative,

This method is also known as Factor Comparison Method . When the number of
employees is large it becomes difficult to compare and rank them on different at
Grading Method: This is a simple method where certain features are considered fo
grading, such as analytical ability, job knowledge, etc. Certain scales are then
and the employee is graded on those features on the scale. The scale could be A:
outstanding; B: very good; C: average; D: below average. This is a widely used
Graphic or Linear Rating Method: This is another most commonly used method. The
method considers two factors: employee characteristics and contribution. Persona
qualities such as initiative, dependability, decisiveness, etc., are measured. W
ith regard
to contribution, both quality and quantity of work are considered. While measuri
contribution, weightages are assigned to both the quality and quantity. Rating i
s on a continuous scale. The drawback of the system is that the rating generally
tends to be
subjective. The system assumes each character to be equally important for all jo
Forced Choice Description and Forced Distribution Method: These methods force
the superior to make his choices. The underlying idea is to minimize the bias. T
employee is rated on a predetermined distribution scale. The factors normally
considered are job performance and suitability for promotion. In the choice desc
method the superior is asked to select the statements which best describe the
employee. The statements are predetermined sets of description of people.
Group Appraisal Method: This is a method in which employees are rated by -a grou
of appraisers consisting of the immediate supervisor and three or four others, w
ho have
some knowledge of the performance of the employee. The advantage is that it is a
thorough method with least bias as it involves multiple raters. But it is a very
consuming process and may get reduced to just a ritual if the number of employee
s to
be rated is high.
Modern Methods
Assessment centre workshops: This is a modem method of assessment. It is a
radically different method from the traditional appraisal techniques. The method
uses a
number of assessors and different activities. In a job-related simulated situati
on the
behaviour of the employee is assessed through their performance of different
activities/exercises such as group discussion, business games, in-basket exercis
committee meetings, psychometric tests, etc.
Purpose of Assessment Centre
1. to measure the potential of the candidate for higher managerial position;
2. to assess training and development needs;
3. to select candidates in campus recruitment or fresh students for employment;
4. to identify future potential leaders.
The Assessment Centre generally measures interpersonal skills, leadership
qualities, organizing and planning abilities, problem-solving abilities, stress

capacity, motivational orientation and communication skills of the candidates.
The drawback of the Assessment Centre is that it is a time consuming activity.
Good performers are averse to the idea of exam-taking. It also requires highly t
observers to assess various personality traits and behaviour pattern of candidat
es. To
make Assessment Centres successful the objectives of the centre must be clearly
stated. It is a system which can be used in conjunction with the appraisal syste
m for
taking career progression decisions.
Management by Objectives (MBO): This method attempts to minimize external
controls and emphasizes on the motivation levels of the employees. This is sough
t to be
achieved through joint goal setting and the employee participation in the decisi
ons that
directly affect him. The objective of the MBO is to change the behaviour and att
itude in respect of getting the results. It is a result-oriented system. The sys
tem emphasizes on
goal achievement rather than the method involved.
MBO Process
1. The organizational goals are first set and are clearly stated in measurable t
These goals have to be realistic and achievable, although challenging.
2. The goal setting process is a joint process. The short-term performance goals
are set
jointly by the employees and their superiors.
3. There are frequent reviews of performance through one to one meetings.
4. Sharing of feedback in such meetings helps in altering the course of action,
required. It acts as a motivating factor as one gets to know where he stands thr
ough the
feedback session.
It is, therefore, a process of setting goals, exchanging feedback and seeking
participation of employees.
Advantages of MBO
1. It involves participative approach in goal-setting.
2. It enhances the motivational levels of the employees.
3. It creates an atmosphere of competition within the organization for enhanced
4. It provides objective appraisal method.
5. Problems can be identified in the early stages through reviews and feedback
6. It is an effective tool for identifying the training and development needs.
Disadvantages of MBO
1. It is a system which concentrates on results and not on the process.
2. It may lead to unhealthy competition amongst the employees.
3. It may create a conflicting situation when it comes to goal-setting.
4. Sometimes, very soft targets are set to show higher performance achievement.
Human Asset Accounting Method: In this method the employees of the organization
are treated as Human Capital and money estimates are attached to the value of an
organization's personnel and its external goodwill. The principle behind this sy
stem is
that like any other asset, human asset is also valuable to the organization. If
any trained
and experienced employee leaves, the human asset value depreciates and if someon
joins the organization bringing with him the skills and experience important to
it, the

human asset value increases. The current value of the human asset is appraised b
undertaking periodic measurements of two variables called 'key causal' and 'inte
enterprise'. The first variable includes management policies, strategies, skills
, etc. The
later includes loyalty, attitudes and motivation level, effective interaction, e
tc. Again, this
is not a method for individual performance measurement. At best it can measure h
uman performance of organization as a whole in terms of increase or decrease in
asset or human capital value.
Behaviourally Anchored Rating Scales (BARS): This is a new appraisal technique.
The jobs are described through illustrations or by giving critical incidents of
effective and
ineffective performance. Based on these incidents a rating scale is devised. A s
et of
incidents are used as 'behaviour anchors' for the performance dimensions. While
system is reasonably objective, it is very time consuming.
360 Degree Appraisal Method: 360 degree refers to full circle or all around the
employee and the employee is in the centre. Under this appraisal system an emplo
is rated by people who are affected by the performance of the employee and have
adequate knowledge about his working and performance. The appraisal is generally
done by the seniors, colleagues (peers), subordinates, suppliers, customers and
other stakeholders. It also includes the self-assessment by the employee himself
Besides the performance appraisal, this system serves as a good feedback mechani
for the employee and the organization for taking corrective measures and
developmental initiatives to improve the performance. Being a multi-rater apprai
system, it is likely to minimize human bias.
We have briefly seen traditional and modem appraisal methods. It is necessary
for each organization to adopt one of these systems, may be with a few modificat
ions. It
is imperative that the objectives of the performance appraisal system are well d
and clearly understood by all the concerned parties, including the employees. Th
success of the system depends not only on the method adopted but also on how it
implemented by the line managers and how open and transparent they are in giving
feedback. It has generally been found that even the best of the appraisal system
designed with all sincerity have suffered because of their poor implementation.
system loses credibility if the employees find that it has become a ritual and i
t is not
open and trustworthy. It is common for organizations to use a combination of som
e of
the traditional methods and taking the ingredients of the modem methods as well.
It is
essential that the appraisal system should be objective as far as possible add s
hould be
perceived so by the appraisee.

The commonly used performance appraisal method in the service industry

including banking is the one which is in three parts. The first part consists of
selfappraisal by the appraisee. The second part is appraisal of the performance by t
reporting authority of the employee. The third part is the review by the superio
r of the
reporting authority. This type of system envisages employee participation in thi
important exercise. The self-appraisal gives the employee an opportunity to asse
ss his
own performance - dispassionately. The appraisal by reporting authority in many
includes appraisal interview and goal setting. While we will study more about ap
interview subsequently, goal setting means the employee and the reporting author
discuss and decide the broad objectives the employee is supposed to achieve in t
following year. In the banking industry, goal setting is not an easy task. It is
simpler when it comes to the goal-setting of a branch manager where the business
parameters are projected in absolute terms and the goal is thus quantified. But
for the
other types of employees it is rather difficult. Depending on the department in
which he
is posted qualitative goals can be decided. The third part, i.e. review by the s
uperior of the reporting authority ensures that subjectivity or bias can be redu
ced or minimized to
some extent.
The method may include both descriptive and scalar appraisal of the
performance against the set goals. It serves the purpose of self-checking both f
or the
employee and the superior. Many banks have now adopted a method of giving
feedback to the officers about their performance. Thus there is an element of op
and transparency. In the private sector, the performance appraisal is carried ou
t with
more seriousness as the financial rewards are directly linked to one's performan
Assessing Potential
While discussing the Assessment Centre Method we have seen that its objective
is to assess the potential of the employee for higher managerial position throug
simulation processes. The performance appraisal system is basically focused on
measuring the present performance of the employee on the given assignment. The
measuring takes place against certain job-related benchmarks. While the results
appraisal system are useful to know his performance on the current job, they do
throw much light on the potential of the candidate in taking up higher assignmen
t. It may
happen that an employee is extremely good at his present position but has little
potential for a higher job. This is because the attributes and skills required f
or the higher
position may be totally different than the one required in performing the presen
t job. An
excellent salesman need not necessarily be an excellent sales manager. If we tak

e a
decision to promote a salesman solely based on his performance appraisal to the
of sales manager who does not have potential for higher post, we will lose a goo
salesman and create a bad sales manager.
Basing the promotion decisions only on performance appraisal system is a
judgmental prediction that the employee may perform well in the higher capacity
as he
is presently doing. Thus, potential appraisal becomes an important aspect of the
performance appraisal system. It is to be used in conjunction with the performan
appraisal techniques. There are many organizations which have a regular potentia
appraisal system in place. Potential Appraisal Report (Annexure) shows one such
used for potential appraisal. Assessment Centre Method used in conjunction with
performance appraisal system, is of great use in such circumstances. Potential
appraisal thus helps in arriving at more appropriate decisions.
Performance Appraisal versus Confidential Report
In a large number of organizations the annual performance appraisal exercise is
carried out as a confidential activity. In fact, the form in which the performan
ce of the
employee is evaluated and reported is called confidential report. This report is
to the head office. As the name suggests, the system is surrounded with a lot of
and the employees tend to dislike it. There is no transparency at all. The super
assumes greater importance and wields power as he can make the career of the
employee through this tool of confidential report. No feedback is given to the e
mployee as to how is he performing his work. Thus there is no developmental cons
ideration. This
is a very old form of reporting on the employee. Its disadvantages outweigh any
sides. Slowly the organizations are moving towards more open and transparent
performance appraisal systems involving employees in goal setting, providing for
selfappraisal and regular feedback, and taking corrective steps jointly with the emp
for better results.
Merits and Demerits
While the merits of the performance appraisal system have been obvious and
many, as in any system, it has a few demerits too.
The merits are:
1. It reveals a concern for performance and creates an atmosphere of openness an
trust in the organization.
2. Gives feedback to the employee and ensures that corrective steps are taken in
3. It raises the general motivation level of the employees if implemented proper
The demerits are:
a tendency to allow one trait or characteristic of an employe
1. The halo effect
e to
influence the assessment. The halo is to rate an employee consistently high or l
2. The leniency or strictness tendency of the superior interferes with the appra

isal and
accordingly the assessment gets influenced. The superior is unable to come out o
these tendencies.
3. The central tendency problem refers to assigning average ratings to all the
employees without properly evaluating each aspect of appraisal carefully and fea
4. Similar error is the tendency of comparing the employee with oneself on vario
us traits
and parameters. Those who show the similar characteristics are normally rated hi
Appraising an employee is an art. One needs to do this job sincerely and
faithfully. The objective is to reflect the true performance of the employee in
the report.
Avoiding the personal liking or disliking to influence the rating is a must. Wit
h some
practice one can be a good appraiser. He needs to learn the art of objectively
distinguishing the good and not-so-good performers to avoid the effect of centra
Check Your Progress (A)
State whether the Following statements are True or False:
1. Performance appraisal is not required in most of the organizations because
performance cannot be measured objectively. . False.
2. Performance appraisal system can be widely used for employees' development. .
True.3. Appraisers do not devote much time on appraisal due to their busy schedu
le. .
4. There is no need to make the system open and transparent; it may spoil the re
at workplace. . False.
5. The system generally suffers from the halo effect. . True.
6. Performance and potential appraisals are more or less the same . False.
7. Performance appraisal has no other use except that in case of promotions . Fal
8. MBO process does not involve seeking participation . False.
This is the end of Part 1 of 2, of chapter 24, of ADVANCED BANK
UNIT 24 - Performance Management
Part 2 of 2
We have seen various methods of performance appraisal. All these methods
envisage performance review. Appraising the performance of the employee is revie
his performance during a specified period.
The review however could be at frequent intervals. Reviewing how the employee
is performing his job, giving him instant feedback, taking corrective steps and
that results are achieved at the end of the year is also part of performance
management. Performance management is possible through constant performance
review, which includes the yearly exercise of performance appraisal or assessmen
t. In
this context, performance review means appraisal of the performance of the emplo
by his superior. Let us now see what are the steps involved in the review.
Preparation for Review
Preparation refers to obtaining information by the superior before he actually
appraises the performance of the subordinate. It may be worthwhile at this stage
for the
superior to take a break from his routine activities and devote some time for th

e review.
The previous year's appraisal will give him the goals set for the current year.
If there are
other documents which have recorded the goal setting activity, the same may also
referred to. As against the set goals, he may have information about the perform
ance of
the employee through various statements, quarterly reports, etc. These documents
the testimony of the performance of the employee. The superior should study them
carefully. This will give him an insight as to how the employee has completed hi
assignments as against the set goals. It may be good for the appraiser to have a
overall view as to how the organization is performing or what is the industry le
performance. The review for higher level jobs may involve such inputs. At this s
tage the
appraiser is in a position to have a fair idea as to the performance of the empl
oyee. If
there have been periodical reviews (mid-term reviews) of the employee's performa
these reports should also be perused. The superior is thus in a position to form
preliminary impression about the performance of the employee. But it is incorrec
t for
him to treat this data as the final one and form his opinion about the employee'
performance. He needs to have a hearty discussion with the employee, understand
point of view about the success or failure, and then come to the final conclusio
Straightaway proceeding to fill in the appraisal report of the employee may not
be a right
course of action. Thus, it is better to have an appraisal interview with the app
There are certain prerequisites for conducting the appraisal interview and we wi
ll now
refer to that.
Appraisal Interview
Appraisal interview refers to the meeting of the appraiser and appraisee for
getting information and clarifications for the purpose of appraising the perform
ance. As
mentioned earlier, it is helpful if the superior prepares himself for the perfor
mance review and the interview. While preparation for review puts him up to date
on the
performance as revealed through various MIS, the interview gives him an opportun
ity to
get to know as to how the employee feels about his performance and the overall
scenario. The appraisal interview also affords him a chance to give feedback to
employee both on the positive and negative aspects noted by him and also the
expectations. The appraiser should be trained for conducting such interview and
providing feedbacks. The appraisee should also be prepared to receive the interv
iew in
a right spirit to take it positively for his self-development. The interview thu
s assumes a
critical importance in the process of performance appraisal system. This is a mo

technique and requires to be handled carefully. If so handled, the benefits are

significant. However, there are certain basic precautions one needs to take abou
t the
1. The venue of the interview should be the place of the appraisee or at least a
place but not the room of the appraiser. This is likely to ensure some amount of
and freedom to the appraisee.
2. The timing of the interview should be so scheduled that there is no disturban
ce at all.
It is necessary to undertake this exercise with due seriousness. Unless the earn
is demonstrated, the employee is not likely to open up. Preferably, interview s
hould be
arranged in a place where there could be no disturbance from outside.
3. The appraiser should adopt the role of a listener and allow the employee to s
peak to
the maximum extent. He should try to understand what the employee has to say bef
the appraisal review starts taking place.
4. He should adopt an encouraging role of a senior colleague and try to understa
what the employee has to say. He should avoid passing judgmental remarks which m
put off the employee.
5. At an appropriate time he should start giving feedback to the employee.
We will now see as to how feedback can be given effectively, without affecting
the motivational level of the employee.
Giving Feedback
Giving a feedback without hurting a person's feelings is an art. The points
covered above in respect of appraisal interview are also relevant for giving fee
dback to
the employee. To give feedback, it is necessary to arrange the meeting in a cong
environment. After carefully listening to the employee, the appraiser should tak
command of the situation and give an honest feedback to the employee with an
objective to help his development. The following points are crucial for giving f
1. The feedback should be objective and should help employee in reaching appropr
level of performance in future.
2. The feedback should be suggestive in nature rather than judgemental and shoul
focus on the training and developmental needs of the employee.
3. The superior should adopt a problem-solving approach and not fault-finding
approach. The trust of the employee will be reinforced if a sincere attempt is m
ade in
giving feedback with an intention to help him.4. The superior should never lose
sight that his aim is to improve the performance of the
appraisee and not to criticize him.
Do's and Don'ts
Based on what has been discussed above, the DO's and DON'Ts of the
appraisal interview and giving of feedback can be easily summarized:
1. allow the employee to do the maximum talking,
2. encourage him to describe his success and failure,
3. create an atmosphere where he will open up.
4. praise him for his achievements.

5. tell him honestly what you think where he could have done well,
6. ask him what kind of help he expects from you.
7. extend to him all that you can do for him.
1. arrange a meeting when you are unable to devote time undisturbed.
2. allow any kind of disturbance once the meeting starts,
3. adopt judgmental role,
4. criticize him for his failures.
It can be seen that the above tenets are basically good etiquettes which pleases
anyone. Treating people well is one of the duties cast upon the seniors and they
perform it without demur. Similarly, it is the duty of the senior to ensure good
performance from his subordinates and to train and develop them to that end.
The dictionary meaning of the word 'counsel- means to 'advise'. In the context o
our subject it means advising the employee about his performance. In other relat
context counselling assumes importance in respect of disciplinary matters in
employment. For the present, let us understand counselling with reference to
performance review. As the term indicates it may be clear that this step comes a
fter the
step of appraisal interview and giving feedback though, practically, it may take
along with appraisal interview. To put it in other words, the superior decides t
o do the
role of a counsellor where he comes to the conclusion that the performance of th
employee requires immediate and major corrective actions. While the appraisal
interview and giving feedback is a normal course of action, in a case where the
employee performance is falling much below the expected level, a serious attempt
made to understand the reasons and to take salvaging action. Counselling has bee
defined as an activity where one individual uses a set of skills to help another
to take
responsibility for, and to manage his own work and behaviour related decision-ma
Counselling ProcessThe prime purpose of counselling is to communicate to employe
e the feedback of
the performance and expectations and, help the employee to understand the areas
concern with the sole objective of improvement of his performance. If the feedba
system is effective, the employee not performing up to the mark gets to know cle
where he stands against the set benchmarks. If the key result areas or key
responsibility areas are clearly defined. there is a lesser chance of falling sh
ort in the
performance level due to ambiguity. Once the superior has come to the conclusion
the case on hand requires serious handling, he has to carefully evolve a process
he will speak to the employee. give him straight feedback, seek to understand th
employee's point of view and guide and advise him so that the employee is in a p
to do his best and reach the benchmark level. Thus, the counselling process is s

elfdefined by the superior. It may consist of three stages: (a) recognizing the pro
blem or
issue, (b) helping the employee to realize the problem and (c) managing the prob
The following could be considered as counselling skills:
1. It is essential to follow the stages mentioned earlier in respect of appraisa
l interview
and feedback session. It helps in creating conducive atmosphere. The appraiser s
realize that it is a common human tendency to react negatively to the feedback p
and particularly to the counselling process.
2. The process should start by communicating the purpose of the counselling.
3. The appraiser should be specific and descriptive when he is evaluating the
4. Appraiser should avoid commenting on the person and centre his discussion on
issues related to performance.
5. His intention should be to assist the employee to overcome his problems. With
prime objective, even when he is criticizing the behaviour (and not the person)
should do it carefully. Criticizing without crippling should be the motto.
6. He should listen to the employee and try to help him.
7. He should offer workable solutions and act where the appraises can initiate
8. Appraiser should not have any prejudice about the employee and try to evaluat
e the
employee's version objectively.
9. Successful counselling is effective listening.
Managing Average Performers
One needs to admit and accept that the level of performance of employees differ
from person to person. Despite the similar work environment a few employees are
in the
bracket of 'average performers.' While both the employee and the organization ma
genuinely wish improvement, many a time only marginal improvement is registered
great difficulty. It will depend on the organization's philosophy as to how it h
average or below average performers. The organization should try various means t
improve the performance of these average performers. It may include rotation in
transfer to another location, training intervention in the classroom environment
, special
skill up-gradation training programmes, etc. But after taking all these steps if
there is no marked improvement, it becomes necessary to handle them with care.
With large scale
technology implementation, many good performers could not cope up with the new
challenges and requirements due to their age and became average or low performer
Normally, the performance linked pay or rewards will differentiate these employe
es from
the rest. If the performance is of acceptable level and the employees are devote
d and
loyal, the tendency is to continue them in the jobs which best suit them. No org
in the Indian culture takes a drastic step of removing people just because they

average performers. But in the changing scenario of mergers and acquisitions and
highly competitive environment, these are the types of people on whom the axe ma
fall. Humane handling is what is recommended. The organization should also reali
that it may have a sizeable number of average performers. But they lend stabilit
y to the
organization by their loyalty. While the organization should incessantly continu
e the
effort for improved performance, a more practical and sympathetic approach is ca
for. These are the type of employees whose motivational levels are low. If the a
level of performance is an attitudinal problem, it can be addressed through coun
In case of bank employees in India, most of the average performers are surviving
moderate performance because of feeling of job security and ineffective reward a
punishment system. The situation may not continue for long.
Motivating through Counselling
Motivation is an emotional need. It explains how in the same work environment,
people of apparently similar capability register different levels of performance
. Take for
example the hundred meter sprint race. The runners participating in the final ra
ce record
almost similar finish time. Many a times, it is a photo-finish kind of a race, i
ndicating that
at least the first two-three runners are probably of equal capability. How that
is someone
does it in a record time? The answer probably is motivation. It may be called de
or inspiration.
Counselling, we have seen, is helping an individual realize his problems and
issues which are acting as a hurdle in his capability and the end results. Couns
elling, if
successful, is likely to remove these hurdles. As a result, the employee will be
in a
position, theoretically, to perform to the full extent of his capability. Good r
esults beget
good feelings. A reputation of good performance results in building of confidenc
e. Thus,
counselling helps in unleashing the potential of the employee and through this p
his performance level may be raised to acceptable levels.
Check Your Progress (B)
State whether the following statements are True or False:
1. Giving feedback is an art; the appraiser should avoid criticism of the person
focus on his performance. ---- True.
2. Conducting appraisal interviews is waste of time. ---- False.
3. Even negative feedback can help an employee to improve his performance. ---True.
4. Counselling of low performers do not yield any results. ---- False.
5. The main purpose of performance review is to do mid-course correction. ---- T
rue.6. Counselling does not help an individual to realize his problems and issue
s which are
acting as a hurdle in his performance ---- False.

Let Us Sum Up
In this unit we have seen the important personnel function of performance
appraisal. We studied the objectives of the performance appraisal system, its us
es and
various methods used in performance appraisal. We considered merits and demerits
different methods of performance appraisal. We also saw how potential can be
assessed and how it is different from the normal performance appraisal system.
Thereafter, we considered the implementation part of performance appraisal to pr
for review, how to conduct appraisal interview, and techniques of giving feedbac
Lastly, we studied the counseling process and how it helps in motivating employe
The single most important central point in this entire discussion has been the n
eed for
the appraisers to be objective, fair, open and trustworthy in the process of per
appraisal. The organizations and the appraisers need to take the system more ser
and take greater pain in finalizing its design and implementation so that it is
as a fair system and is able to serve its intended objectives.
A large Public Sector Bank (PSB) intended to introduce fast-track merit-based
selection process at all the stages in officers' promotion to ensure that the pr
ogress was
based on merit, ability, performance and adherence to bank's code of business
principles. The values of honesty, sincerity, commitment, courage, action and cu
care formed the bedrock of these business principles. Besides the performance
appraisal system to judge the current performance, the bank decided to introduce
interviews to assess the potential of the officers to handle higher responsibili
ties. So far
the seniority and the performance appraisal reports (PAR) were the main criteria
granting the promotion to the next grade and the officers were generally getting
promotion mainly on seniority basis. It was also decided to increase the zone of
consideration so that more officers may be considered and the bank may select be
officers. The proposal was strongly opposed by the Officers' Association on the
that even performance appraisal system itself lacks objectivity and transparency
, the
interview system will add to the problems of non-selection of good performers. T
suggested continuance of seniority-based promotions, which according to them was
only objective criterion. The bank had Lone ahead with the introduction of inter
system by constituting an interview panel comprising senior officers, at least t
wo grades
above the post for which the interview was to be taken. The Bank also included o
expert from outside in each panel to have independent and impartial views.. Sinc
e there
were a large number of officers required to undergo the interviews (due to large

r Lone
of consideration), the process started in a big way to complete the whole exerci
se in a
specified time frame and to cover all the officers who were otherwise eligible f
or the
promotion to the next higher grade. The interview started at different centres
simultaneously, therefore, the Bank could not keep the same panel. The selection
results were surprising not only to the concerned officers but to their seniors
to whom
they were reporting. A large number of quite junior and young officers were sele
while a number of seniors with longer experience could not make it. Some of the
with average track record were found highly suitable for the promotion to the ne
xt higher grade due to their extraordinary performance in the interview. Critics
strongly felt that
the questions which were asked in the interviews were theoretical and did not ha
much bearing with the measurement of performance or potential of the officers. I
t was
also argued that the 5 to 10 minutes interaction with the interview panel was no
sufficient to them to assess the candidates. Moreover, they felt that the interv
were not properly trained in interviewing techniques and some of the interviewer
created lot of stress to the candidates. Such cases, though less in number, made
case of the officers' association stronger for continuance of seniority based sy
supported by performance appraisal system. The management, though not admitting
openly, also realized that something had gone wrong with the whole process.
Keeping in view the facts of the case discuss the merits and demerits of differe
methods of performance and potential appraisals.
Potential; Feedback; 360 degree appraisal; MBO; Appraisal Interview; Counselling
Self-Appraisal; Performance Review;
Answers to Check Your Progress
1. False; 2. True; 3. True; 4. False; 5. True; 6. False; 7. False; 8. False 1. T
rue; 2.
False; 3. True; 4. False; 5. True; 6. False
Terminal Questions
1. What are the objectives of Performance Appraisal system?
2. What different purposes the appraisal system serves?
3. Describe various performance appraisal methods.
4. Why is assessing potential important?
5. Discuss the demerits of the appraisal system and state how they can be overco
6. Study the promotion process in your organization. Does it use Assessment Cent
7. Describe Management by Objectives.
8. Describe the process of performance review?
9. State the significance of appraisal interviews in the performance appraisal s
10. What precautions should be taken while giving feedback to the appraisee abou
t his

11. Describe the counselling process? How can counselling be used for motivation
12. What view should the organization take about average performers? How can the
performance be enhanced?
13. Study the process in your organization? Do you think it has all the ingredie
nts to
make it an appropriate performance appraisal system?Suggested for Further Readin
1. Flippo, Edwin B; Principles of Personnel Management, McGraw-Hill Book Company
6th edition. 1984.
2. Mamoru, C B; Personnel Management, Himalaya Publishing House, 12th edition,
3. Fisher, Martin; Performance Appraisals, Kogan Page Ltd., London, 1995.
4. Venkataratnam, C S and Srivastava, B K; Personnel Management and Human
Resources, Tata McGraw-Hill Publishing Co. Ltd., 1997 Seventh Reprint.
Kindly appraise the employee on the following attributes:
1. Functional Knowledge
(Does he/she possess the functional knowledge required for the next higher level
2. Managing Skills
1. Is he or she able to delegate work responsibility?
2. Is he or she able to provide direction under uncertain conditions?
3. Is he/she able to motivate his/her team members to perform better?
3. Initiative
1. Does he or she put in efforts to learn what falls beyond the purview of his/h
er present
job requirements or is he or she complacent doing what he or she is asked to do?
4. Decision-Making or Problem Solving Skills
1. Is he or she able to take a decision in the absence of specific guidelines?
2. Does he or she identify and anticipate potential problems?
3. Does he or she investigate and analyze problems and situations adequately?
5. Flexibility
1. Is he or she willing to accept new assignments and complete them according to
2. Can he or she handle a variety of assignments?
3. Is he or she open to constructive criticism and suggestions?
6. Self-Managing Skills
1. Does he or she keep calm under pressure?
2. Does he or she concentrate and maintain focus, even when constantly interrupt
3. Does he or she deal effectively with personal stress?7. Communication Skills
1. Does he or she listen carefully to others?
2. Does he or she present ideas and information clearly in speech and in writing
8. Achievement Orientation
1. Is he/she focused in his approach?
2. Is he/she able to prioritise the tasks assigned to him?
3. Does he/she make the best use of resources to achieve objectives?
9. Entrepreneurial Skills
1. Is he or she a self-starter or does he or she await orders?
10. Innovation
1. Does he or she recommend new methods and ideas to improve work performance?
2. Does he or she accept ideas and build on them?
3. Does he or she experiment and learn from mistakes?
11. Training and Development Needs

1. Does he or she require any training at present job or if to be promoted

12. Drawbacks
Are there any reasons as to why he or she should not be promoted in the current
year? This could be due to reasons such as:
1. Gross negligence or Persistent negligence
2. Error in judgment
3. Actions reflecting on integrity
4. Any others (Please specify)
This is the end of Part 2 of 2, of chapter 24, of ADVANCED BANK
MANAGEMENT- C A I I B PAPER 1.Advanced Bank Management
HRM and Information Technology
25.0 Objectives
25.1 Introduction
25.2 Role of Information Technology in HRM
Check Your Progress (A)
25.3 HR Information and Database Management
Check Your Progress (B)
25.4 HR Research
Check Your Progress (C)
25.5 Knowledge Management
25.6 Technology in Training
Check Your Progress (D)
Let Us sum Up
Answers to Check Your Progress (A, B, and C)
Terminal Questions
Suggested for Further Readings25.0 OBJECTIVES
After reading this unit, you should be able to:
1. appreciate and understand the impact of Information Technology on the Organiz
and Human Resource Management.
2. examine the need for creating technology based data base for Human Resource a
HR Information System.
3. appreciate the relevance of research in HRM and the use of technology in this
4. appreciate the importance and use of Knowledge Management.
5. appreciate application of technology in training.
In the emerging information age the parameters of success have changed and
the one who can have access to and can convert and analyze the data into informa
and then extract knowledge and wisdom out of it, has an edge over those who cann
An organization, therefore, cannot shy away from information technology. Though
initially the use had been concentrated in the area of business related dimensio
ns, its
application is possible in practically every activity in the organization. The u
se of
information for decision-making can improve the efficiency and effectiveness of
organization. Left to the imagination of the organizational innovative processes
, right
from the CEO down to the lowest level employee like the receptionist or telephon
operator, can make effective use of IT for their personal productivity and effic

HRM as a function has dual responsibility in responding to this trend of the

twenty first century. As a part of the strategic HRM, the most significant is th
transformation required in the mind set of all individuals across the organizati
on since
this technology challenges some of the traditional beliefs and attitudes. The se
responsibility is its application to HRM function itself for day-to-day decision
-making as
well as policy decisions. There is an emerging need for data based decisions for
a comprehensive Human Resource Information System is the answer. Besides this, i
response to the external and internal changing environment policy reviews are
necessary. Such reviews also need to have research base wherein IT can be of
immense use.
The twenty first century marks the beginning of information age. It has become
necessary to make use of extensive information in all the areas for strategic de
making and policy formulation. As the futurist visualized, this age is marked wi
th new
criteria of success wherein the access to and interpretation of data would be im
determinants of success. 'What the railroad was to nineteenth century enterprise
, what
the assembly line was to twentyth century manufacturing, knowledge is providing
to be
just that to twenty first century business' as Khanna puts it (Business Today 19
Globalization has wiped out the national boundaries linking organizations from a
ll parts of the world. Information Technology has contributed to a great extent
to this process. A
time has come, perhaps, where regardless of an ideology not supporting the
technology, nations or organizations would be compelled to adopt it. It is a mat
ter of
survival as well as achieving excellence.
The advent of microprocessor, the dramatic increase in its power in the last two
decades and the equally dramatic slide in its prices, are forming the shift of
manufacturing economy to information economy. As Thomas Stewart puts it, 'the
microchip is going to be the engine around which the information economy will be
and software will be the fuel.' (Prabhat, 1997). Microchip is expected to change
business beyond recognition. There is no sector which has not touched by it
the banking sector has absorbed the technology in its fullest potential for impr
operational efficiency and providing customer service. The role of technology in
Management has also been quite significant.
Information Technology is the merging of two technologies, namely,
communication and computers. Both these technologies have been making advances i
their own fields. Developments in communication are aiming at accurate, faster
transmission of data/message from one location to another, be it verbal or digit
al. The
computer technology has been advancing in storing volumes of data and doing
accurate, faster, simple and complex computing operations. In addition, intellig
ence in

the form of Decision Support System and Expert System is embedded in the
technology, to help the machine take human-like decisions with much faster speed
With the synergy of these technologies what has become feasible is storing of
voluminous data which can be accessed from any geographically distant place. The
speed and ability to process data has been so much enhanced that it can answer m
human queries and information needs.
When effectively applied, technology is expected to drastically change the
concept of 'work' as there may not be any office (physical) but there could be m
mainly at homes
from where people can communicate, negotiate, and
do the business. Employees may not be meeting each other in the traditional sens
The employees would be basically knowledge workers and quite individualistic in
approach. Flatter and leaner organizations are on the anvil with the introductio
n of IT.
Thus to accommodate this new industry (information industry) and the new workfor
the physical and psychological setting of the workplace has to be substantially
from the traditional ones (Mankidy, 1998). The organizational structures would
necessarily get modified as so many layers would not be required. This has throw
n a
great challenge before HR Managers to prepare people to adopt the new order.
There is a myth that the IT has diluted the importance of Human Resources in
the organizations. 'The mechanization of business has not reduced the role of HR
Computerization cannot replace the strategic decision-making abilities of human
The importance of human resources might be reduced in terms of needed quantity b
the pressure on the quality has increased hundred fold. So the HRM will continue
occupy an important position in any organization where human beings are consider
crucial (Sharad Kumar, Times of India, 28 October 2003)'.The prerequisite to ado
ption of the technology would be to understand the
qualitative changes which are firstly at the level of understanding the new rela
and secondly, in realizing the loss of traditional power centres. Visualizing th
organizations of tomorrow we cannot but realize that they will be compact, less
hierarchical and more egalitarian in structure, and will have a risk taking, con
innovative and learning culture. Since the individuals
where knowledge rests
immense opportunities, enabling them to perform by creating a fostering culture
is going
to be a formidable challenge.
It is evident that moving to the future organization will imply change for the
existing workforce and there is every possibility that the change will be resist
ed. It will
be more so if the organization is a successful one today. There can be various r
for the resistance; part of the resistance could be due to the inability of indi
viduals to
chance their thinking. Anxieties, implicit loss of power and fear of unknown cou

operate at a subconscious level leading to resistance. Similarly, the mind could
be blind
to the opportunities of improvements and the possibility of creating multiple so
lutions by
playing with the data. If an organization has to adopt technology for survival a
nd also
utilize it for excellence, the prime responsibility will be changing the mind-se
t of
individuals across all levels and units in the organization. HRM therefore, has
responsibility in responding to this revolution. The major one would be to build
organizational culture that will facilitate creativity and innovation thus enabl
individuals at all levels to make use of IT. Implementation of IT initiatives an
d HRM are
closely interdependent. There are instances where the implementation of IT suffe
due to improper HRM and also FIRM initiatives could not be implemented effective
due to change in technology. Thus, these two need to be properly interlinked for
individual success.
Utilization of technology is bound to release excess staff, will have increasing
need for officer staff, will release a lot of space, and will render certain bra
nches and its
employees surplus. This group of employees will act as a damper on the enthusias
m of
the organization. This has to be appropriately managed by H.R. strategies includ
ing exit
policy. One of the foreign banks had handled this issue quite successfully.
The banking sector worldwide has absorbed maximum technology for their
operations. Technology has also provided variety of delivery channels to support
customers' needs in an efficient and effective manner. The banks in India are al
increasingly being driven by power of information technology. However, the appli
are limited to the core banking operations, the power of technology has not been
to the desired extent for Human Resource Management and Development. There is
need to do a lot in this area to get best out of the people within the organizat
To envisage this qualitative change, HR departments have to be transformed to
set an example for the entire organization. It has to become a `learning' set-up
with all
its ingredients like self-introspection, sensitivity to environmental changes, a
openness to accept new ideas and systems.As such its first responsibility would
be to adopt the IT orientation within the
department. There is tremendous scope to use IT in a whole range of HRM function
viz. recruitment, training, placement, appraisal and reward systems, organizatio
development initiatives, etc. The need for use of IT can be seen through the fol

1. Certain basic information about an employee is used by number of functionarie

within and outside the HR department. For instance, if the organization has a
geographical spread, the information about an employee is floated at field units
maintained and processed at field administrative units as well as at the corpora
(control) office. This means that same database is used for different purposes.
Conventionally, the data collection took place from both these sources involving
duplication of efforts. This could definitely be avoided if database is regularl
y updated
and shared.
2. The database related to an employee is becoming broad-based as various
dimensions are getting added. e.g. along with the traditional data regarding sal
allowances, increments, leave, etc., information about his work experience, trai
competencies, skills, performance, expectations, etc. need to be stored. This ma
kes the
entire HR database voluminous.
3. Updating the data could be done partially by different individuals from diffe
day-to-day or policy reviews
need to be embedded
4. The decisions related to HR
databases to achieve objectivity and consistency in decisions. Such objectivity
imperative and can be achieved as IT enhances transparency. For example, if some
has to be deputed for training, the database can help in choosing the right pers
on for
the right training at the right time.
5. Human Resources being one of the significant components of internal environme
policy review must be undertaken to respond to the changes. To examine how the
existing practices or policies are functioning and whether there are biases/prej
udices in
any one, the database available could be analyzed.
6. To ensure adherence to statutory requirements, maintaining of such database i
From the points observed above, it is evident that just like any other MIS, a
comprehensive computer based Human Resource Information System (HRIS) is the
need of the hour. Proper security measures are required to be implemented to ens
the confidentiality, integrity, availability and access control of data/informat
ion stored.
Check Your Progress (A)
State whether the following statements are True or False:
1. The information technology is relevant only to developed countries not develo
ones. . False.2. Information Technology is a merging of computing and communicati
on technology.
. True.
3. IT can effectively, substitute our present manual systems and no other change
will be
required. . False.
4. IT can be used in HRM to reduce the drudgery of accounting and preparing sala

. False.
5. There is a certain loss of power in IT as no single one has exclusive authori
ty and
access to information. . True.
6. The positive aspect of IT is that more number of people can be utilized for s
decision making. . True.
7. IT has reduced the importance of human resources in organizations. . False.
Human Resource Information System (HRIS) has become an organizational
necessity. The need for HRIS is an offshoot of the requirement to take frequent
decisions concerning employees. Decisions taken on the basis of information, whe
ther it
is concerning, posting, training, compensation, job rotation, promotion, etc, ne
ed the
background of the person in terms of his competence, training needs, performance
appraisal, etc. A computer based data can enhance such decisions and make them
objective. When the criteria are known and systems are used, the decisions are
perceived to be unbiased and fair.
A typical Human Resource Information System (HRIS) includes the Bio-data
(Name, Gender, Address, Age, Insurance Policy, Blood Group, etc.), Educational a
Professional Qualifications, Organizational History (Placements, Promotions, Tra
Competencies, Performance Appraisal), Salary and Allowances, etc.
Maintenance of Database, Access Control and Use for Decision Making
It is evident from the contents of HRIS database mentioned above that all data
do not need updating frequently. Some of the static data required to be entered
once in master file, viz., name, date of birth, date of joining, etc. Data on pl
training, etc., are upgraded frequently. Secondly, all sections of data are not
needed by
all. The computer technology gives scope for having partial access to such secti
enabling a number of individuals to have simultaneous access to basic data for
upgrading or analysis. It can also be possible to maintain the confidentiality o
f some part
of data like performance appraisal data, etc., which can be allowed to be access
ed by
selected persons through implementing software supported access control measures
through assignment/restriction of permissions.
The database also makes it possible to have any kind of analysis. For instance,
for any reviews, the analysis could be done on variables like age, gender, geogr
regions, level in the organization, etc. Such simple analysis can enhance review
s. The
analysis could also help in deciding about training placement or career planning
of an
individual as it can consider the past experience of an individual and indicate
the gaps that need to be filled. HRIS, thus, is not only a desired database syst
em but an
imperative decision support system. Newer and newer software tools are available
help in organizing, classifying, analyzing, querying and mining the data from th
databases. The Decision Support System (DSS), Expert Systems, Structured Query

Language (SQL), Artificial Intelligence, Data warehouse and Data Mining tools he
lp not
only in accessing the relevant data but also help the decision-maker to take a b
etter and
well informed decision. Thus, the database does not remain passive on the hard d
isk of
the computer, it is kept in such an active way that it itself prompts the decisi
on-maker to
use it from time to time depending upon the need of any activity involving use o
f data for
arriving at a decision.
Check Your Progress (B)
State whether the following statements are True or False:
1. Database is useful only for taking decisions regarding training and placement
. .
2. Decisions based on computerized data can improve the objectivity, fairness an
perceived as unbiased in decision-making. . True.
3. Human Resource Information System (HRIS) can be used for taking vital decisio
relating to individual employees. . True.
4. Computerized database can allow only one person to access it at a time. . Fals
5. Confidentiality cannot be maintained in computerized data as it can be access
ed by
anyone from any location. . False.
6. Intelligence for decision making cannot be embedded into the computerized sys
. False.
One of the primary orientations of the future organizations is to develop a
problem-solving perspective. As such a research orientation is a necessity in al
all the more in HRM. For instance some problems related to business
parameters would get such attention through the usual activities of market share
analysis, surveys, etc., as they are reflected obviously in the tangible dimensi
ons of the
business performance. But for HRM, a conscious effort to identify the issues is
Research in HRM areas can be undertaken to understand: (a) trends of existing
systems like recruitment, promotion, training, appraisal system, etc., and (b) t
o feel the
pulse of the workforce in terms of their motivation, commitment, expectations, f
and so on. With reference to systems, a regular review by looking at the analysi
s of
'what is happening' can also be undertaken. For instance, a comparison of the ap
population and finally the selected one can indicate biases or prejudices
if any
, that
are present in the selection strategy being used. It will help to understand the
profile of
new entrants which can then be compared with the existing one to identify if the
re is any
mismatch that might affect their working together. The analysis on the variables
education (discipline and level of achievement), gender, regional representation
, can be valuable for taking proactive steps. The research on methods and the be

st practices
adopted by different organizations and their relevance and applicability can als
o be
studied through HR research initiatives as part of organizational development an
change management process.
Other important subsystems in this regard are: Promotions, Performance,
Appraisal and Training. Very simple analysis and research can, at times throw up
problem, indicating the need for a policy revision.
For a better understanding of the intangible environment which is very critical,
climate or a job satisfaction survey can provide data for action. It can also be
meaningful feedback to the management to ensure that some of the things stated i
n the
HR philosophy are actually being felt by the employees or otherwise.
In the framework of strategic FIRM too, research is viewed as an integral
component. Since one of the functions of HRM is to remain sensitive to internal
external environment, a research perspective is imperative. HR functionaries can
afford to be happy while maintaining a status quo. Dynamism is an imperative for
progress and growth.
To remain sensitive to internal environment, regular opinion surveys,
benchmarking, climate studies, etc., have to be conducted. In the proactive appr
oach to
FIRM these surveys would throw signals of change which the HR functionaries need
pick-up for drawing up future strategies.
Check Your Progress (C)
State whether the following statements are True or False:
1. Research orientation in HRM is not as necessary as in other functions. . False
2. HR research is helpful to feel the pulse of the workforce. . True.
3. Cost of HR Research is much higher than its perceived benefits. . False.
4. HR research has not been given due importance in banks. . True.
5. To remain sensitive to internal environment, regular opinion surveys, climate
etc., should be conducted. . True.
6. People do not take interest in surveys, therefore the surveys are useless. . F
7. For a better understanding of the intangible environment which is very critic
al, a
climate or a job satisfaction survey can provide data for action. . True.
The information and the knowledge are considered most active resources for
competitive success and strategic decision-making. In this knowledge era, knowle
creation and deployment has certainly moved to the centre stage of organization'
priorities. Thus, the Organizational experts are talking about knowledge managem
ent as
a vital task for organizations. Primarily knowledge management refers to the pro
cess of creating knowledge, storing, distributing and pooling it (Wilcox, 1997).
These processes
have implication for all the subsystems of the organizations. The people in an
organization are the sources of creating knowledge, while the storing and distri

the information is the responsibility of information technology machinery of the

organization. Pooling the knowledge depends on the culture, inter-personal inter
and other management processes. Ultimately, the individuals have to explicitly s
their thinking, rationale, basis of judgment so that it can be stored and used i
n similar
situations by others. Obviously, management of the 'knowledge workers' is a very
critical issue and cannot be done by the traditional, bureaucratic processes. Th
knowledge based economy needs to recognize the value of human capital and the
knowledge workers need to be continually re-skilled'. Thus, the knowledge manage
is the process of capturing the tacit knowledge of people in a systematic manner
future use. New knowledge and new skills are required to manage the new challeng
due to deregulation, globalization and technological advancements for speeding u
p of
processes and acquiring competitive edge.
Knowledge management is gaining more and more prominence in the light of the
fact that it is not sure whether an employee who has been developed by the
organization will remain for long with the organization. The obvious and direct
implications of this are visible in IT industry. With the attrition rate going h
particularly in the Information Technology Industry, this trend is already visib
However, it is applicable everywhere else too. The banks in India have also been
affected by this trend. Public Sector Banks have lost a good number of competent
employees who have joined the new private sector banks and foreign banks at lucr
remunerations. The work will not remain the same when we put *Knowledge' and
'Innovations' as strategies to face competition. In any service industry particu
larly in
banks the knowledge management will become a need as well as a strategy.
These had been aptly highlighted by Nonaka and others (1995) in their book
titled 'The Knowledge-Creating Company' wherein they have documented their
exploration of success of Japanese companies. They have defined the Organization
knowledge creation as 'the capability of a company as a whole to create new
knowledge, disseminate it through the organization and embody it in products, se
and systems'.
This implies that an industry or organization which adopts 'Knowledge
Management' as a strategy will have to do the basic exercise of identifying who
are the
knowledge workers. They could be seen in different categories as knowledge creat
handlers, processors and so on. Since knowledge is critical, managing all these
critical too. Organizations will have to examine their management processes with
a view
to utilizing their knowledge workers.
Developments in technology have dramatically increased the potential leverage
of trainer and opened up a number of new and more sophisticated options for lear

The opportunities presented by technological advancements could bring about dras
changes in training techniques and could substantially bring changes in training
methodology. The technology offers an opportunity in tailoring and designing tr
intervention to suit individual learners. Its main advantage is its cheap mass p
of user friendly learning material. It allows an element of choice to the learne
r. Trainer
and trainee(s) are physically separate. Technology has provided a lot many
opportunities for open learning. Trainee has the flexibility to chose time, plac
e and form
convenient for learning. Technology based training methods help in Distance lear
Communication technology facilitated anywhere learning. Graphic user interface (
and interactive software have helped in developing e-Learning packages. It is a
powerful tool for distance learning. The learner has the choice of control and r
through the programme depending upon his individual needs. The use of multimedia
has improved the effectiveness of the e-Learning packages. Communication technol
has provided the facility of remote logging.
IT has provided various technology driven options for learning in the form of
interactive multimedia (i.e. audio, interactive video, animation, graphics), ele
publishing, video conferencing, computer simulation and virtual reality that enh
the speed and quality of learning and training at work place.
Advantages of E-Learning
1. Enables learner to study at his convenient time and place and can have privac
2. Enables him to study at his own pace
3. Can offer high level inter-action with immediate feedback and provide opportu
nity to
check his understanding
4. Can be simulated to real life situation
5. Can be cost effective depending upon its use
Disadvantages of E-Learning
1. Relatively inflexible depending on a pre-produced programme
2. Requires greater self-discipline and commitment by the learner
3. May induce a sense of isolation
4. Does not permit personal reinforcement, therefore, the motivational effects a
5. Can prove costly as expensive H1W and S/W are required
Emerging Trends
Animation software, fusion of computer and communication technology, image
processing and video conferencing all will simulate the learning to the real lif
e situation.
Artificial Intelligence (AI) technologies viz. Expert/Knowledge-based systems, s
and natural language understanding, user interfaces, sensory perception, will be
commonly available. The interactive video disc with a video camera can help in r
oleplay exercises. The multimedia aids will be the part and parcel of any training
exercise.Check Your Progress (D)

State whether the following statements are True or False:

1. Knowledge management most closely refers to capturing tacit knowledge of peop
for future use. . True.
2. Technology offers an opportunity in tailoring and designing training interven
tion to suit
individual learner. . True.
3. Enables learner to study at his convenient time and place and can have privac
y. .
4. Cannot simulate to real-life situation. . False.
5. Communication technology facilitated anywhere learning. . True.
6. Technology-driven training has made the trainers totally redundant. . False.
Let Us Sum Up
In this unit we have discussed the use and application of Information Technology
in HRM. The HR Research is getting prominence as a feedback mechanism for the
management to review the HR policies. The Use of HRIS as a database for HR relat
decisions like posting, promotions, performance appraisal, etc has been highligh
ted in
this unit. We have also examined how the twenty first century is going to have
knowledge workers pivotal to the economy and how the Information Technology is
going to play a critical role in transforming the entire concept of work. Inform
ation will
play an important role in strategic decision-making.
The organizations will have to be geared for this change and the challenge
before HR functionaries would be to prepare the individuals and, create conditio
ns and
processes that will enable the individuals to contribute to the environment wher
innovations and risk-taking are encouraged.
The HRM can initiate this orientation by adopting IT in its own functioning. Eve
otherwise, there are reasons why HR database needs to be created and maintained.
Indeed, data-based decision-making is going to be the order of the day. Such dat
can also be meaningfully utilized for research in HRM. HR research can help the
organizations to feel the pulse of the workforce. The application of technology
in training
for enhancing effectiveness of training has also been discussed. The computer an
communication technology has created immense opportunities for the trainers and
learners where the trainer has access to variety of training tools and the learn
er has the
flexibility to chose time, place and form convenient for learning.
Information Age; Information Technology; Computer Technology; Information Highwa
Human Resource Information System; Database Management; Structure of HR
Database; Decision Support System; Expert System; Artificial Intelligence; HR
Research; Climate Studies; Knowledge Management; Data warehouse and Data
Mining; E-learning.Answers to Check Your Progress
1. False; 2. True; 3. False; 4. False; 5. True; 6. True; 7. False
1. False; 2. True; 3. True; 4. False; 5. False, 6. False
1. False; 2. True; 3. False; 4. True; 5. True; 6. False; 7. True 1). 1. True; 2.
True; 3.
True; 4. False; 5. True; 6. False

Terminal Questions
1. How is twenty first century going to be a different challenge of HR managemen
2. Does IT have any relevance to HRM besides the activity of developing computer
related skills in the employees'?
3. Briefly describe the use of IT in different HRM functions.
4. Why does HRM need an information system?
5. What is the significance of having HR database? What kind of data can be stor
6. What is the significance of HR Research? Describe briefly the areas of HR res
which can be useful in Indian Banks for HR policy formulation.
7. What is Knowledge Management (KM)? Describe the need, structure and use of KM
system in present context.
8. Discuss the application of technology in training. Can technology replace hum
interface completely?
Suggested for Further Readings
Prabhat, G B, The 3-D Competitive Space
Managing in the New Economy, Tata
McGraw-Hill, New Delhi, 1997.
Mankidy, J, 'Employment Relations: The Trend Towards Individualism'. Indian Jour
of industrial Relations, Vol. 33, No. 3, Jan. 98.
This is the end of chapter 25, of ADVANCED BANK ANAGEMENT- C
A I I B PAPER 1 - HRM and Information Technology. Advanced Bank Management
26 UNIT Overview of Credit Management
26.0 Objectives
26.1 Importance of Credit
26.2 Historical Background of Credit in India
26.3 Principles of Credit
26.4 Types of Borrowers
26.5 Types of Credit
26.6 Components of Credit Management
26.7 Role of RBI Guidelines in Bank's Credit Management
After reading this chapter, you will have better understanding of:
1. the importance of credit and its historical background in India,
2. types of credit, types of borrowers, principles of lending,
3. RBI influence in credit management of a bank,
4. components of credit management.
Credit plays an important role in driving the national economy. It provides
leverage to an entrepreneur to undertake a project larger than what he could hav
undertaken without availability of credit. This results in accelerated industria
l production
and services. It also enables individuals to first purchase/create assets and re
pay the
loan from their future earnings. Credit also enables a consumer to spend more th
what he would have otherwise spent. The increased demand drives the producers to
step up the production. Thus, adequate and cheap availability of credit propels
economy to higher growth trajectory. But, let us also look at the other side of
the coin.

There is always a time lag between increase in demand and creation of supply to
that demand. That is why excessive availability of credit, specially, for nonpro
purposes, puts inflationary pressure on the economy. Sometimes, Reserve Bank of
India has to use the monetary tools available to it, like Bank rate, CPR, SLR, e
tc., to
control credit so as strike a balance between economic growth and inflation.26.2
Private moneylenders have traditionally played an important role in meeting the
credit requirements of individuals in India, though it has caused its own socioeconomic
problems like rural indebtedness and creation of rural landless population. The
was aggravated due to high level of illiteracy/financial illiteracy. With the gr
owth of
banking sector, this problem has been tackled to a great extent even though the
banking sector credit has sometimes been misused as a means of achieving politic
ends. Nationalization of banks in 1969 was a watershed event in the history of c
flow from the banking sector. Prior to nationalization, the flow of credit was m
towards big business houses who often had an ownership/management interest in th
banks. After nationalization, RBI exercised greater control on the banks and ens
that more credit flows to the hitherto neglected sectors of the economy. The con
cept of
'Priority Sector' became an integral part of the banking system as RBI ensured t
hat a
substantial portion of bank credit flows to this sector.26.3 PRINCIPLES OF CREDI
Over a period of time, bankers have evolved certain basic principles for their
lending operations. Bank's loan policies, and other aspects of credit management
, are
influenced to a great extent by these unwritten principles, which are as under:
1. safety of funds
2. purpose
3. profitability
4. liquidity
5. security
6. risk spread
A borrower can be:
1. An individual
2. Sole proprietary firm
3. Partnership firm and joint ventures
4. Hindu undivided family
5. Companies
6. Statutory corporations
7. Trusts and co-operative Societies
The laws applicable to all these different kinds of borrowers are different.
Individuals are governed by the Indian Contract Act, partnership firms by the In
Partnership Act, Hindu undivided family by the customary laws pertaining to Hind
companies by the Companies Act, statutory corporations by the Acts that created
trusts by the Indian Trusts Act, Public Trusts Act, Religious and Charitable End

Act, Wakf Act and Co-operative Societies by the Co-operative Societies Act or th
Societies Registration Act.
Bank credit can be either fund-based or non fund-based. In fund-based credit,
there is actual transfer of money from the bank to the borrower. In non fund bas
credit, there is no transfer of money, but the commitment by the bank on behalf
of the
client, may result in future transfer of money to the beneficiary of such a comm
Example of this is a bank guarantee issued in favour of government departments (
any other beneficiary) on behalf of a contractor, who is bank's customer. If the
beneficiary invokes the guarantee, the bank will have to remit the amount to it
and the client, for whom guarantee was issued, will be liable to pay this amount
to the bank.
Thus, a non fund-based credit always has a possibility of getting converted into
a fundbased credit.
Apart from guarantees, the other forms of non fund based credit are letters of
credit, co-acceptance of bills, forward contracts, and derivatives.
The fund based credit can be further divided, based on period, as short term
credit or long term credit (term loan)
Credit can also be classified based on purpose, like working capital finance,
project finance, export finance, crop loan, etc. Banks often classify their cred
it portfolio
based on the type of the customers like, Corporate, retail, agriculture, interna
institutional credit, etc.
RBI guidelines
The banks have to report their business, for public reporting purposes, based on
the geographical segments, as 'domestic' and 'international'. In addition, as pe
guidelines, banks have adopted the following business segments, for public repor
purposes, from March 31, 2008:
1. Treasury
2. Corporate/Wholesale Banking Retail Banking
3. Other Banking Business
An indicative list of items to be included under each category is as under:
(a) Treasury
Treasury for the purpose of Segment Reporting should include the entire
investment portfolio.
(b) Retail Banking
The Retail Banking would include exposures which fulfill the following four crit
of orientation, product, granularity and low value of individual exposures for r
exposures laid down in Basel Committee on Banking Supervision document
'International Convergence of Capital Measurement and Capital Standards: A Revis
1. Orientation Criterion: The exposure is to an individual person or persons or
to a
small business; Person under this clause would mean any legal person capable of
entering into contracts and would include but not be restricted to individual, H

partnership firm, trust, private limited companies, public limited companies, co
societies, etc. Small business is one where the total annual turnover is less th
an Rs. 50
crore. The turnover criterion will be linked to the average of the last three ye
ars in the
case of existing entities and projected turnover in the case of new entities.
2. Product Criterion: The exposure takes the form of any of the following: revol
credits and lines of credit (including overdrafts), term loans and leases (e.g.
instalment loans and leases, student and educational loans) and small business f
acilities and
3. Granularity Criterion: No aggregate exposure to one counterpart should exceed
per cent of the overall retail portfolio. 'Aggregate exposure' means gross amoun
t (i.e.
not taking any benefit for credit risk mitigation into account) of all forms of
exposures (e.g. loans or commitments) that individually satisfy the three other
criteria. In
addition, 'one counterpart' means one or several entities that may be considered
as a
single beneficiary (e.g. in the case of a small business that is affiliated to a
nother small
business, the limit would apply to the bank's aggregated exposure on both busine
4. Low Value of Individual Exposure: The maximum aggregated retail exposure to
one counterpart should not exceed the absolute threshold limit of Rs.5 crore.
(c) Corporate and Wholesale Banking
Wholesale Banking includes all advances to trusts, partnership firms, companies
and statutory bodies, which are not included under 'Retail Banking'.
(d) Other Banking Business
'Other Banking Business' would include all other banking operations not covered
under 'Treasury', 'Wholesale Banking' and 'Retail Banking' segments. It will als
o include
all other residual operations such as para banking transactions and activities.
Loan Policy of the Bank
Each bank formulates its own loan policy and sanction of any credit proposal has
to be within the framework of this policy. The formulation of loan policy is inf
luenced by
various factors like market conditions, policies of the competitors, bank's own
analysis and, of course, the RBI guidelines. The loan policy normally contains
guidelines about the following aspects:
1. Exposure limits for single borrowers and groups
2. Exposure limits for individual sectors like real estate, capital market, stee
l, cement,
software etc. This is under constant watch of the bank and if bank's perception
any particular sector deteriorates, the exposure limit is reduced suitably and f
sanctions of credit proposals, pertaining to that sector, are curtailed. In such
bank may even decide to exit some of the existing accounts by formulating suitab
le exit
strategies .The loan policy also covers the thrust areas, low priority areas etc

3. Discretionary powers at various levels for sanctioning of credit proposals. N
the policy also lays down the powers of various authorities for allowing over
drawings/ad-hoc limits.
AppraisalBefore a lender agrees to give his money to a borrower, as per his prop
osal, a
few questions arise in his mind. Normally, these questions are as follows:
1. Is the borrower trustworthy?
2. What is he going to do with my money'? Is the project/activity, where he is g
oing to
put this money, viable? What are the risks involved?
3. Should I give him the amount he has asked for or, a different amount?
4. What should be the terms of repayment, interest rate etc.
5. What covenants should be prescribed to have effective monitoring of the proje
ct and
activity in which money is invested
6. Should I take any collateral security or personal guarantee.
7. How should charge be created over primary/collateral security? What documents
should be taken to enforce my claim in a court of law in case of default?
The process of finding the answers to the above questions is credit appraisal.
The complexity of this appraisal will depend on various factors like, amount inv
duration and purpose of loan, category of borrower, risks involved, security ava
RBI guidelines etc. Thus, appraisal for a small crop loan or a vehicle loan will
different from that for an industrial project. For appraisal, the tender will no
depend on some or all of the following information/records, depending upon the
uniqueness of each case.
1. The background, credit history, market reports of the borrower.
2. The financial track record of the borrower as represented by the financial st
Where these statements are not available, as in case of most of the individuals,
the net
worth and repayment capacity is judged by collecting details of assets and liabi
lities and
sources of income.
3. Techno-economic feasibility report of the activity proposed; The details requ
ired in
this depend on the nature of activity and amount of loan. The purpose is to ensu
re that
there is reasonably high probability of the activity being successful and bank g
back its principal and interest in time. Mostly, in case of industrial projects
only a
detailed project report is prepared by the competent agency. In other cases, the
is judged by the analysis of past track record, present financial position, sour
ces of
income, expenditure and bank's own judgment
4. Securities available, their value and realisability.
This relates to legal aspects of documentation and creation of charge over
security .This also covers the method of delivery ( like loan or cash credit in
case of
working capital limits) and procedures for disbursal of a term loan.
Control and Monitoring

This is necessary not only to ensure end use of the bank's funds but also to ens
safety of it. An efficient monitoring is in the interest of the borrower as well
, as the bank
can provide timely help in case of unforeseen difficulties. It is very important
for the bank as any delay in taking suitable action in cases of activity not be
ing carried out as
projected, reduces the chances and amount of recovery of bank's funds.
Rehabilitation and Recovery
Even with best of loan policies, appraisal, delivery, control and monitoring, cr
default is possible either due to genuine business problems or due to intentiona
l (called
willful) default. In the first case, the banks normally examine the feasibility
of providing
additional assistance, concessions, re-phasing etc. to help the enterprise to ma
ke its
operations viable again. The widely known terms like rehabilitation of sick SSI
units and
Corporate Debt Restructuring (CDR) are part of this process. However, if rehabil
itaion is
not considered feasible or, if the rehabilitation process does not yield the des
results, and in case of willful defaults, bank has to start the recovery process
Credit Risk Management
Credit risk is a major risk faced by a bank and it is very important that suitab
policies are put in place to identify, measure and control this risk within acce
'This aspect of credit management assumes importance in times of tight liquidity
position. There are elaborate norms for availing refinance from NABARD, SIDBI, R
etc., in respect of certain priority sector advances. However, even if a bank av
ails of
refinance for eligible advances, the risk remains with the bank. Therefore, this
does not affect bank's decision on a credit proposal.
RBI has a direct influence on credit management of any bank in India. In fact,
keeping abreast with RBI guidelines and ensuring their compliance is an importan
t work
of the credit department of any bank. Following are some of the important RBI an
Government guidelines or policies, which directly influence the credit managemen
t of a
End Use of the Funds
It is the primary responsibility of banks to ensure proper end use of bank
funds/monitor the funds flow. It is, therefore, necessary for banks to evolve su
arrangements as may be considered necessary to ensure that drawals from cash
credit/overdraft accounts are strictly for the purpose for which the credit limi
ts are
sanctioned by them. There should be no diversion of working capital finance for
acquisition of fixed assets, investments in associate companies/subsidiaries, an

acquisition of shares, debentures, units of mutual funds, and other investments
in the
capital market.
Priority Sector(For complete details, RBI Master circular dated 1
July, 2009,, available on their
website may be referred.)
RBI, as regulator of banks in India, decides about the sectors which are include
in the priority sector, as also, the minimum percentage of total credit of a ban
k which
should go to this sector. Priority sector lending by commercial banks is monitor
ed by
Reserve Bank of India through periodical 'Returns' received from them. Performan
ce of
banks is also reviewed in the various forums set up under the Lead Bank Scheme (
State, District and Block levels).
The main sectors, included in the priority sector are as follows:
1. Agricultural finance
2. Finance to micro and small enterprises
3. Housing finance [( loans up to Rs 20 takh to individuals for purchase or cons
of dwelling unit), Loans up to Rs I lakh and Rs 2 lash for repairing of houses i
n rural or
semi-urban and urban areas respectively].
4. Educational loans(up to Rs 10 lakh for studies in India and Rs 20 lakh for st
5. Export credit: export credit by domestic banks is not treated as finance to p
sector for the purpose of priority sector target. But, export credit by foreign
banks is
treated as finance to priority sector.
6. Micro-credit provided by banks either directly or through any intermediary: L
oans to
self help groups (SHGs) [Non Governmental Organizations (NGOs) for on-lending to
7. Retail trade
8. Khadi and Village Industries Sector (KVI);All advances granted to units in th
sector, irrespective of their size of operations, location and amount of origina
investment in plant and machinery, are covered under priority sector advances a
nd are
eligible for consideration under the sub-target (60 per cent) of the small enter
segment within the priority sector.
Bank's lending to medium enterprises is not included for the purpose of
reckoning under the priority sector.
Targets for Priority Sector Lending
The targets and sub-targets set under priority sector lending for domestic and
foreign banks operating in India are furnished here: (Figures are given as per c
ent of
Adjusted Net Bank Credit (ANBC) or credit equivalent amount of Off-Balance Sheet
Exposure, whichever is higher)
Segment a , Total Priority Sector advances,, Target for Domestic Banks, both public

and private sectors, 40 per cent and Target for Foreign Banks operating in India
, 32 per
Segment b , Total Agricultural advances,, Target for Domestic Banks, both public an
private sectors, 18 per cent and Target for Foreign Banks operating in India, No
target. Segment c , Small enterprise advances,, Target for Domestic Banks, both pu
blic and
private sectors, No target and Target for Foreign Banks operating in India, 10 p
er cent.
Segment d , Export Credit,, Export credit does not form part of priority sector.
Segment e , Advances to weaker sections,, Target for Domestic Banks, both public
and private sectors, 10 per cent and Target for Foreign Banks operating in India
, No
The weaker sections under priority sector include the following:
1. Small and marginal farmers with land holding of 5 acres and less and landless
labourers, tenant farmers and share croppers.
2. Artisans, village and cottage industries where individual credit
t exceed Rs
50,000/3. Beneficiaries of Swarnjayanti Gram Swarojgar Yojana (SGSY)
4. Scheduled Castes and Scheduled Tribes
5. Beneficiaries of Differential Rate of Interest (DRI) scheme
6. Beneficiaries under Swama Jayanti Shahari Rojgar Yojana (SJSRY)
7. Beneficiaries under the Scheme for Liberation and Rehabilitation
8. Self Help Groups (SHGs)
MSMED Act 2006
The MSMED Act, 2006 has modified the definition of micro, small and
enterprises engaged in manufacturing or production and providing or

limits do no

of Scavanger

rendering of

services. This Act provided the comprehensive rules pertaining to both the
manufacturing and service enterprises in the MSM sector and has cleared much of
apprehension/confusion in the minds of bankers regarding definition, guidelines,
targets etc pertaining to this sector .The details can be seen in Master Circula
r No.
RPCD.SME & NFS. BC. No. 10/ 06.02.31/ 2009-10 dated 1
July 2009 on RBI website
The definition of Micro, Small and Medium Enterprises is as follows:
(a) Enterprises engaged in the manufacture or production. processing or
preservation of goods
1. A micro enterprise is an enterprise where investment in plant and machinery d
not exceed Rs. 25 lakh;
2. A small enterprise is an enterprise where the investment in plant and machine
ry is
more than Rs. 25 lakh but does not exceed Rs. 5 crore;
3. A medium enterprise an enterprise where the investment in plant and machinery
more than Rs. 5 crore but does not exceed Rs.10 crore.In case of these enterpris
es, investment in plant and machinery is the original
cost excluding land and building and the items specified by the Ministry of Smal

l Scale
(b) Enterprises engaged in providing or rendering of services and whose
investment in equipment (original cost excluding land and building and furniture
, fittings
and other items not directly related to the service rendered or-as may be notifi
ed under
the MSMED Act, 2006) are specified as follows:
1. A micro enterprise is an enterprise where investment in equipment does not
exceed Rs. 10 lakh;
2. A small enterprise is an enterprise where the investment in equipment is more
Rs. 10 lakh but does not exceed Rs. 2 crore;
3. A medium enterprise an enterprise where the investment in equipment is more
than Rs. 2 crore but does not exceed Rs.5 crore.
These include small road and water transport operators, small business,
professional and self-employed persons and all other service enterprises.
Credit Exposures Norms
1. For Individual or Group Borrowers: The exposure ceiling limits are 15 per cen
t of
capital funds in case of a single borrower and 40 per cent of capital funds in t
he case of
a borrower group. The capital funds for this purpose comprise of Tier I and Tier
capital as defined under capital adequacy standards .Credit exposure to a single
borrower may exceed the exposure norm of 15 per cent of the bank's capital funds
an additional 5 per cent (i.e. up to 20 per cent) and to borrowers belonging to
a group
may exceed the exposure norm of 40 per cent of the bank's capital funds by an
additional 10 per cent (i.e., up to 50 per cent), provided the additional credit
exposure is
on account of extension of credit to infrastructure projects. In addition to the
permitted above, banks may, in exceptional circumstances, with the approval of t
Boards, consider enhancement of the exposure to a borrower (single as well as gr
up to a further 5 per cent of capital funds subject to the borrower consenting t
o the
banks making appropriate disclosures in their Annual Reports. With effect from M
ay 29,
2008, the exposure limit in respect of single borrower has been raised to twenty
five per
cent of the capital funds, only in respect of Oil Companies who have been issued
Bonds (which do not have SLR status) by Government of India. In addition to this
banks may, in exceptional circumstances, consider enhancement of the exposure to
Oil Companies up to a further 5 per cent of capital funds. The bank should make
appropriate disclosures in the 'Notes on account' to the annual financial statem
ents in
respect of the exposures where the bank had exceeded the prudential exposure lim
during the year.
2. For Exposures to NBFCs: The exposure (both lending and investment, including
balance sheet exposures) of a bank to a single NBFC/NBFC-AFC (Asset Financing

Companies) should not exceed 10 per cent/ 15 per cent respectively, of the bank'
capital funds, as per its last audited balance sheet. Banks may, however, assume
exposures on a single NBFC/NBFC-AFC up to 15 per cent/20 per cent respectively,
their capital funds provided the exposure in excess of 10 per cent/15 per cent
respectively, is on account of funds on-lent by the NBFC/NBFC-AFC to the
infrastructure sector. Further, banks may also consider fixing internal limits f
or their
aggregate exposure to all NBFCs put together. Infusion of capital funds after th
published balance sheet date may also be taken into account for the purpose of
reckoning capital funds. Banks should obtain an external auditor's certificate o
completion of the augmentation of capital and submit the same to the Reserve Ban
k of
India (Department of Banking Supervision) before reckoning the additions to capi
The exposure limits are also applicable to lending under consortium
arrangements and bills discounted under Letter of Credit (LC) (where the payment
the beneficiary is made 'under reserve'). However, the ceilings on single/group
exposure limits are not applicable to existing/additional credit facilities (inc
luding funding
of interest and irregularities) granted to weak/sick industrial units under reha
packages .These are also not applicable to borrowers to whom limits are allocate
directly by the Reserve Bank for food credit as also to loans where principal an
d interest
are fully guaranteed by the Government of India. Loans and advances (both funded
non-funded facilities) granted against the security of a bank's own term deposit
s are not
to be reckoned for computing the exposure to the extent that the bank has a spec
lien on such deposits. The ceiling on single or group borrower exposure limit is
also not
applicable to exposure assumed by banks on NABARD.
Interest Rates on Lending
(details as per RBI circular No. Dir. BC. 14/13.03.00/2008-09 dated 1, July 2008
(1) Regulated Rates
An objective of financial sector reform has been to ensure that the financial
repression, inherent in administered interest rate, is removed. Accordingly, in
context of granting greater functional autonomy to banks, effective 18, October
1994, it
was decided by the RBI to free the lending rates of scheduled commercial banks f
credit limits of over Rs. 2 lakh. For loans up to Rs. 2 lakh, it was decided tha
t it was
necessary to 'continue to protect these borrowers by prescribing the lending rat
es. For
credit limits up to Rs.2 lakh, banks should charge interest not exceeding their
credit limits of over Rs.2 lakh, the prescription of minimum lending rate was ab
and banks were given the freedom to fix the lending rates for such credit limits

to BPLR and Spread guidelines . Banks are now required to obtain the approval of
respective Boards for the Benchmark Prime Lending Rate (BPLR), which would be th
reference rate for credit fruits of over Rs.2 lakh. Each bank's BPLR has to be d
and be made uniformly applicable at all branches. Banks have to declare the maxi
spread of interest rates over BPLR.
Banks are free to determine the rates of interest without reference to BPLR and
regardless of the size in respect of loans for purchase of consumer durables, lo
ans to
individuals against shares and debentures/ bonds, other non-priority sector pers
loans, etc. The interest rate directives on advances granted by banks are also n
applicable to loans or advances or other financial accommodation provided by a s
cheduled bank to its own employees or co-operative credit societies formed by th
banks' staff members for lending to constituents (i.e. staff of the bank).
Introduction of Base Rate: The BPLIZ system, introduced in 2003, fell short of i
original objective of bringing transparency to lending rates. This was mainly be
under the BPLR system, banks could lend below BPLR. For the same reason, it was
also difficult to assess the transmission of policy rates of the Reserve Bank to
rates of banks. In view of this, RBI has decided that banks switch over to the s
ystem of
Base Rate with effect from 1, July 2010. The Base Rate system is aimed at enhanc
transparency in lending rates of banks and enabling better assessment of transmi
of monetary policy. Accordingly, the following guidelines are issued for impleme
by banks as per RBI circular RBI / 2009-10/390, DBOD. No. Dir. BC M 113.03M/2009
10 dated April 9, 2010).
1. The Base Rate system will replace the BPLR system with effect from 1, July
2010. Base Rate shall include all those elements of the lending rates that are c
across all categories of borrowers. Banks may choose any benchmark to arrive at
Base Rate for a specific tenor that may be disclosed transparently. Banks are fr
ee to
use any other methodology, as considered appropriate, provided, it is consistent
and is
made available for supervisory review or scrutiny, as and when required.
2. Banks may determine their actual lending rates on loans and advances with
reference to the Base Rate and by including such other customer-specific charges
considered appropriate.
3. In order to give banks some time to stabilize the system of Base Rate
calculation, banks are permitted to change the benchmark and methodology any tim
during the initial six month period, i.e. end-December 2010.
4. The actual lending rates charged may be transparent and consistent and be
made available for supervisory review/scrutiny, as and when required.
5. All categories of loans should henceforth be priced only with reference to th

Base Rate. However, the following categories of loans could be priced without
reference to the Base Rate: (a) DRI advances (b) loans to banks' own employees (
loans to banks' depositors against their own deposits.
6. The Base Rate could also serve as the reference benchmark rate for floating
rate loan products, apart from external market benchmark rates. The floating int
rate based on external benchmarks should, however, be equal to or above the Base
Rate at the time of sanction or renewal.
7. Changes in the Base Rate shall be applicable in respect of all existing loans
linked to the Base Rate, in a transparent and non-discriminatory manner.
8. Since the Base Rate will be the minimum rate for all loans, banks are not
permitted to resort to any lending below the Base Rate. Accordingly, the current
stipulation of BPLR as the ceiling rate for loans up to Rs. 2 lakh stands withdr
awn. It is
expected that the above deregulation of lending rate will increase the credit fl
ow to small
borrowers at reasonable rate and direct bank finance will provide effective comp
to other forms of high cost credit.9. Reserve Bank of India will separately anno
unce the stipulation for export
10. Banks are required to review the Base Rate at least once in a quarter with
the approval of the Board or the Asset Liability Management Committees (ALCOs) a
per the bank's practice. Since transparency in the pricing of lending products h
as been
a key objective, banks are required to exhibit the information on their Base Rat
e at all
branches and also on their websites. Changes in the Base Rate should also be
conveyed to the general public from time to time through appropriate channels. B
are required to provide information on the actual minimum and maximum lending ra
to the Reserve Bank on a quarterly basis, as hitherto.
11. The Base Rate system would be applicable for all new loans and for those
old loans that come up for renewal. Existing loans based on the BPLR system may
till their maturity. In case existing borrowers want to switch to the new system
, before
expiry of the existing contracts, an option may be given to them, on mutually ag
terms. Banks, however, should not charge any fee for such switch-over.
12. In line with the above Guidelines, banks may announce their Base Rates
after seeking approval from their respective ALCOs/ Boards.
(2) Periodicity of Charging interest on Advances
The interest at the specified rates should be charged at monthly rests (subject
certain conditions ) and rounded off to the nearest rupee. Banks should club ter
m loans
and working capital advances together for the purpose of determining the size of
loan and the applicable rate of interest.
Instructions on charging interest at monthly rates are not applicable to
agricultural advances and banks should follow the practice of charging/compoundi
ng of

interest on agricultural advances linked to crop seasons. Banks should charge in

on agricultural advances for long duration crops at annual rates. As regards oth
agricultural advances in respect of short duration crop and allied agricultural
such as dairy, fishery, piggery, poultry, bee-keeping, etc., banks should take i
consideration due dates fixed on the basis of fluidity with borrowers and
harvesting/marketing season, while charging interest and compounding the same, i
f the
loan or installment becomes overdue. Further, banks should ensure that the total
interest debited to an account should not exceed the principal amount in respect
short term advances granted to small and marginal farmers.
(3) Fixed or Floating Rate of Interest on Loans
RBI guidelines in this regard are as under:
'Banks have the freedom to offer all categories of loans on fixed or floating ra
subject to conformity to their Asset-Liability Management (ALM) guidelines. In o
rder to
ensure transparency, banks should use only external or market-based rupee
benchmark interest rates for pricing of their floating rate loan products. The
methodology of computing the floating rates should be objective, transparent and
mutually acceptable to counter parties. Banks should not offer floating rate loa
ns linked
to their own internal benchmarks or any other derived rate based on the underlyi
ng.'(4) Penal rate of Interest
With effect from 10, October 2000, banks have been given the freedom to
formulate a transparent policy for charging penal interest with the approval of
Board of Directors. However, in the case of loans to borrowers under priority se
ctor, no
penal interest should be charged for loans up to Rs.25,000. Penal interest may b
levied for reasons such as default in repayment, non-submission of financial
statements, etc. However, the policy on penal interest should be governed by wel
laccepted principles of transparency, fairness, incentive to service the debt and
difficulties of customers.
Collateral Security
Banks are free to decide about the collateral security to be obtained for the lo
granted by them. However, RBI has instructed that banks should not obtain collat
security for certain categories of loans. The exemption limit for all MSME(as de
under MSMED Act) borrowal accounts (both manufacturing or production and providi
or rendering of services), for obtaining collateral security, is Rs 5 lakh.RBI h
as clarified
that these guidelines are mandatory and not advisory.
Monetary and Credit Policy
Traditionally, RBI announces its monetary at the beginning of the financial year
(reviewed quarterly) and credit policy twice a year. The contents of these polic
ies are

very important for the banks and they adjust their loan policy and lending rates
, if
considered desirable, based on these.
Statutory and Other Restrictions on Some Credits
The following credit restrictions have been placed on the banks:
(details as per RBI circular No. Dir. BC. 13113.03.00/2009-10 dated 1, July 2009
1. Advances against bank's own shares: In terms of Section 20(1) of the Banking
Regulation Act, 1949, a bank cannot grant any loans and advances on the security
of its
own shares.
2. Restrictions on granting loans and advances to relatives of Directors
3. Restrictions on Grant of Loans & Advances to Officers and Relatives of Senior
Officers of Banks
4. Restrictions on Grant of Financial Assistance to Industries Producing or Cons
Ozone Depicting Substances (ODS)
5. Restrictions on Advances against Sensitive Commodities under Selective Credit
Control (SCC)
6. Advances against Fixed Deposit Receipts (FDRs) Issued by Other Banks
7. Loans against Certificate of Deposits (CDs)
8. Restrictions on Credit to Companies for Buy-back of their Securities
Methods of Credit AssessmentFor quite a long time, credit was considered to be a
scarce commodity and RBI
had a tight control over the methods of credit assessment by the banks. The guid
on MPBF first or second or third method of lending, permissible inventory levels
, etc.
originated in this period. RBI has since relaxed the rules in this area and the
banks are
now free to adopt their own method of credit assessment. However, for loans and
advances to Small Scale Industries, RBI guidelines are as under:
'SS1 units having working capital limits of up to Rs. 5 crore from the banking
system are to be provided working capital finance computed on the basis of 20 pe
r cent
of their projected annual turnover. The banks should adopt the simplified proced
ure in
respect of all SSI units (new as well as existing).'
Delivery of Credit
RBI has advised the banks to follow, as far as feasible, the loan system, for
delivery of bank credit. RBI guidelines in this respect are as under:
1. In the case of borrowers enjoying working capital credit limits of Rs. 10 cro
and above from the banking system, the loan component should normally be 80 per
cent. Banks, however, have the freedom to change the composition of working capi
by increasing the cash credit component beyond 20 per cent or to increase the 'L
Component' beyond 80 per cent, as the case may be, if they so desire. Banks are
expected to appropriately price each of the two components of working capital fi
taking into account the impact of such decisions on their cash and liquidity
2. In the case of borrowers enjoying working capital credit limit of less than R
10 crore, banks may persuade them to go in for the 'Loan System' by offering an
incentive in the form of lower rate of interest on the loan component. as compar
ed to the

cash credit component. The actual percentage of 'loan component' in these cases
be settled by the bank with its borrower clients.
3. In respect of certain business activities, which are cyclical and seasonal in
nature or have inherent volatility, the strict application of loan system may cr
difficulties for the borrowers. Banks may, with the approval of their respective
identify such business activities which may be exempted from the loan system of
Income Recognition and Asset Classification
One of the important functions of RBI is to ensure the stability of financial se
and thus ensuring the interests of the depositors. Banks are required to present
financial position in a fair and transparent manner. A crucial factor, affecting
the health
of a bank, is the quality of its assets. As these assets are formed mainly with
money( bank's capital in formation of these assets can be as low as 9 per cent,
which is
the mandatory CAR), even a small deterioration in the quality of these assets ca
n affect
the interests of the depositors very badly. RBI has, therefore, prescribed guide
lines for
the banks to classify their assets depending on the conduct of each account. A
provision, out of bank's profit, has to be made to provide for the possibility o
f default The
amount of provision depends on the classification of the asset. Similarly, there
are norms prescribed for not recognizing some of the perceived incomes so that
the profit of
the bank is not inflated unduly. For example, in an account where the principal
itself is
doubtful of recovery, there is no point in considering the interest receivable a
s part of
the accrued income. There are elaborate RBI guidelines on these matters and all
banks have to compulsorily follow them. (consolidated guidelines are contained I
RBI NI aster circular No. DBOD.'s o).BI-BC.I 7/ 21.04.04S/2009-10 dated July 1.
Prudential norms on Income
2009. Fide 01 [1112 circular is 'Master Circular
Recognition Asset Classification and Provisioning pertaining to Advance)
Fair Practices Code
(Details in RBI circulars dated 5/5/03 and 6/3/07)
RBI has issued guidelines on fair practices code for lending. These are to be
compulsorily followed by all banks in India. These guidelines pertain to:
(1) application for loans and their processing
(2) loan appraisal and terms and conditions
(3) disbursements of loans
(4) post disbursement supervision
(5) general guidelines relating to discrimination based on sex, caste and religi
harassment in recovery, transfer/takeover of accounts, etc.
In banking business, the main source of income is still the income on advances
given by the bank and, therefore, efficient credit management is very important
achieving the financial objectives of any bank. But, it is also a fact that cred
it involves

some peculiar inherent risks which should be understood, measured and managed.
Each bank formulates its own elaborate loan policy detailing the organizational
set up
for credit administration, and prudential norms for single/group borrowers, as a
lso for
specific activities. The policy also lays down the appraisal standards, delegati
on of
sanctioning powers, credit risk parameters and guidelines for delivery and monit
oring .
Appraisal of a credit proposal plays a major role in ensuring timely repayment o
f money
lent by the bank and interest on it. Analysis of financial statements, both past
and the
projected, help the bank in appraisal of the viability of the proposal as also t
he amount
needed by the borrower. The main methods used for this analysis are trend and ra
analysis. Banks also provide non fund based credit like guarantees, Letters of c
redit, coacceptance of bills, etc. The fund based credit is mainly in the form of working
finance or term loans, which include project and infrastructure finance. Despite
precautions taken in appraisal, delivery, monitoring and various other risk mana
measures, sometimes, there is default in timely repayment of principal and inter
Management of these problematic assets is also an important part of credit
management. RBI, being the regulator of financial system in India, still has gre
at influence on credit management of any bank despite relaxation of controls ove
r the
period of time. Knowledge and compliance of relevant RBI guidelines is essential
credit management department of any bank.
Prudential norms; Asset classification; Provisioning; Collateral security; Prior
ity sector;
MSM enterprises; Rehabilitation; Regulated interest rates; Principles of credit;
types of
borrowers; Appraisal; Delivery; Monitoring and supervision; Credit Risk Manageme
Check your progress
Fill in the blanks with correct choice:
1. As per RBI guidelines, the turnover method of assessment should be applied fo
working capital limit of up to Rs case of SSI units.
(a) One Crore (b) Two Crores (c ) Five Crores (d) Ten Crores
2. Interest rates, regulated by RBI, are applicable for credit limit up to Rs ..
(a) One (b) Two (c ) Five (d) Ten
3. The total priority sector target fore foreign banks, operating in India, is ..
(a) 20% (b) 32% (c ) 40% (d) 18%
State True or False:
4. As per RBI guidelines, the assets should be classified as Standard, Non-stand
and doubtful. . False.
5. As per RBI guidelines, no provision is required for Standard Assets. . False.
6. As per MSMED Act 2006, small manufacturing enterprise is an enterprise where
investment in plant and machineryis more than Rs 25 lakh but dos not exceed Rs 5

crore. . True.
7. Fair practices code provides guidance and is not compulsory for the banks in
. False.
Answer to Check Your Progress
1. (c); 2. (b); 3. (b); 4. False; 5. False; 6. True; 7. False
This is the end of chapter 26, of ADVANCED BANK ANAGEMENT- C
A I I B PAPER 1 - Overview of Credit Management. ADVANCED BANK MANAGEMENT
Analysis of Financial Statements
Part 1 of 2
27.0 Objectives
27.1 Introduction
27.2 Which are the Financial Statements?
27.3 Users of Financial Statements
27.4 Basic Concepts Used in Preparation of Financial Statements
27.5 Legal Position Regarding Financial Statements
27.6 Balance Sheet
27.7 Profit and Loss Account
27.8 Funds Flow and Cash Flow Statements
27.9 Projected Financial Statements
27.10 Purpose of Analysis of Financial Statements by Bankers
77.11 Rearranging the Financial Statements for Analysis
27.12 Techniques used in Analysis of Financial Statements
After reading this chapter, you will have better understanding of:
1. Types of financial statements
2. Funds flow /Cash flow statement
3. The importance and uses of financial statements in credit appraisal
4. Projected financial statements
5. Analysis of financial statements
6. Relationship between items in balance sheet and P & L account
7. Trend analysis
8. Ratio analysis
27.1 INTRODUCTIONWhenever a bank considers a loan proposal, apart from the inte
grity and K Y C
aspects, it has a keen interest in knowing the financial details of the prospect
borrower. The extent of these details depends upon the type of loan, type of bor
purpose of the loan etc. In case of security based lending like loans against fi
deposits, shares etc, these financial details may be few or may not be required
at all.
But, in all other cases, such details are invariably collected with a view to as
sessing the
1. The Net Worth of the Application: For an individual, the excess of his assets
his liabilities is his net worth. The same thing applies to any business entity
as well but,
prima facie, its financial statement shows assets and liability to be equal as b
usiness is
considered to be separate legal entity and its net worth is added to liabilities
that this is the amount payable to the promoters by the business entity. The net
worth of
an applicant helps the bank in deciding the level of activity which may be desir
able by

that applicant and the amount of money which can be lent to him.
2. Repayment Captivity: In case of an individual, the bank collects information
like his
income (salary, interest, dividend etc.) as also his expenditure, including repa
yments of
existing borrowings, if any, to assess the surplus available for repayment of in
and interest on bank's loan. In case of a business enterprise, this information
available from its financial statements.
3. Viability: Bank loan mayor may not result in increased earnings for a borrowe
r. For
example, a loan for consumer durables will not increase the income while a home
may result in increased income from rent or reduced expenditure by way of saving
s on
rent. In case of a business enterprise, bank loan is normally intended to increa
se the
income level. A scrutiny of the financial records of the existing activity helps
bank in
assessing whether the proposed bank loan will result in a viable increase in ope
4. Availability of Unencumbered Securities: In case of individuals, where normal
ly no
formal statements of their financial position are available, the bank asks quest
ions to
find out about their assets, liabilities, sources of income, expenditure, terms
repayment of existing loans, need for the loan, use of the loan, etc., to addres
s the
above mentioned questions. In case of other applicants, such information is norm
available from the financial statements, which they are required to prepare as p
er the
The statutory provisions ions regarding preparation and audit of financial
statements are mostly applicable to corporate entities but these provide the dir
ections to
the non-corporate entities as well, and most of such entities, having substantia
business volume, follow these guidelines, prescribed for the corporate entities.
There are basically two financial statements which every business enterprise is
required to prepare. These are:
1. Balance sheet2. Profit & Loss account (Income & Expenditure statement in case
of non-profit
Apart from these, the auditors' report, explanatory schedules and notes on
accounts, if applicable, provide useful information to the bankers.
A funds flow statement also provides useful information but, this is only a
mathematical analysis of changes in the structure of two consecutive balance she
and can be easily prepared by the banker/ analyst himself if the basic statement
s, i.e.
the balance sheets, are available. Accounting Standard-3 makes it mandatory for
enterprises to prepare Cash Flow statement for the accounting period (these
enterprises are those whose equity or debt is listed or is in the process of bei
ng listed
on a recognized stock exchange and also all other commercial, industrial and bus

enterprises whose turnover for the accounting period exceeds Rs.50 crore. These
enterprises are also required to do segment-wise reporting as per A S -1 7.
Apart from bankers, the other users of financial statements are:
1. Other creditors and lenders
2. Investors
3. Government agencies
4. Rating agencies
5. Customers
6. Employees
7. General public
8. Analysts
The important concepts are as under:
1. Entity Concept
2. Money Measurement Concept
3. Stable Monetary Unit Concept
4. Going Concern Concept
5. Cost Concept
6. Conservatism Concept
7. Dual Aspect Concept
8. Accounting Period Concept9. Accrual Concept
10. Realization Concept
11. Matching Concept
1. Format:
In case of banking companies, the formats of both balance sheet and P&L
account are prescribed by the Banking Regulation Act. In case of other companies
while the format of balance sheet is prescribed by the Companies Act, no format
Profit and Loss account is prescribed. However, Schedule VI of Companies Act req
that the statements should present a true and fair view of the state of affairs.
Companies Act has also specified that the profit and loss account must show spec
information as required by Schedule-IV.
The format of balance sheet can be either Vertical or Horizontal as illustrated
below (activities like banking, insurance, electricity generation etc, which are
by acts other than Companies Act, need not follow these formats)
Horizontal Form: Horizontal form is maintained in two columns. The first column
the Liabilities and the second one shows the Assets.
The items shown in the first column against Liabilities are:
Share Capital
Reserves and surplus
Secured loans
Unsecured loans
Current liabilities
The items shown in the second column against Assets are:
Fixed assets
Current assets
Loans and advances

Miscellaneous expenditure
Vertical Form: In the Vertical Form, the different items are shown one below the
(A) Sources of funds
1. Shareholders funds
(a) Share capital(b) Reserves and surplus
2. Loan funds
(a) Secured loans
(b) Unsecured loans
(B) Application of funds
1. Fixed assets
2. Investments
3. Current assets, loans and advances
Less: Current liabilities and provisions Net current assets
4. Miscellaneous expenditures
2. Accounting
As per Income Tax rules, April to March is considered as the financial year for
purposes. However, as per Companies Act, this can be different. Only restriction
, as per
Companies Act, is that the maximum duration of the financial year can be 15 mont
and can be extended up to 18 months with the permission of Registrar of Companie
3. For incomplete Projects and no Activity
Every company has to prepare the financial statements even if there is no activi
during the accounting period or the project is not completed.
It is a statement of assets (what is owned) and liabilities (what is owed to oth
of an entity at a particular moment. It is like a snapshot of assets and liabili
ties and just
as one picture may be different from another taken anytime earlier, the balance
may also be different at different moments of the same day. Therefore, every bal
sheet must indicate the date at the end of which it is prepared. Normally, the b
sheet is prepared at the end of the accounting period for which the Profit & Los
account is prepared.
The Companies Act classifies liabilities as follows:
1. Share capital
2. Reserve and surplus
3. Secured loans
4. Unsecured loans
5. Current liabilities and provisions.
Share CapitalThis is divided into two categories: equity capital and preference
capital. The first
represents the contribution of equity shareholders who are the owners of the fir
Equity capital carries no fixed rate of return by way of dividend. However, on t
preference capital, the dividend rate may be fixed and cumulative.
Reserve and Surplus
Reserves and surplus are profits which have been retained in the firm. There are

two types of reserves: revenue reserves and capital reserves. Revenue reserves
represent accumulated retained earnings from the profits of normal business
operations. These are held in various forms: general reserve, investment allowan
reserve, capital redemption reserve, dividend equalization reserve, etc. Capital
arise out of gains which are not related to normal business operations. Examples
such gains are the premium on issue of shares or gain on revaluation of assets.
Surplus is the balance in the profit and loss account which has not been
appropriated to any particular reserve.
Secured Loans
These denote borrowings of the firm against which specific securities have been
provided. The important examples of secured loans are: debentures, loans from
financial institutions and banks.
Unsecured Loans
These are the borrowings of the firm against which no specific security has been
provided. The examples of unsecured loans are: fixed deposits, loans and advance
from promoters, inter-corporate borrowings, and unsecured loans from banks.
Current Liabilities and Provisions
Current liabilities and provisions, as per the classification under the Companie
Act, consist of the following: amounts due to the suppliers of goods and service
s bought
on credit; advance payments received; accrued expenses; unclaimed dividend;
provisions for taxes, dividends, gratuity, pensions, etc.
Current liabilities for managerial purposes (as distinct from their definition i
n the
Companies Act) are obligations which are expected to mature in the next twelve
months. So defined, they include the following:
(1) loans which are payable within one year from the date of balance sheet, (2)
accounts payable (creditors) on account of goods and services purchased on credi
t for
which payment has to be made within one year, (3) Provision for taxation, (4) ac
for wages, salaries, rentals, interest, and other expenses (these are expenses f
services that have been received by the company but for which the payment has no
fallen due), and (5) advance payment received for goods or services to be suppli
ed in
the future.
AssetsBroadly speaking, assets represent resources which are of some value to th
firm. They have been acquired at a specific monetary cost by the firm for the co
nduct of
its operations. Assets are classified as follows under the Companies Act:
1. Fixed assets
2. Investments
3. Current assets, loans and advances
4. Miscellaneous expenditures and losses
Fixed Assets
These assets have two characteristics: they are acquired for use over relatively
long periods for carrying on the operations of the firm and they are ordinarily
not meant
for resale.
Examples of fixed assets are land, buildings, plant and machinery, office

furniture, computer systems etc.

These are financial securities owned by the firm. Some investments represent
long term commitment of funds. (these may be equity shares of other firms held f
investment or control purposes.) Other investments are of short-term nature and
may be
classified undercurrent assets for the purpose of financial analysis. (As per Co
Act, short-term holding of financial securities also has to be shown under inves
Current Assets, Loans, and Advances
This category consists of cash and other resources which get converted into
cash during the operating cycle of the firm. Current assets are held for a short
period of
time as against fixed assets which are held for relatively longer periods. The m
components of current assets are: cash, debtors, inventories, loans and advances
, and
pre-paid expenses. Cash includes credit balances in the bank accounts. Debtors (
called receivables or sundry debtors) represent the amount owed to the firm by i
customers who have bought goods, services on credit. Debtors are shown in the
balance sheet at the amount owed, less provision for bad debts. Inventories/ sto
consists of-raw materials, work-in-process, finished goods, and stores and spare
s. They
are accounted at the lower side of the cost or market value as per the accountin
concept of conservatism.
Loans and Advances
These are loans to employees, advances to suppliers and contractors, and
deposits made with governmental and other agencies. They are shown at the actual
amount. Pre-paid expenses are expenditure incurred for services to be rendered i
n the
Miscellaneous Expenditures and Losses
This category consists of two items: (1) miscellaneous expenditures and (2)
losses. Miscellaneous expenditures represent certain outlays such as preliminary
expenses and pre-operative expenses which have not been written off. From the
accounting point of view, a loss represents a decrease in owners' equity. Hence,
when a
loss occurs, the owners' equity should be reduced by that 'amount. However, as p
company law requirements, the share capital (representing. equity) cannot be red
when a loss occurs. So, the share capital is kept intact on the liabilities side
of the
balance sheet and the loss is shown on the assets side of the balance sheet.
It is a statement of income and expenditure of an entity for the accounting peri
Every P and L account must indicate the accounting period for which it is prepar
ed The
items of a P & L account are:
1. Gross and Net sales
2. Cost of goods sold
3. Gross profit

4. Operating expenses
5. Operating profit
6. Non-operating surplus/deficit
7. Profit before interest and tax
8. Interest
9. Profit before tax
10. Tax
11. Profit after tax (Net Profit)Gross and Net Sales
The total price of goods sold and services rendered by an enterprise, including
excise duty paid on the goods sold, is called Gross sales. Net sales are gross s
minus excise duties.
Cost of Goods Sold
This is the sum of costs incurred for manufacturing the goods sold during the
accounting period. It consists of direct material cost, direct ]about cost, and
overheads. It is different from the cost of production, which represents the cos
t of goods
produced in the accounting year, not the cost of goods sold during the same peri
Gross Profit
This is the difference between net sales and cost of goods sold. Most companies
show this amount as a separate item. Some companies, however, show all expenses
one place without making gross profit a separate item.
Operating Expenses
These consist of general administrative expenses, selling and distribution
expenses, and depreciation. Some companies include depreciation under cost of go
sold as a manufacturing overhead rather than under operating expenses.
Operating Profit
This is the difference between gross profit and operating expenses. As a
measure of profit, it reflects operating performance and is not affected by nonoperating
gains/losses, financial leverage, and tax factor.
Non-operating Surplus
This represents gains arising from sources other than normal operations of the
business. Its major components are income from investments and gains from dispos
of assets. Likewise, non-operating deficit represents losses from activities unr
elated to
the normal operations of the firm.
Profit before, Interest and Taxes
This is the sum of operating profit and non-operating surplus/deficit. Referred
also as earnings before interest and taxes (EBIT), this represents a measure of
which is not influenced by financial leverage and the tax factor.
This is the expenses incurred for borrowed funds, such as term loans,
debentures, public deposits, and working capital advances.
Profit before tax
This is obtained by deducting interest from profits before interest and taxes.
TaxThis represents the income tax payable on the taxable profit of the year.
Profit after tax
This is the difference between the profit before tax and tax for the year.
This is the end of Part 1 of 2, of chapter 27, of ADVANCED BANK
Analysis of Financial Statements
Chapter 27, Part 2 of 2


Each item in the balance sheet represents either source of funds or use of funds
All items on the liabilities side represent the funds provided to the enterprise
and all
items on the assets side (except cash) represent use of these funds. Cash in the
balance sheet represents the unutilized portion of funds, available to the enter
prise. If
cash is also perceived as a use of funds then all the uses of funds are equal to
all the
sources of funds. This perception of available cash, as a use of funds, is what
the wide spread confusion about difference in a Funds flow statement and a Cash
statement. When we compare two balance sheets of different dates, change in each
item (or introduction of a new item) in the balance sheet of later date, as comp
ared to
that item in the balance sheet of earlier date, will represent either addition o
f funds or
additional use of funds in the intervening period. Any increase in any item on t
liabilities side means additional funds available. Please note that additional f
unds are
also available if there is decrease in any item on the assets side. Similarly, a
ny increase
in any item on the assets side or decrease in any item on the liabilities side m
additional use of funds. A statement of these additional sources of funds and ad
uses of funds is called Funds flow statement for the intervening period. Normall
y, this
intervening period is the accounting year, as the balance sheets, which form the
of this statement, are prepared as on the last day of each accounting period. If
we have
to prepare the cash flow statement, we start with the cash in the first balance
sheet as
opening balance, add all the additional sources, excluding cash (cash is also a
of funds if it is at a reduced level in the subsequent balance sheet), and deduc
t all
additional uses (excluding cash), thus arriving at, the closing balance, which w
ill be
equal to the cash shown in the second balance sheet. In practice, the statement
prepared perceiving cash as a use or source of funds and it is known as Funds fl
ow or
cash flow statement. This should not be confused with the cash budget (which als
o is
referred to as cash flow statement) prepared for the purpose of assessing the ne
ed for
working capital funds from the bank. In that statement, all cash flows during a
excluding bank finance, are taken and the deficit shown forms the basis of bank
Actual financial statements are for the past period and analysis of these gives
very useful financial information to the banker. But for assessing the need for

credit and to examine the viability of the activity, it is necessary to anticipa
te the
financial position of the enterprise in future. For example, for assessing the w
capital needs, the statement of assets and liabilities of the last year will not
adequate. We will have to anticipate the level of operations during the current
year and
accordingly project the level of assets and liabilities to arrive at the need fo
r bank's loan.
Of course, the financial statements for the past period serve as the most import
guide for this estimate. Also, in case of a new enterprise, where no financial s
are available, it becomes necessary to decide on a level of activity and accordi
ngly prepare the projected financial statements. Generally, in case of smaller e
where adequate financial expertise may not be available, the projected financial
statements for the next year are prepared by the bank by interviewing the concer
person . In case of term loans for new projects/expansion, the projected financi
statements are normally prepared for the entire duration of bank loan to establi
sh the
viability of operations as also to determine the disbursal and repayment schedul
Whenever the projected financial statements are submitted by the borrower, these
critically examined for their reasonability and if projections are considered to
unreasonable, the matter is discussed with the borrower and suitable consensus a
Different users, interested in the financial statements of an entity, may analyz
these with focus on evaluation of different aspects. For example, a share market
investor may be more interested in Earning Per Share (E P S), while the statutor
authorities may be more interested in compliance and provisions. The banker's fo
cus is
normally on the following aspects:
(a) Assessment of Performance and Financial Position: An analysis of the financi
statements reveals the trend of growth of its business and its profitability. By
these to the industry trend, opinion about the management and efficiency of the
enterprise is formed. Also, the financial statements reveal the composition of a
ssets and
liabilities of the enterprise. By seeing the trend of leverage (Debt/equity), re
tention of
profits etc., the financial health of the enterprise is judged.
(b) Projection of Future Performance: Past performance is often a good indicator
future performance. The financial statement analysis helps in projecting the ear
prospects and growth rates in the level of activity and earnings with a reasonab

degree of certainty.
(c) Detecting Danger Signals: Financial statement analysis is an important tool
knowing the direction of business of the enterprise as also to detect any deteri
oration of
its financial health. Being aware of any deterioration of the financial position
, the bank
can take preventive measures to avoid/ minimize losses. Important ratios, arrive
d at
from the financial analysis. also help the bank to achieve this goal.
(d) Assessment of Credit Requirements: One of the difficulties in credit is the
accurate assessment of the financial need of the applicant. Over-financing and u
nderfinancing both are risky for the borrower and the bank. Financial statement anal
ysis is
used by banks to assess the credit requirement more accurately. Banks are also
concerned with repayment of loan interest within a reasonable time. Analysis of
financial statements of the borrower helps in assessing the repayment schedule a
s also
to assess credit risk, decide the terms and conditions of loan.
(e) Examine Funds Flow: This is to ascertain that the bank's funds have been use
d for
the intended purposes and there is no diversion. Also, the use of short term sou
rces is
examined to find if there is any unacceptable mismatch created in the liquidity
(f) Cross Checking: The statements of stocks and book debts. as on the date of t
balance sheet, submitted by the borrower. for calculation of drawing power in th
e cash
credit account, are cross checked with the figures given in the balance sheet .
statements of the balance sheet date are not available, the statements of neares
t date
are used, which give a fair idea if the correct statements are being submitted.
In keeping with the above objectives, a banker rearranges the figures in the
financial statements under distinct groups for a meaningful analysis.Balance She
The assets and liabilities are normally regrouped as under:
In regrouping, the items shown under Liabilities are: (1) Net worth, (2) Long-te
liabilities (3) Current liabilities and provisions.
In regrouping, the items shown under Assets are: (1) Fixed assets, (2) Current
(3) Non-current assets (4) Intangible assets.
Profit and Loss Account
The format prescribed under erstwhile Credit Monitoring Arrangement (CMA)
under which banks used to report sanction of large credit proposals to RBI, stil
l serves
as a useful guide for rearranging the items in Profit and Loss account. The impo
groups of items are as under:
The format is in three columns. The first column shows different items. The
second and the third one show the values of these items in the last year and pre
year respectively.
The different items shown in the first column are:

1. Gross sales
2. Cost of sales
(a) Raw materials
(b) Power and fuel
(c) Direct labour
(d) Other manufacturing expenses
(e) Depreciation
(f) Sub total
(g) Add opening stocks
(h) Less closing stocks
(i) Total cost of sales
3. Selling, general and administrative expenses
4. operating profit
5. Interest
6. operating profit after interest
7. add non operating income
8. less non operating expenditure
9. Profit before tax
10. tax
12. Profit after taxImportant Points for Rearranging Financial Statements
While rearranging the financial statements, the following points should be
examined by the banker and suitable changes made in different items:
(a) Instalment of term loans due within one year
(b) Advance tax and provision of tax
(c) Deferred tax assets and liabilities
(d) Non moving inventory
(e) Receivables more than 6 months old
(f) Revaluation of assets and Intangible assets
(g) Investments
(h) Bills purchased and discounted
(i) Contingent liabilities
(j) Provisioning
(k) Depreciation method
(l) Inventory valuation
(m) Expenses relating to earlier years
(n) Important events after account period.
Bankers mostly use three methods for analysis of financial statements.
(a) Funds Flow Analysis
(b) Trend Analysis
(c) Ratio Analysis
Funds Flow Analysis: If the borrower has not submitted the funds flow statement,
bank prepares the same from the last two balance sheets. The total sources of fu
are categorized as 'Long term' and 'Short term'. Similarly, the total uses are a
categorized as 'Long term' and 'Short term'. If the short term sources are more
than the
short uses it indicates diversion of working capital funds and needs to be probe
d further.
Sometimes, it may be a desirable thing e.g., in case of companies with very high
ratio, it may be desirable to use the idle funds for creating additional capacit
y. The
guiding principle is that this diversion should not affect the liquidity positio
n of the
company to unacceptable level.
Trend Analysis: Under trend analysis, bankers adopt the following methodology:(a

) The items for which trend is required to be seen, are arranged in horizontal
form and percentage increase or decrease from the previous year's figures is ind
below it. Generally, this is used to see the trends of sales, operating profit,
etc. from P and L account. Similarly, the balance sheets, arranged in horizontal
give the trends of increase or decrease of various items.
(b) Common size statements are prepared to express the relationship of various
items to one item in percentage terms. For example, consumption of raw materials
expressed as a percentage of sales for different years and comparison of these f
gives indication of trend of operating efficiency.
Common size financial statements contain the percentages of a key figure alone,
without the corresponding amount figures. The use of percentages is usually pref
to the use of absolute figures.
The use of common size statements can make comparisons of business
enterprises of different sizes much more meaningful since the numbers are brough
t to
common base, i.e. per cent. Such statement allows an analyst to compare the oper
and financing characteristics of two companies of different sizes in the same in
Ratio Analysis: This is the most favourite method of bankers for analysis of fin
statements. A ratio is comparison of two figures and can be expressed as a perce
(e.g. profitability is 23.7 per cent), as a number (e.g. current ratio is 1.33)
or simply as a
proportion (e.g. debt equity is 1: 2).Both the figures,used in calculation of a
ratio, can be
from either P& L account, or balance sheet or one can be from P& L account and t
other from balance sheet. Ratios help in comparison of the financial performance
financial position of an entity with other entities, as also for comparison with
its own
status over the years. While different users of financial statements are interes
ted in
different ratios, the ratios which interests a banker most, are the following:
(a) Profitability Ratios: Operating Profit Margin (OPM) and Net Profit Margin
(NPM) are calculated by dividing the figures of operating profit (EBIT, which me
earnings before interest and tax) and net profit respectively by the net sales.
OPM is an
indicator of the operating efficiency of the enterprise while NPM is an indicati
on of ability
to withstand the adverse business conditions.
(b) Liquidity Ratios: These are Current ratio (CR) and Acid test ratio or quick
ratio. While CR is a ratio of total current assets to total current liabilities,
quick ratio is
calculated by dividing current assets (excluding inventory) by total current lia
These ratios indicate the capacity of an enterprise to meet its short term oblig
(c) Capital Structure Ratios: Debt Equity Ratio (DER) is a ratio of total outsi
long term liability to the Net worth of an enterprise. Bankers are averse to hig

h debt
equity ratios as it not only represents high borrowings in relation to the owned
funds but
also affects the viability of the operation of the enterprise, as higher borrowi
ngs mean
higher costs and lower operating margins. In case of those enterprises, which ar
e not
capital intensive (i.e. the requirement of fixed assets is low), this ratio may
not indicate
the correct picture as working capital borrowings, which are not indicated by DE
R, may be disproportionate to the capital. So, bankers use ratio of TOL (Total O
utside Liabilities
to TNW (Tangible Net Worth).
(d) Ratio Indicating Ability to Service Interest and Instalmemts: Interest
Coverage Ratio (ICR) and Debt Service Coverage Ratio (DSCR) are the important
ratios in this category. ICR is calculated by dividing EBIT (earnings before int
erest and
tax) by total interest on long term borrowings. DSCR is ratio of total cash flow
s before
interest (net profit plus depreciation plus interest on long term borrowings) to
repayment obligation (instalment plus interest on long term borrowings).
(e) Turnover Ratios:
(1) Inventory Turnover Ratio: This is an indicator of movement of inventory. It
calculated by dividing cost of goods sold by average inventory. A higher ratio i
faster movement of inventory. This is also used for calculating average inventor
holding period.
(2) Debtors Turnover Ratio: It is an indicator of how fast the debtors are
realized. It is calculated by dividing the net credit sales by average debtors o
during the year. A higher ratio indicates faster collection of debts. This is al
so used for
calculating average collection period.
Deficiency in Ratio Analysis Method
The profit and loss account covers the entire fiscal period, whereas the balance
sheet is on a particular date. To compare an income statement figure such as sal
es to a
balance sheet figure such as debtors, we need a reasonable measure of average
debtors for the year, which is normally arrived at by using an average of beginn
ing and
ending balance sheet figures. This approach does not eliminate problems due to
seasonal and cyclical changes or bunching of sales near the year end.
Financial statements are prepared on the basis of accounts of financial
transactions of an enterprise. The balance sheet depicts the position of its ass
ets and
liabilities as on a particular date, while P and L account is prepared for an ac
period and states the position of income, expenses and the profit. By comparing
successive balance sheets, we can calculate the flow of funds in the intervening
So, the financial statements are effective tools in monitoring of an account. As
the credit
decisions are applicable for future needs of an enterprise, usually projected fi

statements are also prepared, specially, in case of medium and large enterprises
These are based on actual statements for the past period and anticipated perform
in the future. Analysis of financial statements helps banks in knowing the finan
health and performance and viability of an enterprise and in assessing its credi
requirements. The main methods used for this analysis are trend and ratio analys
The trend analysis shows how the business of an enterprise is growing while the
analysis depicts the most critical financial parameters at a glance. Thus, if th
e key ratios
like OPM, debt to equity ratio, current ratio, DSCR, debtors' turnover ratio are
seen by a banker, he can form a reasonably correct opinion about the enterprise
. However, for a
final decision, a more detailed analysis is necessary.
While the format for balance sheet is prescribed by law, the format for P&L
account is prescribed only for the banking companies. But all entities, includin
g non
corporates, usually follow the well established accounting principles and prepar
e their
accounts accordingly. For meaningful analysis, a banker has to rearrange these
statements into various groups.
Balance Sheet; P and L Account; Funds flow statement: Cash flow statement; Sourc
and uses of funds; Common size statements; OPM, debt to equity ratio; current ra
DSCR, debtors' turnover ratio; Contingent liabilities; Intangible assets; Pre-op
expenses: Short term liabilities: Long term liabilities: Net worth; TNW; TOLChec
k Your Progress State True or False:
State True or False:
1. Companies Act has prescribed the format of the balance sheet. . True.
2. Format for P & L account for banking companies is prescribed by the Banking
Regulation Act. . True.
3. As per Companies Act, short-term holding of financial securities has to be sh
Linder investments. . True.
4. The furniture available in a furniture shop is classified under Fixed Assets.
. False.
5. For the purpose of analysis, installments of term loan, due within one year,
classified under current assets. . True.
6. Banks reduce the amount of intangible assets from the Net Worth for the purpo
se of
analysis of financial statements. . True.
7. The change in the method of inventory valuation does not affect the profit in
accounting year. . False.
8. The method of ratio analysis is the best method of financial analysis, as it
does not
suffer from any deficiency. . False.
9. Debt: Equity ratio (D E R) is a ratio of total outside liability to the net w
orth of an
enterprise. . False.
10. Interest Coverage Ratio (I C R) is calculated by dividing E B I T(earnings b

interest and tax) by total interest on long term borrowings . True.

11. D S C R indicates the ability of an enterprise to service interest and insta
llments. .
12. Contingent liabilities of an enterprise do not affect the financial analysis
. . False.
13. Funds flow statement and the statement of Sources and Uses of funds are the
same. . True.
14. Liquidity ratios indicate the capacity of an enterprise to meet its short te
obligations. . True.
Key to Check Your Progress
1. True; 2. True; 3. True; 4. False; 5. True; 6. True; 7. False; 8. False; 9. Fa
lse; 10.
True; 11. True; 12. False; 13. True; 14. TrueThis is the end of Part 2 of 2, of
chapter 27, of ADVANCED BANK
MANAGEMENT- C A I I B PAPER1, Analysis of Financial
28.0 Objectives
28.1 Concept of Working Capital
28.2 Working Capital Cycle
28.3 Importance of Liquidity Ratios
28.4 Methods of Assessment of Bank Finance
28.5 Bills/Receivables Finance by the Banks
28.6 Guidelines of R B I for Discounting/Rediscounting of Bills by Banks
28.7 Non Fund Based Working Capital Limits
28.8 Other Issues Related to Working Capital Finance
After reading this chapter, you will have better understanding of:
1. The concept of working capital, total/gross working capital, net working capi
2. Working capital cycle
3. Components of current assets/current liabilities, liquidity, importance of li
quidity ratios
4. Various sources of meeting working capital requirements
5. Bank finance for working capital, methods of assessment
6. Financing of bills/receivables
7. Non fund based working capital limits
8. Commercial paper, factoring, forfeiting
Whenever a business enterprise is started, some fixed assets like office,
furniture, machines/computers etc, depending upon the need, are acquired. But th
alone may not be sufficient for running the business of that enterprise, except
for a few
activities like broking/commission agent, etc. Most of the business enterprises,
in the
course of their business, have to carry some current assets like raw materials,
finished goods, receivables etc. The money blocked in these current assets is ca
lled working
Let us take example of an entrepreneur setting up a small manufacturing
enterprise for manufacture of polythene bags. He completes the construction of f
shed and puts up all the plant and machinery. At this point, if he takes a snaps
hot of his
assets and liabilities, it will be as under:
Balance sheet of ABC Ltd as on 9 September, 2009

Liabilities (Capital) Rs. 25 lakh

Assets (
Fixed assets) Rs 100
Liabilities (Long term liabilities) Rs. 75 lakh
Liabilities Total Rs 100 lakh
Total Rs 100 lakh
For running the factory, he needs raw material, i.e. the polythene granules. He
goes to the dealer and finds out that the rate of granules is Rs 100 per kg and
credit of 3
months is available. His requirement is 1000 kg (1 ton) per day. He purchases 30
of granules which is the minimum quantity which the dealer sells. He starts manu
of the bags on 10 September 2009. The process takes very little time, and on the
evening of 10 September 2009 he has 1 ton of bags with him. He incurs a cost (po
labour, transport, miscellaneous expenses, but ignoring depreciation) of Rs10,00
0 for
converting 1 ton of granules into bags. He approaches the wholesale dealer of ba
gs for
selling the bags to him. The deal is struck at Rs 1,10,000 per ton, but a minimu
m of 10
tons of bags is to be supplied. Also, credit of one month is to be given to the
So, the entrepreneur continues to manufacture for 10 days and on 21 September, 2
supplies 10 tons of bags by raising an invoice of Rs 11 lakh, payable on 21/10/0
9. The
next supply will be made on 1 October, 2009. If he takes a snapshot of his asset
s and
liabilities on the evening of 30 September 2009, the picture will be as under;
Balance sheet of ABC Ltd as on 30 September, 2009
(Liabilities) Capital Rs 25 lakh
(Assets) Fixed assets Rs 100 lakh
(Liabilities) Long term liabilities Rs 75 lakh
(Assets)Raw material( 10tons)
Rs 10
(Liabilities) Amount payable to supplier Rs 30 lakh
(Assets) Work in process
(Liabilities) Expenses payable Rs 2 lakh
(Assets) Finished goods( 10 tons)
Rs 11
(Liabilities) Amount receivable Rs 11 lakh
(Liabilities) Total Rs 132 lakh.
(Assets) Total Rs 132 lakh
The amount of raw materials, work in progress, finished goods, receivables
totaling Rs 32 lakh, is called the working capital or the current assets require
d to run the
enterprise smoothly. In this example, the entrepreneur has not arranged for any
to run his factory as his entire requirement of working capital is met through t
he credit
provided by the supplier. But, life in business, often, is not as simple as show
n here. It is a fact that current assets are required by almost every enterprise
to run the business
smoothly. How much of current assets are required to be maintained depends on th
nature of activity and the market conditions. Working capital finance by the ban
ks is
nothing but assessment of total current assets needed and how this need is to be

In the above example, what happens if the credit is not available from the
supplier or, the credit is available only for 10 days? The credit provided to pu
may not be reduced if the market practice is like that. In such a case, he will
the bank and request for a working capital loan of Rs 32 lakh. Assuming that ban
k is
convinced about K Y C norms, viability of the project etc, the bank will assess
the needs
and sanction an amount. How much will that amount be, we will discuss later in t
chapter. But, bank will definitely ask him to bring some of his own money either
by way
of capital or long term borrowings like fixed deposits, loans from friends and r
This amount, which is intended to meet part of the working capital, is called Ne
t Working
Capital. The other part of the working capital will be met by credit provided by
supplier, other credit available, and the bank finance. In short, we can say tha
t the total
requirement of current assets of an enterprise, which is termed as Total or Gros
working capital is met by short term credit available (including bank finance) a
nd some
amount arranged by the enterprise through long term funds (either capital or
borrowings), called Net Working Capital.
The normal operations of a business enterprise consist of some or all of the
actions like, purchase of raw materials, processing and conversion of raw materi
als into
finished goods, selling these goods on cash/ credit basis, receive cash on sale
or end of
credit period and again purchase raw materials. This is called working capital c
ycle. The
length of this cycle depends on:
(a) the stocks of raw materials required to be held
(b) the work in process, which in turn depends on the process involved in manufa
and processing the raw materials.
(c) the credit required to be provided to the purchasers
The longer the working capital cycle, the more is working capital requirement,
i.e., the need for maintaining the current assets. The correct assessment of thi
s cycle is
the most important part in a bank's assessment of gross working capital, net wor
capital and the bank finance. The assessment of working capital finance by the b
follows the assessment of working capital requirement of the enterprise.
For a banker, providing working capital finance, the liquidity ratios, specially
current ratio, play a very important role in assessment, sanctioning decision, a
monitoring. The assessment involves stipulation of a minimum Net Working Capital
W C) to be brought in by the enterprise from its long term sources. This results
in a
minimum current ratio (more than one) which the bank wants the enterprise to mai

at all the times. This is, normally, mentioned in the terms and conditions of sa
nction and
becomes an important tool for the bank to monitor the use of funds by the enterp
Holding Norms Based Method of Assessment of Bank Finance:
(1) Deciding on the level of Turnover of the Enterprise: This is a very importan
t step
in any method of assessment of working capital limits. In case of existing enter
the past performance is used as a guide to make an assessment of this. In case o
f new
enterprises, this is based on the production capacity, proposed market share,
availability of raw materials, industry norm etc. Despite analysis of all the da
ta, accurate
estimate of future turnover is often an area of disagreement between the bank an
d the
(2) Assessment of Gross or Total Working Capital: This is the sum total of the
assessment of various components of the working capital:
(a) Inventory: For assessing the stock levels of raw materials, work in process
and the finished goods, information like lead time, minimum order quantity, loca
tion and
number of suppliers, percentage of imported material, manufacturing process, etc
. are
taken into account. Tandon committee had prescribed inventory norms for various
industries but these are not mandatory now and banks can estimate the levels
applicable to each case based on its peculiarities. Industry norms, available in
the data
base, are also used as a guide for the estimate of inventory level.
(b) Receivables and Bills: This estimate is relatively simpler compared to that
the inventory. This is mostly governed by the market practice applicable to a pa
business or place.
(c) Other Current Assets: A reasonable estimate of other current assets like
cash level, advances to suppliers, advance tax payment etc is necessary to avoid
Sources for Meeting Working Capita Requirement:
(a) Own Sources (N W C): The balance sheet of the last accounting year, depicts
position of available N W C. Also, as the estimate of limits is based on the pro
balance sheet at the end of the current accounting year, there are some internal
accruals which are also taken into account. Depending on the desired current rat
io to be
maintained, bank may stipulate additional N W C to be brought in if the availabl
e N W C
and anticipated internal accruals are not considered enough to maintain the desi
current ratio.
(b) Suppliers Credit: Estimate of this depends on the market practice.
(C) Other Current Liabilities like salaries payable, advances from customers, et
(d) Bank Finance
Calculation of Bank Finance
Logically, the need for working capital finance from the bank is equal to the ga
between total working capital and the availability of funds from all the sources

, as
mentioned above (of course, excluding bank finance). The enterprise or the bank
not have much control on the 'suppliers' credit' or 'other current liabilities',
as these are driven by market conditions or business needs. But banks can presc
ribe the amount to
be brought in by the enterprise through its own long term sources i.e. the N W C
. This
was at the core of the recommendations of the erstwhile Tandon committee, which
dominated the psyche of the bankers for a long time. Though banks are now free t
formulate their own policies in this regard, the methods of lending, mentioned t
here, still
find place in the calculations followed by the banks. The methods are;
(a) First Method of Lending: Under this, the enterprise was required to bring in
at least
25 per cent of the working capital gap (total current assets minus total current
excluding bank finance)
(b) Second Method of Lending: Under this, the enterprise was required to bring i
n at
least 25 per cent of the total current assets
(b) Third Method of Lending: Under this, the enterprise was required to bring in
per cent of those current assets which are considered 'core assets' and at least
25 per
cent of the remaining current assets.
It may be noted that while the second method of lending results in current ratio
at least 1.33, in case of first method, it could be less and in the third method
it is likely to
be more than this.
Depending upon the loan policy of the bank, the working capital limit can be
arrived at by deducting from the total projected current assets, the stipulated
NWC and
the projected short term liabilities.
Cash Budget Method of Assessment
Any economic activity, however small it may be, involves outflows ( expenditure)
of money for procurement of inputs and inflows of money (income) from the sale o
output The nature, amount and periodicity of outflows and inflows is peculiar to
the type
of activity, level of operations, market conditions and the policies adopted by
owners/managers etc. The genesis of an enterprise's requirement for the working
capital funds, from the bank, lies in the fact that during a particular day, its
opening cash
balance and cash inflows are not sufficient to meet its normal cash outflows. Sh
ort term
bank finance, called working capital finance, fulfils this requirement of excess
outflows. Therefore, an ideal way to assess the need for bank finance is to prec
project the cash inflows and outflows for each day and provide finance to meet t
he cash
deficit. But, projection of daily cash flows is not a feasible option because ma
conditions are not perfect. Therefore, the periodicity of estimating cash flows

increased to a more feasible level of a month or a quarter. A statement of estim

cash inflows and outflows is prepared for this period and bank finance equal to
the cash
deficit, if any, is sanctioned.
A normal statement / budget, will look as under;
1 2 3 5
1. Opening balance
2. Term loan from Bank3. Sales (Total sales-credit sales + realization for ealie
r sales)
4. Other cash inflows
Total inflows
1. Capital expenditure
2. R. M. Purchase
3. Labor
4. Power and fuel
5. Payment of Interest
6. Repayment of Term loan installment
7. Other cash outflows
Total outflows
Cash surplus or (deficit)
Bank finance needed
Closing balance
Turnover Method of Assessment
The assessment of working capital limit by the banks, in some cases, is
influenced by the guidelines of R B I.
For working capital advances to Small Scale Industries. R B I guidelines are as
`SSI units having working capital limits of up to Rs.5 crore from the banking
system are to be provided working capital finance computed on the basis of 20 pe
r cent
of their projected annual turnover. The banks should adopt the simplified proced
ure in
respect of all S S I units (new as well as existing).'
The R B I guidelines may result in under-financing for those S S I units where t
working capital cycle is more than 3 months. Therefore, the banks, normally, als
assess the requirement on the basis of holding norms also and sanction the limit
whichever is higher.
Comparison of the Three Methods of Assessment
It is easy to infer from the above that there is no basic difference between the
holding method and the cash budget method of assessment of bank finance. Both
involve the essential steps of projecting the level of activity, credit provided
customers, credit received from suppliers, requirement of other current assets a
liabilities. The preciseness of the assessment in both the methods depends on ho
w precisely the credit officer estimates these parameters. However, the holding
method is
based on the estimate of average of all these parameters over next one year, whi
may be too long a period for correct assessment, specially, for seasonal industr
Therefore, this method is more suitable for those activities which have relative
ly uniform

operations and for which the market conditions are not very volatile. The cash b
method may be more suitable for activities which have wide fluctuation from mont
h to
month in the level of activities or market conditions, like seasonal industries
or execution
of project contracts.
The turnover method is more suitable for Small enterprises where detailed
financial records may not be available.
Receivables are part of the current assets of a business enterprise. These arise
due to sales on credit basis to the customers. If the credit sales are based on
alone, the amount receivable from the customers is represented in the accounts a
'book debts' or 'sundry debtors'. The bank provides finance against these in a f
similar to that for inventory. The borrower submits a statement of book debts an
d bank
calculates the drawing power by deducting the applicable margin.
Another method of sales is through Bills of exchange drawn by the seller on the
purchaser in the following manner;
(a) If no credit is to be provided to the customer, a demand bill is drawn. This
along with the transport document like MR, RR etc, is given to bank either for c
or purchase. If bank purchases the bill, it provides immediate credit to the sel
ler (drawer
of bill), which may be even 100 per cent of the bill amount, after collecting th
e usual
charges. In case of either purchase or collection, the bank's branch at the purc
place presents the bill to him and delivers the transport documents to him again
payment of the bill. In case of collection, till the payment is credited to the
account, the amount is shown as book debt in his books. In case of purchase of t
he bill
by the bank, the amount of bill is not represented in the books.
(b) If the credit is to be provided on the sales, a bill of exchange, called usa
bill, mentioning the period of payment, is drawn on the purchaser and is accepte
d by
him The outstanding amount is shown in the accounts as 'bills receivables'. The
advantage of sales under bills of exchange, which are governed by the NI Act, is
increased legal protection in case of default by the customer. For bank finance,
the accepted bill is given to the bank or the documents are sent through bank wh
delivers the same to the purchaser against his acceptance of usance bill. Bank p
finance to the seller by discounting the usance bill after deducting the usual c
and interest for the usance period.
The terms used in bills finance are purchase, discount and negotiation. Normally
'purchase' is used in case of demand bills, 'discount' in case of usance bills a

'negotiation' in case of bills which are drawn under letters of credit opened by
purchaser's bank.
In case of purchase/discount/negotiation of the bill by the bank, the outstandin
amount of bills is not represented in the assets in the accounting books of the
drawer (i.e., the seller, who is customer of the financing bank). It may be repr
esented in his
contingent liabilities if the bills are not 'without recourse to drawer'. To get
a realistic
picture, at the time of assessment of working capital finance, the amount of bil
purchased/discounted is added to both current assets and liabilities, depending
on the
bank's loan policy. However, the bills negotiated are normally not added as the
counterparty is another bank and the probability of recourse to drawer will be e
The gist of R B I guidelines to banks, while purchasing / discounting /
negotiating / rediscounting of genuine commercial / trade bills, are as under:
(a) Banks may sanction working capital limits, as also bills limit, to borrowers
after proper appraisal of their credit needs and in accordance with the loan pol
icy as
approved by their Board of Directors. Banks should clearly lay down a bills disc
policy approved by their Board of Directors, which should be consistent with the
ir policy
of sanctioning of working capital limits. In this case the procedure for Board a
should include banks' core operating process from the time the bills are tendere
d till
these are realized. Banks may review their core operating processes and simplify
procedure in respect of bills financing. In order to address the often-cited pro
blem of
delay in realization of bills, banks may take advantage of improved
computer/communication networks like the Structured Financial Messaging System (
M S) and adopt the system of 'value dating' of their clients' accounts.
(b) Banks should open letters of credit (L Cs) and purchase / discount / negotia
bills under L Cs only in respect of genuine commercial and trade transactions of
borrower constituents who have been sanctioned regular credit facilities by the
Banks should not, therefore, extend fund-based (including bills financing) or no
based facilities like opening of L Cs. providing guarantees and acceptances to n
onconstituent borrower or/and non-constituent member of a consortium / multiple ba
arrangement. However, in cases where negotiation of bills drawn under L C is res
to a particular bank and the beneficiary of the L C is not a constituent of that
bank, the
bank concerned may negotiate such an L C, subject to the condition that the proc

will be remitted to the regular banker of the beneficiary. However, the prohibit
regarding negotiation of unrestricted L Cs of non-constituents will continue to
be in
(c) Sometimes, a beneficiary of the LC may want to discount the bills with the L
issuing bank itself. In such cases, banks may discount bills drawn by beneficiar
y only if
the bank has sanctioned regular fund-based credit facilities to the beneficiary.
With a
view to ensuring that the beneficiary's bank is not deprived of cash flows into
account, the beneficiary should get the bills discounted/ negotiated through the
with which he is enjoying sanctioned credit facilities.
(d) Bills purchased/discounted/negotiated under L C (where the payment to the
beneficiary is not made 'under reserve') will be treated as an exposure on the L
issuing bank and not on the borrower. All clean negotiations as indicated above
will be assigned the risk weight as is normally applicable to inter-bank exposur
es, for capital
adequacy purposes. In the case of negotiations 'under reserve', the exposure sho
uld be
treated as on the borrower and risk weight assigned accordingly.
(e) While purchasing / discounting / negotiating bills under L Cs or otherwise,
banks should establish genuineness of underlying transactions/documents.
(f) The practice of drawing bills of exchange claused 'without recourse' and
issuing letters of credit bearing the legend 'without recourse' should be discou
because such notations deprive the negotiating bank of the right of recourse it
against the drawer under the Negotiable Instruments Act. Banks should not theref
open L Cs and purchase/discount/negotiate bills bearing the 'without recourse' c
On a review it has been decided that banks may negotiate bills drawn under L Cs,
'with recourse' or 'without recourse' basis, as per their discretion and based o
n their
perception about the credit worthiness of the L C issuing bank. However, the res
on purchase/discount of other bills (the bills drawn otherwise than under L C) o
n 'without
recourse' basis will continue to be in force.
(g) Accommodation bills should not be purchased/discounted/negotiated by
banks. The underlying trade transactions should be clearly identified and a prop
record thereof maintained at the branches conducting the bills business.
(h) Banks should be circumspect while discounting bills drawn by front finance
companies set up by large industrial groups on other group companies.
(i) Bills rediscounts should be restricted to usance bills held by other banks.
Banks should not rediscount bills earlier discounted by non-bank financial compa
nies (N
B F Cs) except in respect of bills arising from sale of light commercial vehicle
s and
two/three wheelers.
(j) Banks may exercise their commercial judgment in discounting of bills of the
services sector. However, while discounting such bills, banks should ensure that

services are rendered and accommodation bills are not discounted. Services secto
r bills
should not be eligible for rediscounting. Further, providing finance against dis
counting of
services sector bills may be treated as unsecured advance and, therefore, should
within the norm prescribed by the Board of the bank for unsecured exposure limit
In the course of its business, an enterprise may sometimes need bank
guarantees or letters of credit or bank's co-acceptance of bills drawn on the en
In providing such facilities, there is no outlay of funds by the banks. Therefor
e, in the
balance sheet, these do not appear in the assets of the bank or the liabilities
of the
enterprise. However, these appear in the contingent liabilities of both bank and
enterprise because in case of any liability arising on account of these items, t
he bank
has to fulfill its obligation and get the reimbursement from the enterprise on w
behalf this obligation was taken.
Banks issue guarantees on behalf of their customers for various purposes. The
guarantees executed by banks comprise both performance guarantees and financial
guarantees. The guarantees are structured according to the terms of agreement, v
security, maturity and purpose. Sometimes, it becomes difficult to distinguish b
performance and financial guarantees but broadly, the difference between the two
is as
The performance guarantee guarantees, to the beneficiary, reimbursement of
monetary loss arising due to non performance or under performance of a contract
the customer( applicant). Examples of performance guarantees are guarantees issu
towards completion of a contract within a time limit, or with certain quality or
for the
satisfactory performance of any equipment, project etc. The financial guarantee,
on the
other hand, is for meeting certain financial obligations or dues of the customer
(applicant) to the beneficiary. Examples of financial guarantees are guarantees
in lieu of security deposits, earnest money or payment of dues in case of defaul
t by the
Co-acceptance of Bills
A supplier of goods will be more willing to provide credit to the purchaser (ban
customer), if the bill of exchange drawn by him on purchaser and accepted by him
also accepted by the bank. Bank's co-acceptance acts like a guarantee for him ag
non payment by the purchaser. By providing this facility to the customer, the ne
ed for
working capital finance from the bank is reduced due to credit provided by the s

RBI Guidelines on Guarantees and Co-acceptances

(Details available in Master circular no. DBOD. No. Dir. BC. 18/13.03.00/2008-09
dated 1, JuIy 2008)
A gist of the guidelines, which banks should comply with, in the conduct of thei
guarantee business is given below:
General Guidelines
As regards the purpose of the guarantee, as a general rule, the banks should
confine themselves to the provision of financial guarantees and exercise due cau
with regard to performance guarantee business.
No bank guarantee should normally have a maturity of more than 10 years.
Precautions for Issuing Guarantees
Banks should adopt the following precautions while issuing guarantees on behalf
of their customers.
(a) As a rule, banks should avoid giving unsecured guarantees in large amounts
and for medium and long-term periods. They should avoid undue concentration of s
unsecured guarantee commitments to particular groups of customers and / or trade
(b) Unsecured guarantees on account of any individual constituent should he
limited to a reasonable proportion of the bank's total unsecured guarantees. Gua
on behalf of an individual should also bear a reasonable proportion to the const
equity.(c) In exceptional cases, banks may give deferred payment guarantees on a
unsecured basis for modest amounts to first class customers who have entered int
deferred payment arrangements in consonance with Government policy.
(d) Guarantees executed on behalf of any individual constituent, or a group of
constituents, should be subject to the prescribed exposure norms.
While issuing guarantees on behalf of customers, the following safeguards
should be observed by banks:
(1) At the time of issuing financial guarantees, banks should be satisfied that
customer would be in a position to reimburse the bank in case the bank is requir
ed to
make payment under the guarantee.
(2) In the case of performance guarantee, banks should exercise due caution
and have sufficient experience with the customer to satisfy themselves that the
customer has the necessary experience, capacity and means to perform the obligat
under the contract, and is not likely to commit any default.
(3) Banks should, normally, refrain from issuing guarantees on behalf of
customers who do not enjoy credit facilities with them.
Bank Guarantee Scheme of Government of India
Banks should adopt the Model Form of Bank Guarantee Bond given in Annexure
1 (Please refer R B I circular mentioned above). The Government of India have ad
all the Government departments/ Public Sector Undertakings, etc. to accept bank
guarantees in the Model Bond and to ensure that alterations/additions to the cla
whenever considered necessary are not one-sided and are made in agreement with t
guaranteeing bank. Banks should mention in the guarantee bonds and their
correspondence with the various State Governments, the names of the beneficiary
departments and the purposes for which the guarantees are executed. In regard to

guarantees furnished by the banks in favour of Government Departments in the nam

e of
the President of India, any correspondence thereon should be exchanged with the
concerned ministries/ departments and not with the President of India. In respec
t of
guarantees issued in favour of Directorate General of Supplies and Disposal, the
following aspects should be kept in view:
(1) In order to speed up the process of verification of the genuineness of the
bank guarantee, the name, designation and code numbers of the officer/officers s
the guarantees should be incorporated under the signature(s) of officials signin
g the
bank guarantee.
(2) The beneficiary of the bank guarantee should also be advised to invariably
obtain the confirmation of the concerned banks about the genuineness of the guar
issued by them as a measure of safety.
(3) The initial period of the bank guarantee issued by banks as a means of
security in Directorate General of Supplies and Disposal contract administration
be for a period of six months beyond the original delivery period. Banks may inc
a suitable clause in their bank guarantee, providing automatic extension of the
period of the guarantee by 6 months, and also obtain suitable undertaking from t
he customer at the time of establishing the guarantee to avoid any possible comp
(4) A clause would be incorporated by Directorate General of Supplies and
Disposal in the tender forms of Directorate General of Supplies and Disposal
(Instruction to the tenderers) to the effect that whenever a firm fails to supp
ly the stores
within the delivery period of the contract wherein bank guarantee has been furni
the request for extension for delivery period will automatically be taken as an
for getting the bank guarantee extended. Banks should make similar provisions in
bank guarantees for automatic extension of the guarantee period.
Guarantee on Behalf of Share and Stock Brokers / Commodity
Banks may issue guarantees on behalf of share and stock brokers in favour of
stock exchanges in lieu of security deposit to the extent it is acceptable in th
e form of
bank guarantee as laid down by stock exchanges. Banks may also issue guarantees
lieu of margin requirements as per stock exchange regulations. Banks have furthe
been advised that they should obtain a minimum margin of 50 per cent while issui
such guarantees. A minimum cash margin of 25 per cent (within the above margin o
f 50
per cent) should be maintained in respect of such guarantees issued by banks. Th
above minimum margin of 50 per cent and minimum cash margin requirement of 25 pe
cent (within the margin of 50 per cent) will also apply to guarantees issued by
banks on
behalf of commodity brokers in favour of the national level commodity exchanges,

National Commodity Derivatives Exchange (N C D E X), Multi Commodity Exchange of
India Limited (M C X) and National Multi-Commodity Exchange of India Limited (N
E I L) in lieu of margin requirements as per the commodity exchange regulations.
Appraisal of Guarantee / Co-acceptance Limit
The bank guarantees may be required by the enterprise either on regular basis
or ad-hoc basis. For example, a normal manufacturing enterprise may require
guarantee in favour of Customs department for release of imported good, for whic
h no
regular assessment can be made. The sanction of regular B G limit is required fo
r some
businesses like contractors, who have to provide the guarantees on a regular bas
is for
security deposits of tenders, receipt of advance payment or return of retention
as also performance guarantees for execution of projects. The assessment in such
cases depends on the nature of business and the terms of contracts. The bank has
examine the impact of sanction of guarantee limit on the fund based requirements
of the
borrower. For example, a guarantee issued in respect of receipt-of advance payme
will reduce the fund based need of the enterprise. So, a part of the B G limit m
ay be
carved out of its total fund based W C limits.
The co-acceptance limit helps the borrower to get more credit from the supplier
and, therefore, is carved out of the fund based W C limit, if this credit was no
t taken into
account at the time of assessment.Letters of Credit
The genesis a letter of credit lies in the fact that a seller of good is worried
receipt of money from the buyer if he supplies the goods first, and the buyer is
about non receipt of contracted goods if he makes the payment first. The bank ac
ts as
an intermediary between the two by using its credibility, as it is acceptable to
both buyer
and the seller. Letter of Credit (L C) is an undertaking by the bank, at the req
uest of the
buyer( applicant, who is customer of the bank), to the seller, to pay him the co
amount if he supplies the goods as per the terms specified and submits the requi
documents, including the documents of the title of the goods. The conduct of LC
business is governed by the publication no.600 of the International Chamber of
Commerce (I C C), commonly known as U C P D C 600.
Appraisal of LC Limit
An L C is used for purchase of goods either through imports or local purchase.
For assessing the L C requirement of an enterprise, we have to know the followin
(1) Average Amount of Each L C: This is dependent on the monthly consumption of
goods and the economic order quantity. Economic order quantity (E O Q) is estima
by examining the sources of supply, means of transport, discount etc. In case of
imports, the E O Q is often larger in comparison to indigenous purchases.
(2) Frequency of L C Opening: Once E O Q is estimated, the number of I-Cs to be

opened in a year can be calculated by dividing annual consumption by E O Q.

Frequency of opening L Cs will be 12 divided by the number of I-Cs to be opened
in a
(3) How many L Cs will be outstanding at a particular time: The time taken for o
ne L
C to remain in force depends upon the lead time (time taken from the date of ope
ning L
C to shipment of goods), the transit time and the usance available to purchaser
from the
date of receipt of goods. If the frequency of opening L C is less than this, ban
k will have
more than one L C outstanding at any point of time.
Example: If lead time is 10 days, transit is 20 days and usance period is six mo
nths, the
total time for which an L C will remain outstanding is seven months. If consumpt
ion of
goods is Rs 6 crore per year and E O Q is Rs one crore, the frequency of opening
L C is
every 2 months. It means that at any point of time, there will be four L Cs outs
( 7divided by 2 and rounded off to next figure). As the amount of each L C is Rs
crore, the total L C limit will be Rs 4 crore.
While sanctioning L C limit, its impact on the fund based requirements of the
borrower should be examined. In view of the increased credit available to him th
rough L
C, normally, an L C limit is carved out of the total fund based W C limit sancti
Commercial Paper
Commercial Paper (C P), an unsecured money market instrument issued in the
form of a promissory note, was introduced in India in 1990 with a view to enabli
ng highly
rated corporate borrowers to diversify their sources of short-term borrowings. T
he cost
of borrowing through C P is normally lower compared to other sources of short te
finance and therefore, it serves as a useful tool in working capital management
of the
corporate. Guidelines for issue of C P are governed by directives issued by the
R B I. A
master circular of all these guidelines issued up to 30/6/09, has been issued by
RBI on
1 July, 2009 and is posted on their website
This is a method of financing the receivables of a business enterprise. The
financier is called 'Factor' and can be a financial institution. Banks are not p
ermitted to
do this business themselves but they can promote subsidiaries to do this. Under
factoring, the factor not only purchases the book debts/receivables of the clien
t, but may
also control the credit given to the buyers and administer the sales ledger. The
purchase of book debts/receivables can be with recourse or without recourse to t
client. If it is without recourse, the client is not liable to pay to the factor
in case of failure
of the buyer to pay.

This is similar to factoring but is used only in case of exports and where the s
is supported by bills of exchange/promissory notes. The financier discounts the
bills and
collects the amount of the bill from the buyer on due dates. Forfaiting is alway
s without
recourse to the client. Therefore, the exporter does not carry the risk of defau
lt by the
Most of the business enterprises need to maintain some current assets like,
cash, raw materials, work-in-process, finished goods and receivables for smooth
functioning of their business. The cycle starting from purchase of raw material
culminating in receipt of sales proceeds from the customer, is called working ca
cycle. The longer this cycle, larger is the amount of money blocked in the curre
assets, and vice versa. The amount of money blocked in the current assets is cal
total or gross working capital. A part of this money may come from credit provid
ed by
suppliers, advances from customers and any other short term liability. Also, the
enterprise is also required to arrange for some long term funds (called N W C) t
o meet
part of this requirement. The gap, if any, is provided by the banks as working c
finance. In the past, when credit was scarce, R B I provided elaborate guideline
s for
calculation of bank finance for W C. This has been relaxed substantially over a
period of
time but the guiding principles are still used by many banks for the assessment.
Banks also provide non-fund-based working capital limits. These are mainly, gua
rantees, L Cs
and co-acceptance of bills. The appraisal of these limits is also done by detail
analysis as these carry risks similar to fund based limits. Some of the instrume
methods used in working capital finance are bills financing, factoring, forfaiti
ng and
commercial paper. R B I has issued guidelines in respect of all of these.
Working capital cycle; N W C; Gross W C; Working capital gap; M P B F; First, se
and third methods; Turnover method; Cash budget; Guarantees; Letters of credit;
Coacceptance of bills; Liquidity, Current ratio
Check Your Progress
1. Net Working Capital (N W C) means
The choices are:
(a) Total current assets minus bank finance
(b) Total current assets minus credit from suppliers
(c) Total current assets minus total current liabilities
(d) Short term sources brought in by the promoters
The correct choice is: (c) Total current assets minus total current liabilities
2. Which of the following statements is not true for efficient inventory managem
The choices are:

(a) It results in reduction in inventory

(b) It reduces the working capital requirements of the enterprise
(c) It reduces the N W C available with the enterprise
(d) It increases the Inventory Turnover Ratio if the level of sales remains same
The correct choice is: (c) It reduces the N W C available with the enterprise
3. Which of the following is not a source for meeting working capital requiremen
The choices are:
(a) Suppliers' credit
(b) Bank finance
(c) Other current liabilities
(d) Advance payment to suppliers
The correct choice is: (d) Advance payment to suppliers
(4) Which of the following is a liquidity ratio?
The choices are:
(a) Quick ratio(b) T O L / T N W
(c) D S C R
(d) Other current liabilities
The correct choice is: (a) Quick ratio
(5) Which of the following is not correct regarding Current Ratio?
The choices are:
(a) For same level of current assets, increase in N W C results in increased
current ratio.
(b) The current ratio can be less than one
(c) The current ratio can be negative
(d) Current ratio is an indicator of liquidity
The correct choice is: (c) The current ratio can be negative
(6) The commercial paper can be issued by
The choices are:
(a) Corporates
(b) Corporates and partnership firms
(c) Any business entity
(d) None of the above
The correct choice is: (a) Corporates
(7) Which of the following is not correct regarding Forfaiting? The choices are:
(a) It a form of working capital finance
(b) It is used in export finance
(c) It is with recourse to the drawer of the bill
(d) Under this financier discounts the bills drawn on buyer.
The correct choice is: (c) It is with recourse to the drawer of the bill.
(8) Which of the following is correct regarding Letters of Credit. The choices
(a) These are opened by a bank for export sales by the client
(b) These are opened by a bank for local sales by the client
(c) Letters of Credit do not carry much risk for the opening bank
(d) Letters of Credit are opened by a bank for purchase of goods by the client
The correct choice is: (d) Letters of Credit are opened by a bank for purchase o
goods by the client.(9) Under Turnover method of assessment, the limit is sancti
oned at per cent of the
projected turnover. The choices are:
(a) 25
(b) 20
(c) 30
(d) 35
The correct choice is: (b) 20
(10) Cash budget method of assessment is more suitable for those business enterp

which have . The choices are:

(a) uniform level of operations
(b) High level of operations
(c) Low level of operations
(d) Seasonal operations
The correct choice is: (d) Seasonal operations.
Answer to Check Your Progress
1. (c); 2. (c); 3. (d); 4. (a); 5. (c); 6. (a); 7. (c); 8. (d); 9. (b); 10. (d)
UNIT 29 Term Loans
29.0 Objectives
29.1 Important Points about Term Loans
29.2 Deferred Payment Guarantees (D P Gs)
29.3 Difference between Term Loan Appraisal and Project Appraisal
29.4 Project Appraisal
29.5 Appraisal and Financing of Infrastructure Projects
After reading this chapter, you will have better understanding of:
(1) The meaning of term finance
(2) Deferred payment guarantees
(3) Assessment of term/project finance
(4) Techno-economic feasibility study
(5) Infrastructure finance
1. Banks provide term loans normally for acquiring the fixed assets like land,
building, plant and machinery, infrastructure etc., (personal loans, consumption
educational loans etc. being exceptions) while the working capital loans are pro
vided for
sustaining the working capital i.e. current assets level.
2. In exceptional cases, banks provide term loans for current assets also. This
called Working Capital Term Loan(W C T L) As we are aware, the business enterpri
is supposed to bring a part of its funds required to maintain the desired level
of current
assets from its long term sources (capital or term liabilities), called N W C, s
o that the
stipulated current ratio can be maintained. If the enterprise is not able to bri
ng in the
required amount of N W C, it will feel liquidity crunch and business operations
will be
affected. In such cases, banks may provide W C T L.
3. Working capital loans are normally sanctioned for one year but are payable on
demand. Term loans are payable as per the agreed repayment schedule, which is
stipulated in the terms of the sanction. Therefore, for the purpose of matching
and liabilities of the bank, term loans are considered long term assets while wo
capital loans are considered as short term assets. Practically, however, an ente
rprise continues to enjoy the working capital loan till its working is satisfact
ory, while the term
loan gets repaid over a period of time.
4. As a term loan is expected to be repaid out of the future cash flows of the
borrower, the D S C R assumes great importance while considering term loans, whi
for working capital loans, the liquidity ratios assume greater importance.

5. There is no uniform repayment schedule for all term loans. Each term loan has
its own peculiar repayment schedule depending upon the cash surplus of the borro
Thus, in case of a salaried person, where income level is constant, the repaymen
t can
be through E M I system and in case of a farmer, the repayment of principal and
may coincide with the cropping pattern. In case of industrial enterprises, norma
banks stipulate monthly/quarterly repayment of principal along with all the accu
interest. In some cases, the entire repayment may be stipulated in one installme
nt only,
called the bullet repayment.
When the purchaser of a fixed asset does not pay to the supplier immediately,
but pays according to an agreed repayment schedule, and the bank guarantees this
repayment, the guarantee is called D P G. This is a Non-fund based method for
financing purchase of fixed assets. However, if the purchaser defaults in paymen
t of any
amount, the bank has to pay the same to the supplier and the exposure becomes fu
based till the amount is recovered from the client. The risks involved in a D P
G are
same as those in a term loan and therefore, the appraisal for a D P G is same as
for a term loan.
For appraising a stand alone term loan proposal, all the concepts involved in a
project appraisal may not be necessary to be applied though all concepts of a te
rm loan
appraisal are applicable to project finance also. The differences can be summari
zed as
(a) In project finance all the financial needs of the enterprise, including work
capital requirements, are appraised. This is because the total requirement of lo
ng term
funds includes margin money for working capital. After assessing the total requi
of long term funds, the banks decide upon the amount of term loan to be sanction
and the contribution of the promoters.
(b) If an existing enterprise wants to purchase a few machineries, which are not
going to have a major impact on the volume or composition of the business, it wi
ll serve
little purpose to have a detailed examination of techno- economic feasibility, m
competence, I R R etc. It may be enough for the bank to examine the projections
next 2 to 3 years to find out that D S C R is at satisfactory level. In case of
loans to
individuals also, like housing loans, educational loans etc., it may be enough t
o examine
the projected D S C R to judge the viability. However, the basic principles of a
ppraisal of a project or a standalone term loan are not different and if one is

clear about project

appraisal, the appraisal of a standalone term loan proposal is even simpler.
Project appraisal can be broadly taken in the following steps:
(1) Appraisal of Managerial Aspects
(2) Technical Appraisal
(3) Economic Appraisal
Appraisal of Managerial Aspects: The appraisal of managerial aspects involves
seeking the answer to the following questions:
(a) What are the credentials of the promoters'?
(b) What is the financial stake of promoters in the project? Can they bring addi
funds in case of contingencies arising out of delay in project implementation an
changes in market conditions?
(c) What is the form of business organization? Who are the key persons to be app
to run the business?
Technical Appraisal: The technical feasibility of a project involves the followi
(a) location
(b) products to be manufactured, production process
(c) availability of infrastructure
(d) provider of technology
(e) details of proposed construction
(f) contractor for project execution
(g) waste-disposal and pollution control
(h) availability of raw materials
(i) marketing arrangements
Economic Appraisal: The economic or financial feasibility of a project involves
following aspects:
(a) Return on Investment: The usual methods used are the NPV, IRR, payback perio
cost benefit ratio, accounting rate of return etc.
(b) Break-even Analysis: A project with a high break-even point is considered mo
risky compared to the one with lower break-even point.
(c) Sensitivity Analysis: As market conditions are uncertain, a small change in
prices of raw materials or finished goods may have a drastic impact on the viabi
lity of a
project. Sensitivity analysis examines such impact.29.5 APPRAISAL AND FINANCING
Infrastructure sector deals with roads, bridges, power, transport,
telecommunication, etc. (This is defined in Section 10 of IT Act). Infrastructur
e projects
involve some distinct features like exceptionally long implementation, gestation
and pay
back periods, high debt equity ratio etc. While the basic principles of appraisa
l of an
infrastructure project are same as those involved in a normal project appraisal,
there are
some additional points to be considered, as highlighted in R B I guidelines R B
guidelines to the banks for financing infrastructure projects, are as follows:
(A) Types of Financing by Banks
In order to meet financial requirements of infrastructure projects, banks may

extend credit facility by way of working capital finance, term loan, project loa
subscription to bonds and debentures/ preference shares/ equity shares acquired
as a
part of the project finance package which is treated as 'deemed advance' and any
form of funded or non-funded facility.
(a) Take-out Financing: Banks may enter into take-out financing arrangement with
F C & other financial institutions or avail of liquidity support from I D F C &
other F Is. A
brief write-up on some of the important features of the arrangement is given in
paragraph Banks may also be guided by the instructions regarding tak
finance contained in Circular No. DBOD. BP.BC. 144 / 21.04.048 / 2000 dated 29,
February 2000.
(b) Inter-institutional: Guarantees Banks are permitted to issue guarantees favo
other lending institutions in respect of infrastructure projects, provided the b
ank issuing
the guarantee takes a funded share in the project at least to the extent of 5 pe
r cent of
the project cost and undertakes normal credit appraisal, monitoring and follow-u
p of the
(c) Financing Promoter s Equity: In terms of Circular No. DBOD. Dir. BC. 90/
13.07.05/ 99 dated August 28, 1998, banks were advised that the promoter's
contribution towards the equity capital of a company should come from their own
resources and the bank should not normally grant advances to take up shares of o
companies. In view of the importance attached to the infrastructure sector, it h
as been
decided that, under certain circumstances, an exception may be made to this poli
cy for
financing the acquisition of the promoter's shares in an existing company, which
engaged in implementing or operating an infrastructure project in India. The con
subject to which an exception may be made, are as follows:
(1) The bank finance would be only for acquisition of shares of existing
companies providing infrastructure facilities as defined in paragraph (a) above.
acquisition of such shares should be in respect of companies where the existing
promoters (and/ or domestic joint promoters) voluntarily propose to disinvest th
majority shares in compliance with SEBI guidelines, where applicable.(2) The com
panies to which loans are extended should, inter alia, have a
satisfactory net worth.
(3) The company financed and the promoters or directors of such companies
should not be defaulters to banks or Financial Institutions.
(4) In order to ensure that the borrower has a substantial stake in the
infrastructure company, bank finance should be restricted to 50 per cent of the
required for acquiring the promoter's stake in the company being acquired.
(5) Finance extended should be against the security of the assets of the
borrowing company or the assets of the company acquired and not against the shar
of that company or the company being acquired. The shares of the borrower compan

or company being acquired may be accepted as additional security and not as prim
security. The security charged to the banks should be marketable.
(6) Banks should ensure maintenance of stipulated margins at all times.
(7) The tenor of the bank loans may not be longer than seven years. However,
the Boards of banks can make an exception in specific cases, where necessary, fo
financial viability of the project.
(8) This financing would be subject to compliance with the statutory requirement
under Section 19(2) of the Banking Regulation Act, 1949.
(9) The banks financing acquisition of equity shares by promoters should be
within the regulatory ceiling of 40 per cent of their net worth as on 31 March o
f the
previous year for the aggregate exposure of the banks to the capital markets in
all forms
(both fund based and non-fund based).
(10) The proposal for bank finance should have the approval of the Board.
(B) Appraisal
(1) In respect of financing of infrastructure projects undertaken by Government
owned entities, banks or Financial Institutions should undertake due diligence o
n the
viability of the projects. Banks should ensure that the individual components of
and returns on the project are well defined and assessed. State government guara
may not be taken as a substitute for satisfactory credit appraisal and such appr
requirements should not be diluted on the basis of any reported arrangement with
Reserve Bank of India or any bank for regular standing instructions or periodic
instructions for servicing the loans or bonds.
(2) Infrastructure projects are often financed through Special Purpose Vehicles.
Financing of these projects would, therefore, call for special appraisal skills
on the part
of lending agencies. Identification of various project risks, evaluation of risk
through appraisal of project contracts and evaluation of creditworthiness of the
contracting entities and their abilities to fulfill contractual obligations will
be an integral
part of the appraisal exercise. In this connection, banks or Financial Instituti
ons may
consider constituting appropriate screening committees or special cells for appr
aisal of
credit proposals and monitoring the progress or performance of the projects. Oft
en, the
size of the funding requirement would necessitate joint financing by banks or Fi
Institutions or financing by more than one bank under consortium or syndication
arrangements. In such cases, participating banks or Financial Institutions may,
for the
purpose of their own assessment, refer to the appraisal report prepared by the l
bank or Financial Institutions or have the project appraised jointly.
(C) Prudential Requirements
(1) Prudential Credit Exposure Limits: Credit exposure to borrowers belonging
to a group may exceed the exposure norm of 40 per cent of the bank's capital fun

ds by
an additional 10 per cent (i.e. up to 50 per cent), provided the additional cred
it exposure
is on account of extension of credit to infrastructure projects. Credit exposure
to single
borrower may exceed the exposure norm of 15 per cent of the bank's capital funds
an additional 5 per cent (i.e. up to 20 per cent) provided the additional credit
exposure is
on account of infrastructure as defined in paragraph (a) above. In addition to t
exposure permitted above, banks may, in exceptional circumstances, with the appr
of their Boards, consider enhancement of the exposure to a borrower up to a furt
her 5
per cent of capital funds. The bank should make appropriate disclosures in the '
on account' to the annual financial statements in respect of the exposures where
bank had exceeded the prudential exposure limits during the year.
(2) Assignment of Risk Weight for Capital Adequacy Purposes: Banks are
required to be guided by the Prudential Guidelines on Capital Adequacy and Marke
Discipline- Implementation of the New Capital Adequacy Framework, as amended fro
time to time in the matter of capital adequacy.
(3) Asset Liability Management: The long-term financing of infrastructure projec
may lead to asset - liability mismatches, particularly when such financing is no
t in
conformity with the maturity profile of a bank's liabilities. Banks would, there
fore, need to
exercise due vigil on their asset-liability position to ensure that they do not
run into
liquidity mismatches on account of lending to such projects.
(4) Administrative arrangements: Timely and adequate availability of credit is t
pre-requisite for successful implementation of infrastructure projects. Banks/ F
ls should,
therefore, clearly delineate the procedure for approval of loan proposals and in
stitute a
suitable monitoring mechanism for reviewing applications pending beyond the spec
period. Multiplicity of appraisals by every institution involved in financing, l
eading to
delays, has to be avoided and banks should be prepared to broadly accept technic
parameters laid down by leading public financial institutions. Also, setting up
mechanism for an ongoing monitoring of the project implementation will ensure th
at the
credit disbursed is utilized for the purpose for which it was sanctioned.
(D) Take-out Financing or Liquidity Support
(1) Take-out Financing or Liquidity Support: Take-out financing structure is
essentially a mechanism designed to enable banks to avoid asset-liability maturi
mismatches that may arise out of extending long tenor loans to infrastructure pr
Under the arrangements, banks financing the infrastructure projects will have an

arrangement with I D F C or any other financial institution for transferring to

the latter the
out standings in their books on a pre-determined basis. I D F C and S B I have d
different take-out financing structures to suit the requirements of various bank
addressing issues such as liquidity, asset-liability mismatches, limited availab
ility of project appraisal skills, etc. They have also developed a Model Agreeme
nt that can be
considered for use as a document for specific projects in conjunction with other
loan documents. The agreement between S B I and I D F C could provide a referenc
point for other banks to enter into somewhat similar arrangements with I D F C o
r other
financial institutions.
(2) Liquidity support from I D F C: As an alternative to take-out financing
structure, I D F C and S B I have devised a product, providing liquidity support
to banks.
Under the scheme, I D F C would commit, at the point of sanction, to refinance t
entire outstanding loan (principal+ unrecovered interest) or part of the loan, t
o the bank
after an agreed period, say, five years. The credit risk on the project will be
taken by the
bank concerned and not by I D F C. The bank would repay the amount to I D F C wi
interest as per the terms agreed upon. Since I D F C would be taking a credit ri
sk on the
bank, the interest rate to be charged by it on the amount refinanced would depen
d on
the I D F C's risk perception of the bank (in most of the cases, it may be close
to I D F
C's P L R). The refinance support from I D F C would particularly benefit the ba
which have the requisite appraisal skills and the initial liquidity to fund the
Term loans are normally provided by the banks for the acquisition of fixed asset
or other long-term requirements (like for education or investments) of a custome
r. The
terms of sanction invariably stipulate schedule of repayment of principal and in
terest. In
appraisal of a term-loan proposal, D S C R is as important a ratio as current ra
tio is in
appraisal of working capital limits. Sometimes, banks issue Deferred payment
Guarantees (D P Gs) in favour of suppliers of capital equipments, if he is prepa
red to
accept the sales price on deferred basis. However, the appraisal or a D P G is s
imilar to
that of a term-loan as the risks involved are similar. A project appraisal is si
milar to a
term-loan appraisal with some additional points to consider. Project appraisal b
involves appraisal of managerial aspects and examination of techno-economic
feasibility. Infrastructure sector deals with roads, bridges, power, transport,
telecommunication etc. Infrastructure projects involve some distinct features li
exceptionally long implementation, gestation and pay back periods, high debt equ

ratio, etc. R B I has issued elaborate guidelines to banks on infrastructure fin
Repayments; D P G; W C T L; D S C R; E M I; Project; Infrastructure; I D F C; Ta
ke out
financing; Inter-institutional guarantees
Check Your Progress
1. A D G P is issued by the bank for ----------, by its client.
The choices are
(a) Sale of goods
(b) Purchase of goods
(c) Sale of capital goods(d) Purchase of capital goods
The correct choice is (d) Purchase of capital goods
2. Which of the following statements is not true for an infrastructure project?
The choices are
(a) It has long gestation period
(b) It reduces the risk for the lender as his funds get assured deployment for a
long time.
(c) The debt equity ratio is normally high for an infrastructure project
(d) The implementation period is usually long
The correct choice is (b) It reduces the risk for the lender as his funds get as
deployment for a long time.
3. Which of the following is not a source of funds for meeting the cost of fixed
assets by
an enterprise?
The choices are
(a) Credit by supplier of assets
(b) Internal accruals
(c) Debentures
(d) D P G
The correct choice is (d) DPG
4. Which of the following is ratio, indicative of the repaying capacity of a bor
The choices are
(a) Quick ratio
(b) T O L/T N W
(c) D S C R
(d) D E R
The correct choice is (c) D S C R
5. Which of the following is not correct regarding term loans by the banks?
The choices are
(a) Asset liability matching is an important consideration in term financing
(b) Installment of term loan, payable within one year is considered as current
(c) Repayment of a term loan can be in equated monthly instalments
(d) Current ratio is the most important ratio in appraisal of a term loanThe cor
rect choice is (d) Current ratio is the most important ratio in appraisal of a
term loan
6. Project loans can be given by the bank to
The choices are
(a) Only corporates
(b) Only corporates and partnership firms
(c) Only corporate, partnership firms and societies
(d) Any business entity
The correct choice is (d) Any business entity
7. Which of the following is not correct regarding infrastructure project by the

The choices are

(a) Banks are allowed to funds promoters' equity in certain circumstances
(b) Exposure norms are relaxed by R B I
(c) Asset liability mismatch has been permitted by R B I
(d) I D F C provides liquidity support to banks
The correct choice is (c) Asset liability mismatch has been permitted by R B I
8. Which of the following statements is not correct for project appraisal?
The choices are
(a) Examination of technical feasibility is carried out
(b) The contribution of promoters forms a part of economic appraisal
(c) Promoters' background is part of the management appraisal
(d) Capacity of promoters to arrange for additional funds, in case of
contingencies, forms a part of economic appraisal.
The correct choice is (d) Capacity of promoters to arrange for additional funds,
case of contingencies, forms a part of economic appraisal.
Key to Check your Progress
1. (d); 2. (b); I (d); 4. (c); 5. (d); 6. (d), 7. (c); 8. (d)
UNIT 30 Credit Delivery
30.0 Objectives
30.1 Introduction
30.2 Documentation
30.3 Third Party Guarantees
30.4 Charge over Securities
30.5 Possession of Security
30.6 Disbursal of Loans
30.7 Lending under Consortium/Multiple Banking Arrangements
30.8 Syndication of Loans
After reading this chapter, you will have better understanding of:
(1) Documentation
(2) Third party guarantees
(3) Various methods of creating charge over securities
(4) Methods of delivery of bank loans
(5) Consortium / multiple banking and syndication of loan
While, for the safety of an advance, the credit appraisal is critical for select
ing the
right borrower, assessing his credit needs and the viability of his operations
appropriately and prescribing suitable terms and conditions for the credit, ther
e are a
few questions to be addressed before the bank parts with its money. These questi
(1) What documents should be obtained from the borrower and the guarantor so
that in the event of any default, the bank has the legal recourse to recover the
(2) Whether any charge is to be created on the primary and collateral security?
yes, how it should be done?(3) Whether the charge of the bank on the securities
is to registered with any
authority prescribed by the law?
(4) Whether the securities should be in possession of the borrower or the bank'?
(5) How the loan should be disbursed'? Whether we issue a cheque for the loan
amount in the name of the borrower or, should his account with the bank be credi
ted or
should some other method be adopted?

(6) What are the R B I guidelines in this respect?

Documents are to be signed by the borrowers and guarantors so that the bank
can establish their liability in a court of law. In addition, the borrower has t
o sign the
documents which create charge over the primary security, i.e. the security creat
ed out
of the bank finance. For charge over collateral security, the owner of that secu
should sign the relevant documents. It should be ensured that if the owner of th
collateral security is someone other than the borrower, he should first become a
guarantor of the loan and then create charge over the security. Each bank's lega
department prescribes the standard documents to be taken depending on the type o
the loan. In case of a structured loan, the legal department drafts the document
applicable to that particular case. However, a few points, which must be ensured
, by the
credit officer. in connection with execution of the documents, are as under:
(1) The documents should be properly stamped
(2) The date of execution of documents should never be earlier than the date of
stamping. Date and place of execution should be properly mentioned in the docume
(3) It should be ensured that the parties executing the documents have the
necessary authority and the capacity to enter into a contract and executed the
documents in that capacity. For example, a partner should sign on behalf of the
firm and
not in his individual capacity.
(4) It should be ensured that the person signing the documents is doing so with
his free will
(5) The documents should be filled in before these are signed.
(5) In case of companies, the charge should be registered with ROC. within 30
days from the date of execution of the documents.
(6) If any document is required to be registered with the Sub-registrar, it shou
be done within the prescribed time limit.
While the enterprise or individual, who has taken the loan from the bank is lega
bound to repay the principal and the interest, in some cases, banks stipulate gu
of third parties, as an additional safety against default. These third parties c
an be
individuals or any other legal entity. In case of finance to firms, the personal
of proprietor or partners is not stipulated as they have unlimited liability and
personal assets can be attached for recovery of bank loans. However, in case of
companies and other legal entities, the promoters/ directors/ trustees do not ha
unlimited/ any liability towards bank's dues. Therefore, in many cases banks sti
their personal guarantees. R B I suggestions to the banks in this respect are as
(1) Personal guarantees of directors may be helpful in respect of companies,
whether private or public, where shares are held closely by a person or connecte

persons or a group (that being professionals or Government), irrespective of oth

factors, such as financial condition, security available, etc., the exception be
ing in
respect of companies where, by court or statutory order, the management of the
company is vested in a person or persons, whether called directors or by any oth
name, who are not required to be elected by the shareholders. Where personal
guarantee is considered necessary, the guarantee should preferably be that of th
principal members of the group holding shares in the borrowing company rather th
that of the director or managerial personnel functioning as director or in any m
(2) Even if a company is not closely held, there may be justification for a pers
guarantee of directors to ensure continuity of management. Thus, a lending insti
could make a loan to a company whose management is considered good.
Subsequently, a different group could acquire control of the company, which coul
d lead
the lending institution to have well-founded fears that the management has chang
ed for
the worse and that the funds lent to the company are in jeopardy. One way by whi
lending institutions could protect themselves in such circumstances is to obtain
guarantees of the directors and thus ensure either the continuity of the managem
ent or
that the changes in management take place with their knowledge. Even where perso
guarantees are waived, it may be necessary to obtain an undertaking from the
borrowing company that no change in the management would be made without the
consent of the lending institution. Similarly, during the formative stages of a
company, it
may be in the interest of the company, as well as the lending institution, to ob
guarantees to ensure continuity of management.
(3) Personal guarantees of directors may be helpful with regard to public limite
companies other than those which may be rated as first class, where the advance
is on
an unsecured basis.
(4) There may be public limited companies, whose financial position and/or
capacity for cash generation is not satisfactory even though the relevant advanc
es are
secured. In such cases, personal guarantees are useful.
(5) Cases where there is likely to be considerable delay in the creation of a
charge on assets, guarantee may be taken, where deemed necessary, to cover the
interim period between the disbursement of loan and the creation of the charge o
(6) The guarantee of parent companies may be obtained in the case of
subsidiaries whose own financial condition is not considered satisfactory.
(7) Personal guarantees are relevant where the balance sheet or financial
statement of a company discloses interlocking of funds between the company and o
concerns owned or managed by a group.R B I has also advised the banks to obtain
an undertaking from the borrowing

company as well as the guarantors that no consideration whether by way of

commission, brokerage fees or any other form, would be paid by the former or rec
by the latter, directly or indirectly. This requirement should be incorporated i
n the bank's
terms and conditions for sanctioning of credit limits. During the periodic inspe
ctions, the
bank's inspectors should verify that this stipulation has been complied with. Th
ere may,
however, be an exceptional case where payment of remuneration may be permitted,
e.g. where assisted concerns are not doing well and the existing guarantors are
longer connected with the management but continuance of their guarantees is
considered essential because the new management's guarantee is either not availa
or is found inadequate and payment of remuneration to guarantors by way of guara
commission is allowed.
Nature of security and the operational convenience often decide the type of
charge to be created over a security. The procedure for creation of charge is sa
me for
both primary and collateral securities. The point to be kept in mind is that onl
y the owner
of an asset can create charge over it. The charge could be any of the following:
(1) Mortgage
(2) Hypothecation Pledge
(3) Lien
(4) Assignment
At the time of appraisal, banker has to decide about the possession of the
security specially in case of inventory. With legal system in the country being
still not
perfect, this aspect has a bearing on the overall risk rating of the proposal. T
ill about a
decade ago, a favoured method of finance of many banks used to be the, 'Lock and
Key' advances in which the goods are kept in a godown and bank holds the keys of
locks of the godown. If any goods are to be delivered to the borrower, he has t
o deposit
the money in his cash credit account (alternatively, provide a trust receipt) be
fore bank's
'Godown Keeper' goes to the godown and delivers the goods. This system was very
inconvenient not only for the borrower but for the bank also and slowly got chan
ged to
'Hypothecation', where possession remained with the borrower. In case of 'Pledge
' also,
the borrower can have possession, called, 'Constructive Possession', and hold th
goods as an agent of the bank.
Working Capital Loans
In case of sole banking, the bank providing working capital limits opens a cash
credit account of the borrower and all his financial transactions should be rout
through this account. Without bank's permission, no account can be opened with a
other bank. Banks give permission to open current account with other bank only i
f they are convinced about its necessity. In such cases, periodic statements of

that account
are obtained to keep a tab on the transactions.
The drawings in the cash credit account are regulated through the system of
'Drawing power' (D P) which is within the sanctioned cash credit limit. Ideally,
the DP
should be calculated by obtaining a statement of all the current assets and liab
(excluding outstanding in cash credit account with the bank) and deducting from
it the N
W C stipulated at the time of assessment of the limit. However, this is not feas
ible as
such a statement is normally available only after accounts are finalized. Even i
f bank
insists for such statement, it will be available after much delay and may not se
rve the
purpose. Therefore, banks obtain the statement of stocks, book-debts/receivables
the sundry creditors (account payable). These three items form major portion of
assets and liabilities in majority of the enterprises. Such statement is normall
y obtained
on monthly basis but the periodicity can be reduced in exceptional cases. By sti
suitable margins (depending on method of assessment) on stocks and book debts an
reducing the amount of sundry creditors, the D P is calculated.
Disbursal of entire W C limit by way of cash credit gives wide flexibility to th
borrower in his working capital management. But, it creates the problem of fund
management for the bank as there could be wide fluctuations in the utilization o
f limits.
This also offers scope for diversion of funds by the borrower. If the liquidity
in the market
is tight and short-term interest on money market instruments is high, he may ten
d to
utilize the limit fully In situations of abundant liquidity, the situation is re
verse and the
utilization of limit may tend to be low. The bank loses in such situations as it
has to
arrange for short term funds when interest rates are high and is left with surpl
us funds
when rates are low. To meet this situation and to ensure that the utilization of
limit is
more stable, a portion of sanctioned limit is disbursed by way of 'Loan', which
is a fixed
component, and remaining amount is disbursed as cash credit.
With this, if the borrower wants to draw very little amount or no amount, there
be debit in the loan account (fixed amount) while the cash credit account may ha
credit balance. R B I guidelines in this respect are as follows:
(1) In the case of borrowers enjoying working capital credit limits of Rs 10 cro
and above from the banking system, the loan component should normally be 80
percent. Banks, however, have the freedom to change the composition of working
capital by increasing the cash credit component beyond 20 percent or to increase
'Loan Component' beyond 80 percent, as the case may be, if they so desire. Banks
expected to appropriately price each of the two components of working capital fi

taking into account the impact of such decisions on their cash and liquidity
(2) In the case of borrowers enjoying working capital credit limit of less than
10 crone, banks may persuade them to go in for the 'Loan System' by offering an
incentive in the form of lower rate of interest on the loan component, as compar
ed to the
cash credit component. The actual percentage of 'loan component' in these cases
be settled by the bank with its borrower clients.
(3) In respect of certain business activities, which are cyclical and seasonal i
nature or have inherent volatility, the strict application of loan system may cr
eate difficulties for the borrowers. Banks may, with the approval of their respe
ctive Boards,
identify such business activities, which may be exempted from the loan system of
Term loans
If the term loan is to be disbursed in one go, e.g. purchase of a machine/ ready
house, the borrower is asked to deposit his margin with the bank, his loan accou
nt is
debited by the amount of the loan and the entire amount to be paid to the buyer,
remitted to him by the bank. If any amount has already been paid to the buyer by
customer, satisfactory proof, like details of bank account etc, of this payment
obtained, and this is considered to be a part of his contribution (margin). In e
cases, like personal loans or consumption loans, the amount may be credited to t
account of the customer with the bank.
In cases where the execution of the project is spread over a period of time, the
disbursement is normally related to the progress of the project. RBI guidelines
respect of disbursement of project loans are as under:
'At the time of financing projects banks generally adopt one of the following
methodologies as far as determining the level of promoters' equity is concerned.
(1) Promoters bring their entire contribution upfront before the bank starts
disbursing its commitment.
50%) upfront and
(2) Promoters bring certain percentage of their equity (40%
balance is brought in stages.
(3) Promoters agree, ab initio, that they will bring in equity funds proportiona
as the banks finance the debt portion.
While it is appreciated that such decisions are to be taken by the boards of the
respective banks, it has been observed that the last method has greater equity f
risk. In order to contain this risk, banks are advised in their own interest to
have a clear
policy regarding the Debt Equity Ratio (DER) and to ensure that the infusion of
equity/fund by promoters should be such that the stipulated level of DER is main
at all times. Further they may adopt funding sequences so that possibility of eq

funding by banks is obviated'

The sole banking is suitable for financing working capital needs of an enterpris
only if the requirement is within the policy framework of the financing bank. If
requirements grow beyond the comfort level of that bank due to prudential norms
or risk
perception for a particular segment [borrower, it would like another bank to fin
ance a
part of the requirements of that enterprise. Sometimes, even the borrowers may p
not to depend on one bank and avail facilities from various banks. If two or mor
e banks
get into a formal arrangement to finance the working capital needs of a borrower
, it is
called consortium arrangement. The consortium banks decide on one of the members
as 'Lead bank' who not only arranges periodic meetings of the member banks but a
lso takes lead in assessment, documentation, charge creation, monitoring of the
etc. In case of multiple banking there is no formal arrangement between the bank
though they may share the information about the account in their mutual interest
RBI Guidelines
Various regulatory prescriptions regarding conduct of consortium, multiple
banking and syndicate arrangements were withdrawn by Reserve Bank of India in
October 1996 with a view to introducing flexibility in the credit delivery syste
m and to
facilitate smooth flow of credit. However, Central Vigilance Commission, Governm
ent of
India, in the light of frauds involving consortium/multiple banking arrangements
, had
expressed concerns on the working of Consortium Lending and Multiple Banking
Arrangements in the banking system. The Commission had attributed the incidence
frauds mainly to the lack of effective sharing of information about the credit h
istory and
the conduct of the account of the borrowers among various banks. It was felt tha
t there
is need for improving the sharing/dissemination of information among the banks a
the status of the borrowers enjoying credit facilities from more than one bank.
Accordingly, RBI advised the banks to strengthen their information back-up about
borrowers enjoying credit facilities from multiple banks as follows:
(1) 'At the time of granting fresh facilities, banks may obtain declaration from
borrowers about the credit facilities already enjoyed by them from other banks i
n the
format prescribed (Ref RBI circular nos. DBOD No. BP.BC.46/08.12.001/2008-09 dat
September 19, 2008 and DBOD. No. BP.BC.94/ 08.12.001/2009-09 dated December 8,
2008.). In the case of existing lenders, all the banks may seek a declaration fr
om their
existing borrowers, availing sanctioned limits of Rupees 5.00 crores and above o
wherever, it is in their knowledge that their borrowers are availing credit faci

lities from
other banks, and introduce a system of exchange of information with other banks
indicated above.
(2) Subsequently, banks should exchange information about the conduct of the
borrowers' accounts with other banks in the format given in Annex 11 of RBI DBOD
circulars referred to in (i) above at least at quarterly intervals.
(3) Obtain regular certification by a professional, preferably a Company
Secretary, Chartered Accountant or Cost Accountant, regarding compliance of vari
statutory prescriptions that are in vogue, as per specimen given in Annex III of
circulars referred to in (i) above and DBOD. No. BP.BC. 110/ 08.12.001/2008-09 d
February 10, 2009.
(4) Make greater use of credit reports available from CIBIL.
(5) The banks should incorporate suitable clauses in the loan agreements in
future (at the time of next renewal in the case of existing facilities) regardin
g exchange
of credit information so as to address confidentiality issues.'
Vide circular RBI/2008-09/354[UBD.PCB.No.36/13.05.000/2008-09 dated
January 21, 2009, in addition to Company Secretaries, banks were permitted to al
so accept the certification by Chartered Accountants & Cost Accountants. Further
, Annex
Part I and Part II has also been modified.
The term 'Syndication' is normally used for sharing a long-term loan to a
borrower by two or more banks. This is a way of sharing the risk, associated wit
lending to that borrower, by the banks and is generally used for large loans. Th
borrower, intending to avail the desired amount of loan, gives a mandate to one
(called Lead bank) to arrange for sanctions for the total amount, on its behalf.
The lead
bank approaches various banks with the details These banks appraise the proposal
per their policies and risk appetite and take the decision. The lead bank does t
he liaison
work and common terms and conditions of sanction may be agreed in a meeting of
participating banks, arranged by the lead bank. Normally, the lead bank charges
'Syndication fee' from the borrower.
It is anticipated, at the time of sanctioning a loan, that the repayment of prin
cipal and
interest will be as per the schedule and all other terms of sanction will also b
e abided by
the borrower. However, in some cases, due to malafide intentions or due to busin
failure, the bank may have to fall back on the securities available and take oth
er legal
action depending upon the circumstances of each case. Therefore, before disbursi
the money, the bank ensures that it creates appropriate charge over the securiti
es and
the documents are executed as per the legal requirement. Personal guarantee of t
directors or third party guarantees can also be stipulated. The working capital
limits are

disbursed as cash credit or a combination of cash credit and loan. RBI guideline
s for
disbursal of both working capital and term loans should be followed. In case of
borrowers, whose working capital requirements are large, two or more banks can m
the requirements. This is done under consortium arrangement or under multiple
banking. To prevent the misutilisation of banking system, RBI has issued guideli
regarding both consortium and multiple banking. RBI has also issued guidelines f
syndication of loans for both working capital and term loans. But, banks are usi
syndication only for term loans.
Personal guarantee; Third party guarantee; Assignment; Lien; Hypothecation; Pled
Possession of security; Documents; Consortium arrangement; Multiple banking;
Syndication of loans; Lead bank for syndication.
Check Your Progress
State True or False:
(1) The stamp duty on documents varies from State to State. . True.
(2) The date of execution of documents can be earlier than the date of stamping.
.False.(3) The parties executing the documents should have the necessary authorit
y and the
capacity to enter into a contract and execute the documents in that capacity. . T
(4) Bank should ensure that the person signing the documents is doing so with hi
s free
will. . True.
(5) The documents can be filled in after these are signed. .False.
(6) In case of companies, the charge should be registered with ROC within 60 day
from the date of execution of the documents. .False.
(7) Some documents may be required to be registered with the sub-registrar. . Tru
(8) Third party guarantees can be taken from individuals only. Any other legal e
ntity can
not be third party guarantor. .False.
(9) Bank can create charge over security not belonging to either the borrower or
guarantor. .False.
(10) Under 'Hypothecation', the possession of goods remains with the borrower. .
(11) Under 'Pledge', the possession of goods may remain with the borrower depend
on bank's decision. . True.
(12) As per RBI guidelines, in the case of borrowers enjoying working capital cr
limits of Rs. 10 crore and above from the banking system, the loan component sho
normally be 80 per cent. . True.
(13) Under 'Loan system', the borrower has to maintain a minimum debit balance i
n his
loan account, while the cash credit account may have a credit balance. . True.
(14) Banks disburse the term loans as per the progress of the project . True.
(15) Consortium banking and Multiple banking are same. .False.
(16) RBI encourages Multiple or Consortium banking for small loans. . False.
Key to Check Your Progress
1. True; 2. False; 3. True; 4. True; 5. False; 6. False; 7. True; 8. False; 9. F

alse; 10.
True; 11. True; 12.True; 13. True; 14. True; 15. False; 16. False
UNIT 31 Credit Control and Monitoring
31.0 Objectives
31.1 Importance and Purpose
31.2 Available Tools for Credit Monitoring/Loan Review Mechanism
After reading this chapter, you will have better understanding of:
(1) Importance and purpose of credit control and monitoring
(2) Various tools used by banks for credit control and monitoring.
(3) Credit audit
Despite an excellent credit appraisal, documentation and attention to security,
the risk of default in an advance may go up as the time passes because the
assumptions made at the time of appraisal may lose their sanctity, in view of th
dynamic nature of business environment. Credit control and monitoring, often ref
as Loan Review Mechanism (L R M), plays an important role in the following aspec
(1) To ensure that the funds provided by the bank are put to the intended use
and continue to be used properly. Any diversion of bank's funds out of the busin
ess or
for unauthorized use within the business should be detected and stopped.
(2) To ascertain that the business continues to run on the projected lines. If t
is any deterioration from what was projected at the time of appraisal, the same
be noticed and appropriate action initiated by the bank, in consultation with th
borrower, to ensure that the business continues to run on viable lines.
(3) If the deterioration of the business continues despite appropriate action, t
bank should decide if any harsh action like, recalling the advance or seizing th
security, etc. is necessary. In such cases, an early detection of the problem is
important as any delay in necessary action by the bank may result in deteriorati
on of the
available security and reduce the chances and amount of recovery.
The following records/information /methods are used by the bankers to monitor th
credit;(1) Conduct of the Accounts with the Bank: This gives very useful
information about the financial health of the enterprise and use of the funds by
Frequent over-drawings, return of cheques and bills, delays in submission of sta
of stock and receivables, low turnover, routing of transactions with some other
delay in payment of interest and installments, devolvement of L Cs, invocation o
f Bank
Guarantees, etc. are some of the unsatisfactory features. In such cases, banks
strengthen their monitoring system by resorting to more frequent inspections of
borrowers' go downs, ensuring that sale proceeds are routed through the borrower

accounts maintained with the bank and insisting on pledge of the stock in place
(2) Periodic Information Submitted as per the Terms of the Advance:
The statements of stock and receivables are to be submitted by the borrower at r
intervals (normally, monthly) and the bank calculates the Drawing Power (D P) on
basis of these. A thorough scrutiny of these is necessary to verify their correc
accumulation of inventory (non-moving stocks) and old receivables (normally
receivables above six months are excluded for calculating D P). The detection of
nonmoving stocks and old receivables is not only necessary for correct calculation
of D P
but is also warranted to detect the danger signals in the business of the borrow
During periodic inspection of the enterprise, by the bank officials, the latest
statement of
stocks and receivables are cross checked with the records. Stocks are also physi
verified either fully or on random selection basis.
(3) Audit of Stocks and Receivables Conducted by the Bank: Stock audit
is used by the bank in case of medium and large size accounts where verifying th
stocks during normal inspection is not feasible or where the stocks are located
various locations. Similarly, audit of receivables may also be conducted in some
The purpose of these audits is to cross check the reliability of the statements
by the borrower.
(4) Financial Statements of the Business, Auditors Report: These are
normally available once a year. An analysis of these statements gives useful inf
about the use and diversion of funds, financial health, realization of debts, pr
etc. In case of working capital limits, this analysis is a part of the renewal e
(5) Periodic Visits and Inspection: The purpose of periodic visits is manifold.
It gives an impression about the activity level. The assessment of limits is bas
ed on an
anticipated level of operations and field visit helps in ascertaining whether ac
tivities are
at that level or not. (b) It helps in finding out the position of stocks and oth
er assets
charged to the bank. (c) The fact of bank's charge over the assets should be
prominently displayed Yield visits help in finding out this.
(6) Interaction: Interaction with select creditors and debtors.
(7) Periodic Scrutiny: Periodic scrutiny of borrowers' books of accounts and the
accounts maintained with other banks
(8) Market Reports about the, Borrower and the Business Segment:
These reports are available from the industry associations and rating agencies.(
9) Appointing Bank s Nominee on Company s Board: In exceptional
cases, or in case of large limits, bank may opt to appoint nominee director on t
he board
to keep a tab on the important decisions.
(10) Credit Audit: (The details given here are based on R B I's 'Guidance note o

credit risk management') Credit audit is an examination of various credit functi
ons of the
bank. It is normally conducted by internal staff having adequate credit experien
Credit Audit examines compliance with extant sanction and post-sanction processe
and procedures laid down by the bank from time to time. Each bank formulates its
policies, procedures, and organizational set up for credit audit. In some banks,
audit plays an important role in monitoring of large value accounts also.
R B I's suggestions in this respect, contained in their 'Guidance note on credit
risk management', are as under:
(A) Objectives of Credit Audit
(1) Improvement in the quality of credit portfolio
(2) Review sanction process and compliance status of large loans
(3) Feedback on regulatory compliance
(4) Independent review of Credit Risk Assessment
(5) Pick-up early warning signals and suggest remedial measures
(6) Recommend corrective action to improve credit quality, credit administration
and credit skills of staff, etc.
(B) Structure of Credit Audit Department: The credit audit and loan review
mechanism may be assigned to a specific Department or the Inspection and Audit
(C ) Functions of Credit Audit Department
(1) To process Credit Audit Reports
(2) To analyze Credit Audit findings and advise the departments/ functionaries
(3) To follow up with controlling authorities
(4) To apprise the Top Management
(5) To process the responses received and arrange for closure of the relative
Credit Audit Reports
(6) To maintain database of advances subjected to Credit Audit
(D) Scope and Coverage: The focus of credit audit needs to be broadened from
the account level to look at the overall portfolio and the credit process being
The important areas are:
(1) Portfolio Review: Examine the quality of Credit & Investment (Quasi Credit)
Portfolio and suggest measures for improvement, including reduction of concentra
tions in certain sectors to levels indicated in the Loan Policy and Prudential L
imits suggested
by RBI.
(2) Loan Review: Review of the sanction process and status of post sanction
processes and procedures (not just restricted to large accounts)
(a) all fresh proposals and proposals for renewal of limits (within 3 to 6 month
from date of sanction)
(b) all existing accounts with sanction limits equal to or above a cut off depen
upon the size of activity
(c) randomly selected ( say 5-10%) proposals from the rest of the portfolio
(d) accounts of sister concerns/group/associate concerns of above accounts,
even if limit is less than the cut off
(3) Action Points for Review
(1) Verify compliance of bank's laid down policies and regulatory compliance wit
regard to sanction

(2) Examine adequacy of documentation

(3) Conduct the credit risk assessment
(4) Examine the conduct of account and follow up looked at by line functionaries
(5) Oversee action taken by line functionaries in respect of serious irregularit
(6) Detect early warning signals and suggest remedial measures thereof
(4) Frequency of Review: The frequency of review should vary depending on
the magnitude of risk (say, for the high risk accounts - 3 months, for the avera
ge risk
accounts- 6 months, for the low risk accounts- I year).
(1) Feedback on general regulatory compliance
(2) Examine adequacy of policies, procedures and practices
(3) Review the Credit Risk Assessment methodology
(4) Examine reporting system and exceptions thereof
(5) Recommend corrective action for credit administration and credit skills of s
(6) Forecast likely happenings in the near future
(5) Procedure to be followed for Credit Audit
(1) Credit Audit is conducted on site, i.e. at the branch which has appraised th
advance and where the main operative credit limits are made available.
(2) Report on conduct of accounts of allocated limits is to be called from the
corresponding branches.
(3) Credit auditors are not required to visit borrowers' factory or office premi
Post-disbursal control, supervision and monitoring are very important for the
safety of bank's advance. The purpose is to ensure that the funds provided by th
e bank
are put to the intended use and continue to be used properly. This is also inten
ded to
ascertain that the business continues to run on the projected lines and continue
s to be
run on viable lines. The deterioration, if any, in the securities charged to the
bank can
also be detected by efficient monitoring This helps the bank in taking timely ac
tion for
taking the corrective measures or starting the recovery proceedings.
The tools available to the bank for effective monitoring are: (a) Conduct of the
accounts with the bank; (b) Periodic information submitted as per the terms of t
advance; (c) The statements of stock and receivables submitted by the borrower a
regular intervals (normally, monthly); (d) Stock/receivables audit conducted by
the bank;
(e) Financial statements of the business, auditors' report; (f) Periodic visits
inspections; (g) Interaction with select creditors and debtors; (h) Periodical s
crutiny of
borrowers' books of accounts and the accounts maintained with other banks; and (
Market reports about the borrower and the business segment. In rare cases, bank
also appoint its nominee on company's board. The credit audit is also a very eff
tool in supervision of credit.
Supervision; Monitoring; Control: Loan Review Mechanism(L R M); Stock statement;
Receivable statement; Deterioration of security; Inspection; Stock audit; Receiv

audit; Credit audit
Check Your Progress
1. Which of the following is not a purpose of credit monitoring? The choices are
(a) To ensure end use of the funds by the borrower
(b) To detect any deterioration in the security charged to the bank
(c) To comply with the guidelines of the RBI
(d) To ascertain that the business continues to run on the projected lines
The correct choice is.. (c) To comply with the guidelines of the RBI
2. Which of the following is not a tool available to check the bank for credit
The choices are:
(a) Sending regular reminders to the borrower
(b) Periodic visits to the business place for inspection
(c) Analysis of financial statements
(d) Examine conduct of borrower's account
The correct choice is.. (a) Sending regular reminders to the borrower3. Which o
f the following is not a method for detecting wrong mention of
inventory in a stock statement? The choices are:
(a) Stock audit
(b) Inspection of stocks
(c) Analysis of financial statements
(d) Cross-check from the balance sheet figure
The correct choice is (c) Analysis of financial statements
4. Which of the following is not a method for detecting wrong mention of
receivables in stock statement submitted by the borrower? The choices are:
(a) Analysis of financial statements
(b) Cross check from the balance sheet figure
(c) Receivables audit
(d) Inspection of books of account
The correct choice is.. (a) Analysis of financial statements
5. Which of the following is not a danger sign about the direction of business o
the borrower? The choices are:
(a) Devolvement of L Cs, invocation of Bank Guarantees
(b) Demand for higher limit
(c) Delays in submission of stock/receivables statements
(d) Return of cheques or bills
The correct choice is.. (d) Return of cheques or bills
6. Which of the following is not an unsatisfactory sign in conduct of the accoun
of the borrower? The choices are:
(a) Delay in payment of interest or instalments,
(b) routing of transactions with some other bank
(c) Frequent over drawings
(d) High turnover
The correct choice is (d) High turnover
7. Which of the following is not the purpose credit audit? The choices are:
(a) Improvement in the quality of credit portfolio
(b) Review sanction process and compliance status of large loans
(c) Feedback on regulatory compliance
(d) Stock inspection
The correct choice is (d) Stock inspection8. Purpose of appointing bank s nominee
on company s board of borrowing
company is:
The choices are:
(a) To keep a tab on the important decisions of the board
(b) To be a part of the management
(c) To guide the company for better working

(d) To safeguard the securities charged to the bank

The correct choice is (a) To keep a tab on the important decisions of the board
PAPER 1 - Credit Control and Monitoring.ADVANCED BANK MANAGEMENT
UNIT 32 Risk Management and Credit Rating
32.0 Objectives
32.1 Meaning of Credit Risk
32.3 Factors Affecting Credit Risk
32.4 Steps taken to Mitigate Credit Risks
32.5 Credit Ratings
32.6 Internal and External Ratings Methodology of Credit Rating
32.7 Use of Credit Derivatives for Risk Management
32.8 Basel 11 Accord
32.9 Introduction of Advanced Approaches of Basel II Framework in India
After reading this chapter, you will have better understanding of:
(1) The various risks faced by the banks
(2) The meaning of credit risk
(3) Factors affecting credit risks
(4) Steps taken to mitigate credit risks
(5) The meaning of credit rating
(7) Objectives and importance of credit rating
(8) What is credit scoring
(9) Method of credit scoring
The risks faced by the business of banking can be classified into three broad
(1) Operational Risks: The examples of such risks are losses due to frauds, disr
of business due to natural calamities like floods etc.
(2) Market Risks: These are the risks resulting from adverse market movements of
interest rates, exchange rate etc.
(3) Credit Risks: The credit risk can be defined as the unwillingness or inabili
ty of a
customer or counterparty (e.g. the L C opening bank in a bills negotiation trans
under that L C) to meet his commitment relating to a financial transaction with
the bank. For example, in a fund based limit, the credit risk is the non payment
of principal and
interest by the borrower, as per the agreed terms of repayment. In case of a non
based limit, the credit risk arises as the customer may not reimburse the bank f
ully in
case of invocation of a guarantee or devolvement of an L C.
(1) External Factors: These factors affect the business of a customer and reduce
capability to honor the terms of financial transaction with the bank. The main e
factors affecting the overall quality of the credit portfolio of a bank are exch
ange rate
and interest rate fluctuations, Government policies, protectionist policies of o
countries, political risks, etc. These factors look similar to what is mentioned
market risks above. But, whereas the market risks directly affect a bank, the fa
mentioned here affect the businesses of the customers thus impairing the quality

of the
credit portfolio.
(2) Internal Factors: These mainly relate to overexposure (concentration) of cre
dit to a
particular segment or geographical region, excessive lending to cyclical industr
ignoring purpose of loan, faulty loan and repayment structuring, deficiencies in
the loan
policy of the bank, low quality of credit appraisal and monitoring, and lack of
an efficient
recovery machinery.
The major objective of credit risk management is to limit the risk within
acceptable level and thus maximize the risk adjusted rate of return on the credi
portfolio. Following are the main steps taken by any bank in this direction;
(1) At Macro Level: The risks to the overall credit portfolio of the bank are mi
through frequent reviews of norms and fixing internal limits for aggregate commi
to specific sectors of the industry or business so that the exposures are evenly
over various sectors and the likely loss is retained within tolerable limits. Ba
nk also
periodically reviews the loan policies relating to exposure norms to single and
borrowers as also the structure of discretionary powers vested with various
functionaries. Many banks classify their credit portfolio based on some paramete
rs of
quality and periodically review this to avoid any rude shocks relating to credit
Earlier, RBI had made it mandatory to classify the portfolio by assigning health
codes to
each account. This is not mandatory now. Normally, banks also formulate policies
relating to rehabilitation, compromise, recovery and write off to get the best o
ut of a
worst case scenario.
(2) At Micro Level: This pertains to policies of the bank regarding appraisal st
sanctioning and delivering process, monitoring and review of individual
proposals/categories of proposals, obtention of collateral security etc. Credit
ratings and
credit scoring play important role in this area. For dispersion/transfer of risk
in large
value accounts, bank can resort to consortium/ multiple banking and use of deriv
like credit default swaps.
32.4 CREDIT RATINGSThe level of credit risk involved in each loan proposal depen
ds on the unique
features of that proposal. Two similar projects, with different promoters, may b
appraised by a bank as having different credit risks. Similarly, two different p
rojects, with
same promoters, may also be appraised by the bank as having different credit ris
While appraising a credit proposal, the risk involved is also measured and often
quantified by way of a rating with the following objectives;
(1) To decide about accepting, rejecting or accepting with modifications/ specia

(2) To determine the pricing, i.e. the rate of interest to be charged
(3) To help in the macro evaluation of the total credit portfolio by classifying
it on the
ratings allotted to individual accounts. This is used for assessing the provisio
requirements, as also a decision making tool, by the management of the bank, for
reviewing the loan policy of the bank.
Most of the banks in India have set up their own credit rating models as till re
past, the rating agencies were not equipped well enough to provide the ratings,
reliable as to banks depending on these for credit decisions. However, with expe
gained in last few years, these rating agencies have gained confidence of the ba
A few of such rating agencies are CARE, ICRA, CRISIL and SMERA.
Based on its loan policies and risk perceptions, each bank has its own rating
model. Common feature in all the risk models is that a score is given for differ
perceived risks by allotting different weightages. The sum of all these scores f
orms the
basis for deciding on risk rating of a proposal. Normally, the broad categories
of risk
areas which are scored are:
(a) Promoters/Management aspects and the securities available
(b) Financial aspects based on analysis of financial statements
(c) Business/project risks
In view of the dynamic market scenario, there is need to review the ratings of a
borrower at regular intervals upgrade or downgrade or maintain it.
Credit derivatives are used to hedge the risks inherent in any credit asset with
transferring the asset itself. The hedging is comparable to insurance and comes
at a
cost. Therefore, if the anticipated risk does not materialize, the return from t
he asset will
be less than what it would have been without the hedging. While simple technique
s for
transferring credit-risk, such as financial guarantees, collateral and credit in
have been prevalent in the Indian banking industry for long, the recent innovati
instruments in credit risk transfer (C R T) such as collateralized debt obligati
ons (C D O),), etc. are yet to gain significant currency. However, Credit Defaul
t Swaps (C D Ss)
finds use as the new hedging instrument. The brief description of two of these n
generation credit risk hedging derivatives is given below:
(1) Credit Default Swaps (C D Ss): This is a bilateral contract in which the ris
k seller
(lending bank) pays a premium to the buyer for protection against credit default
or any
other specified credit event. Normally, C D S is a standardized instrument of I

(International Swaps and Derivatives Association).The credit events defined by I
are, bankruptcy, failure to pay, restructuring, obligation acceleration, obligat
repudiation or moratorium etc. As per R B I guidelines, plain vanilla C D Ss onl
y are
(2) Credit Linked Notes (C L N): In this, the risk seller gets risk protection b
y paying
regular premium to the risk buyer, which is normally a S P V which issued notes
to the underlying credit. These notes are purchased by the general investors and
money received from them is used by the SPV to buy high quality securities. The
general investors get fixed or variable return on the note during its life. On m
aturity of
the underlying credit, the securities purchased by SPV are sold and money return
ed to
the investors. But, in case of default in the underlying credit, these securitie
s are used to
pay to the risk seller.
R B I's Worry on Derivatives
If the banks use these derivatives to hedge their credit risk by way of purchasi
the risk protection, there is no apprehension. But, when the banks start selling
the credit
protection to other lenders, in respect of their credit risks, there is cause fo
r worry
because, often these instruments are so structured that they become very complex
understand and sometimes the liability which arises is many times more than what
anticipated. Therefore, RBI is in favour of slow growth of these derivatives in
financial market. It is not out of place here to quote Warren Buffet, the famous
as saying, 'These are weapons of mass financial destruction'.
The new framework of Basel 2 accord is based on three pillars viz., 1) Minimum
capital requirements, 2) Supervisory review and iii) Market discipline. The mini
capital requirement is based on market risk, operational risk and the credit ris
k. Basel 2
has laid down various approaches for assessment of credit risks. These are;
(a) Standardized Approach
(b) Foundation Internal Rating Based (I R B) Approach
(c) Advanced Internal Rating Based (I R B) Approach
Foreign banks, operating in India and Indian banks having operational presence
outside India have migrated to the simpler approaches available under the Basel
Framework, since March 31, 2009. Other commercial banks have also migrated to
these approaches from March 31, 2009. Thus, the Standardized Approach for credit
has been implemented for the banks in India.32.9 INTRODUCTION OF ADVANCED APPROA
Having regard to the necessary up-gradation of risk management framework as
also capital efficiency likely to accrue to the banks by adoption of the advance

approaches envisaged under the Basel 2 Framework and the emerging international
trend in this regard, R B I considered it desirable to lay down a timeframe for
implementation of the advanced approaches in India. This would enable the banks
plan and prepare for their migration to the advanced approaches for credit risk.
has advised the following time schedule for implementation of the advanced
approaches (Foundation as well as Advanced IRB);
(1) The earliest date of making application by banks to R B I - April 1, 2012
(2) Likely date of approval by the R B I
March 31, 2014
The R B I has advised the banks to undertake an internal assessment of their
preparedness for migration to advanced approaches, in the light of the criteria
envisaged in the Basel 2 document, as per the aforesaid time schedule, and take
decision, with the approval of their Boards, whether they would like to migrate
to any of
the advanced approaches. The banks deciding to Migrate to the advanced approache
may approach R B I for necessary approvals, in due course, as per the stipulated
schedule. If, the result of a bank's internal assessment indicates that it is no
t in a
position to apply for implementation of advanced approach by the above mentioned
dates, it may choose a later date suitable to it based upon its preparation.
The banks, at their discretion, have the option of adopting the advanced
approaches for one or more of the risk categories, as per their preparedness, wh
continuing with the simpler approaches for other risk categories, and it would n
ot be
necessary to adopt the advanced approaches for all the risk categories simultane
However, the banks should invariably obtain prior approval of the R B I for adop
ting any
of the advanced approaches.
The business of banking is prone to various risks like credit risks, market risk
and operational risk. The credit risks to the bank can arise due to internal of
causes. The internal risks are caused by banks own deficiencies like, overexposu
(concentration) of credit to a particular segment/geographical region, excessive
to cyclical industries, ignoring purpose of loan, faulty loan and repayment stru
deficiencies in the loan policy of the bank, low quality of credit appraisal and
and lack of an efficient recovery machinery. The main external risks are, exchan
ge rate
and interest rate fluctuations, Government policies, protectionist policies of o
countries and political risks. A bank takes various measures to mitigate these r
Some of these are; revision of prudential norms, upgrading the appraisal standar
tightening the monitoring mechanism and strengthening the recovery department .T
rating system is introduced with the purpose of quantifying the risks involved i
n a

particular credit proposal. Normally, the scoring system is used for arriving at
the credit
rating. It gives the risk weightage based score to various risk parameters in a
and total of this score is used to award the credit rating. Each bank has its ow
n scale of rating. The derivatives are also used for risk hedging but their use
is, presently, limited.
Base II Accord prescribes Standardized as well as IRB approach for management of
credit risks. While the standardized approach has already been adopted by the ba
IRB approach will take some time for implementation.
Credit risk; internal risk; external risks; mitigation of risks; industry concen
tration; Credit
rating, internal rating; external rating; scoring; Credit derivatives; Basel 11;
approach; IRB (internal rating based) approach
Check Your Progress
1. Which of the Following k not a risk mentioned in the Basel II Accord
The choices are
(a) Operational risk
(b) Market risk
(c) Default risk
(d) Credit risk
(c) Default risk.
The correct choice is
2. Which of the following is not a credit risk? The choices are
(a) Unwillingness of a customer to meet his commitment relating to a financial
transaction with the bank
(b) Inability of the customer to reimburse the bank in case of invocation of a
guarantee or devolvement of an L.C
(c) Inability of a customer to meet his commitment relating to a financial
transaction with the bank
(d) Loss to the bank due to fraud
The correct choice is (d) Loss to the bank due to fraud
3. Which of the following is an external factor affecting credit risk?
The choices are
(a) Government policies
(b) Faulty loan and repayment structuring
(c) Overexposure (concentration) of credit to a particular segment
(d) Lack of an efficient recovery machinery
The correct choice is (a) Government policies
4. Which of the following is not an internal factor affecting credit risk?The ch
oices are
(a) Excessive lending to cyclical industries
(b) Low quality of credit appraisal and monitoring
(c) Deficiencies in the loan policy of the bank
(d) Protectionist policies of other countries
The correct choice is (d) Protectionist policies of other countries
5. Which of the following is not a macro level action for mitigation of credit r
The choices are
(a) Periodically reviews of the exposure norms for single and group borrowers
(b) Improving appraisal standards of credit proposals
(c) Frequent reviews of norms and fixing internal limits for aggregate
commitments to specific sectors of the industry or business
(d) Periodic review of total credit portfolio based on quality parameters
The correct choice is (b) Improving appraisal standards of credit proposals
6. Which of the following is not a micro level action for mitigation of credit r


choices are
Improving sanctioning and delivering process
Obtention of collateral security
Monitoring and review of individual proposals/categories of proposals
Periodical reviews of the exposure limits for business or industry segment
correct choice is
(d) Periodical reviews of the exposure limits for business

or industry segment
7. Which of the following statements is not true regarding credit derivatives
The choices are
(a) These are used to hedge credit risk to the bank
(b) The protection buyer is the lending bank
(c) The protection seller can be another bank or any other organization
(d) The credit asset is transferred in case of derivatives
The correct choice is (d) The credit asset is transferred in case of derivatives
8. Credit rating is a system of: The choices are(a) Measuring risk
(b) Mitigating risk
(c) Migrating risk
(d) Credit appraisal
The correct choice is (a) Measuring risk
9. Internal rating means: The choices are
(a) Rating the project
(b) Rating the promoters
(c) Rating the risk for internal use
(d) None of the above
The correct choice is (d) None of the above.
10. For external credit rating, banks depend on: The choices are
(a) Rating agencies
(b) Experienced staff of the bank
(c) Banking consultants
(d) None of the above
The correct choice is (a) Rating agencies
11. Which of the following is not an approach for assessment of credit risks, la
down under Basel 2 Accord? The choices are
(a) Standardized approach
(b) Foundation Internal Rating Based (I R B) approach
(c) Advanced Internal Rating Based (I R B) approach
(d) Simplified Internal Rating Based (I R B) approach
The correct choice is (d) Simplified Internal Rating Based (I R B) approach
12. Which of the following statements is true regarding Standardized approach?
The choices are: (a) It has already been adopted by all the banks
(b) It has been adopted only the foreign banks operating in India.
(c) It has been adopted by the foreign banks operating in India and some of the
Indian banks
(d) It has to be adopted by the all the banks by March 2010
The correct choice is (a) It has already been adopted by all the banks
13. R B I has suggested which of the following earliest date of making applicati
by banks to R B I regarding implementation of the advanced approaches
(Foundation as well as I R B) The choices are(a) 1, April 2012
(b) 1, April 2013
(c) 1, April 2014
(d) 1, April 2015
The correct choice is (a) 1, April 2012
Answer to Check Your Progress

END OF CHAPTER 32 - Risk Management and Credit Rating. ADVANCED BANK
UNIT 33 - Rehabilitation and Recovery
33.0 Objectives
33.1 Credit Default/Stressed Assets/N P As
33.2 Willful Defaulters
33.3 Options Available to Banks for Stressed Assets
33.4 R B I Guidelines on Restructuring of Advances by Banks
33.5 Corporate Debt Restructuring (C D R) Mechanism
33.6 S M E Debt Restructuring Mechanism
33.7 R B I Guidelines on Rehabilitation of Sick S S I Units
33.8 Credit Information System
33.9 Credit Information Bureau (India) Ltd., (CIBIL)
After reading this chapter, you will have better understanding of:
(1) The meaning of credit default, stressed assets, non performing assets and
the options available to banks for dealing with them.
(2) Meaning of rehabilitation, rescheduling, compromise and write off.
(3) Meaning of Debt restructuring, institutional/organizational framework for de
restructuring available for S M Es and Corporates
(4) The legal framework available for recovery.
(5) Credit information system, objectives and procedures for disclosure of list
defaulters, formation of CIBIL
Credit default means the inability or the unwillingness of a customer or
counterparty to meet commitments in relation to lending, trading, or any financi
transactions. This may take the following forms;
(1) in the case of direct lending: principal and/or interest amount may not be r
epaid as
per the terms of repayment.
(2) in the case of guarantees or letters of credit: funds may not be forthcoming
the constituents upon crystallization of the liability;(3) in the case of treasu
ry operations: the payment or series of payments due from
the counter parties under the respective contracts may not be forthcoming or cea
(4) in the case of securities trading businesses: funds/securities settlement ma
y not
be effected;
(5) in the case of cross-border exposure: the availability and free transfer of
currency funds may either cease or restrictions may be imposed by the sovereign.
Stressed assets are those assets in which the default has either already occurre
or which are facing a reasonably certain prospect of default. For example, the t
erm loan
for an industrial project, implementation of which has been abandoned, is a stre
asset even though the repayment has not yet fallen due as per the repayment term
Non Performing Assets (N P As)
As per R B I directives, banks in India have to classify their assets into
Performing or Standard assets or Non performing assets (N P As). N P As are furt
classified into (a) Sub-standard, (b) doubtful and (c) loss assets. The classifi

cation is
based on the period of default as also the availability of security. The amount
provision required to be made on the asset portfolio of a bank depends on its
classification into the four categories of standard, sub standard, doubtful and
loss. The
consolidated R B I guidelines on this are available in their Master circular Num
ber D B
O D.No.BP.BC.17/21.04.048/2009-10 dated 1, July 2009
The default in payment as per agreed terms could be intentional or due to the
reasons beyond the control of the borrower. The intentional default is referred
to as
willful default. As per R B I guidelines, a 'willful default' would be deemed to
occurred if any of the following events is noted:
(1) The unit has defaulted in meeting its payment or repayment obligations to th
e lender
even when it has the capacity to honour the said obligations.
(2) The unit has defaulted in meeting its payment or repayment obligations to th
e lender
and has not utilized the finance, borrowed for the specific purposes for which
finance was availed of but has diverted the funds for other purposes.
(3) The unit has defaulted in meeting its payment or repayment obligations to th
e lender
and has siphoned off the funds so that the funds have not been utilized for the
purpose for which finance was availed of, nor are the funds available with the u
nit in the
form of other assets.
(4) The unit has defaulted in meeting its payment or repayment obligations to th
e lender
and has also disposed off or removed the movable fixed assets or immovable prope
given by him or it for the purpose of securing a term loan without the knowledge
of the
bank or lender.
(Details available in R B I circular D B O D No. DL.BC. 16/20.16.003/2009-10 dat
ed 1,
July 2009. The Master Circular has been placed on the R B I web-site
Every credit default does not necessarily result in loss to the bank. In many
cases, bank may be able to recover its dues fully. In other cases, the recovery
may be
with some loss or, in the worst scenario there may be no recovery at all. The ti
action and an appropriate strategy play very important role in achieving the bes
recovery for any stressed asset. While formulating the strategy, the bank has to
keep in
mind the legal system as also the social aspects prevailing in the country. Norm
ally, a
bank follows the following steps in case of a stressed asset:
(1) Exit from the account
(2) Rescheduling or Restructuring
(3) Rehabilitation
(4) Compromise
(5) Legal action

(6) Write off

Exit from the Account: Bank's first effort is to exit from the account which is
signs of stress. This is possible only when the symptoms of stress are detected
at a
very early stage so that the borrower is able to shift his account to another ba
nk which
has a different credit appetite. Once the symptoms become more pronounced,
acceptance of account by another bank may not materialize. In case of
consortium/multiple banking, there is good possibility of other banks taking up
the share
of the bank wanting to exit but in case of sole banking, bank may find it very d
ifficult to
exit a problematic account and it has to consider other options for dealing with
Rescheduling or Restructuring: If the default is not willful, the banks normally
reschedule or restructure the loans in accordance with the revised cash flow est
of the borrower.
Rehabilitation: Sometimes, the business enterprises face adverse internal or mar
conditions and incur losses for a long time, resulting in default in payment of
dues. This is, specially true of the manufacturing enterprises, which are consid
ered as
'sick' if there is erosion in the net worth due to accumulated cash losses to th
e extent of
50 per cent of its net worth during the previous accounting year and the unit ha
s been in
commercial production for at least two years. Banks may examine the possibility
'Rehabilitation' in such cases after undertaking detailed viability study.
Compromise: If the restructuring or rescheduling or rehabilitation is not consid
viable or, does not yield the desired results, banks try to recover their dues b
y offering
some concessions to the borrower. Such decision is influenced by the availabilit
y or
realisability of the securities, enforceability of the documents etc.
Legal Action: In cases where even the compromise does not materialize, banks hav
to initiate recovery proceedings. The forums available to the banks are as under
;(1) Government Machinery: In case of finance under government sponsored
schemes, the recovery officers, appointed by the state governments, help in reco
very of
bank's dues
(2) Civil Courts: Banks can file the civil suits for recovery of their dues in t
he civil
courts. This option is used for dues up to Rupees ten lakhs only as Debt Recover
Tribunals (DRTs) are preferred for higher amount. However, the proceedings in th
e civil
courts are very slow. The Committee on Financial Sector Assessment (C F S A) has
observed that, 'the average time taken in India for winding-up proceedings is on
e of the
highest in the world. Improvements in effective enforcement of creditor rights a

insolvency systems are critical for strengthening market efficiency and integrat
ion and
for enhancing commercial confidence in contract enforcement. A quick resolution
stressed assets of financial intermediaries is essential for the efficient funct
ioning of
credit and financial markets.'
(3) Lok Adalats: In the area of dispute settlement, the Legal Services Authority
Act, 1987 has conferred statutory basis on the Lok Adalats (people's courts). Th
Reserve Bank has consequently issued guidelines to commercial banks and financia
institutions to make increasing use of the forum of Lok Adalats. As per the earl
guidelines, banks could settle disputes involving amounts up to Rupees 5 lakh th
the forum of Lok Adalats. This was enhanced to Rupees 20 lakh in August 2004.
Further, banks have also been advised by the Reserve Bank to participate in the
Adalats convened by various DRTs or DRATs for resolving cases involving Rupees 1
lakh and above to reduce the stock of N P As.
(4) Debt Recovery Tribunals (DRTs): These are created specially for banks
and Financial Institutions (F Is) for expediting the recovery cases involving am
ounts in
excess of Rupees 10 lakh. The Debt Recovery Tribunal (Procedure) Rules 2003 were
amended substantially regarding application fee and plural remedies for better
administration of the Recovery of Debts due to Banks and Financial Institutions
(5) SARFAESI Act, 2002: The passage of the Securitization and Reconstruction
of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act
) has
provided the necessary impetus for banks and Financial Institutions (F I s) to h
asten the
recovery of their dues. This Act, effective from the date of promulgation of the
Ordinance, i.e. 21, June 2002, has been extended to cover co-operative banks by
notification dated January 28, 2003. The Act provides, inter alia, for enforceme
nt of
security interest for realization of dues without the intervention of courts or
The Government has also notified the Security Interest (Enforcement) Rules, 2002
enable secured creditors to authorize their officials to enforce the securities
and recover
the dues from the borrowers.
Since the Act provides for sale of financial assets by banks or Financial
Institutions (F ls) to Securitization Companies (S Cs) or Reconstruction Compani
es (R
Cs), guidelines have been issued to ensure that the process of asset reconstruct
proceeds on sound lines. These guidelines, inter-alia, prescribe the financial a
which can be sold to S Cs or R Cs by banks or F Is, procedure for such sales (in
valuation and pricing aspects), prudential norms for the sale transactions (viz.

, provisioning or valuation norms, capital adequacy norms and exposure norms) an

related disclosures required to be made in the Notes on Accounts to balance shee
The I F C L along with other banking and F Is, incorporated an asset
reconstruction company called 'Asset Care Enterprise Ltd.' (ACE) in June 2002 wi
th an
authorized capital of Rupees 20 crore. More recently, the I D B I, the I C I C I
Bank, the
S B I and few other banks have jointly promoted the Asset Reconstruction Company
(India) Ltd. (ARCIL) with an initial authorized capital of Rupees 20 crore and p
capital of Rupees 10 crore. Similar asset reconstruction or management companies
also being proposed by other institutions or banks.
The Enforcement of Security Interest and Recovery Debts Laws (Amendment)
Act, 2004 has amended the SARFAESI Act, Recovery of Debts due to banks and
financial institutions Act, 1993 and the Companies Act, 1956. By this amendment,
SARFAESI Act has been amended, inter alia, to (a) enable the borrower to make an
application before the debt recovery tribunal against the measures taken by the
creditor without depositing any portion of the money due; (b) provide that the d
recovery tribunal shall dispose of the application as expeditiously as possible
within a
period of 60 days from the date of application and (c) enable any person aggriev
ed by
the order by the debt recovery tribunal to file an appeal before the debt recove
appellate tribunal after depositing with the appellate tribunal 50 per cent of t
he amount
of debt due to him as claimed by the secured creditor or as determined by the de
recovery tribunal, whichever is less.
(5) Write off: When all the efforts to recover the dues are exhausted or, the ba
nk is
convinced that further pursuit of the case will not result any worthwhile result
s, the
outstanding amount is written off by utilizing the provision made for that accou
nt in the
books. If the provision is not enough, the excess amount is debited to Profit an
d Loss
account (P & L account). The write off does not mean that the borrower's liabili
ty to the
bank has ended. If bank is able to recover any amount from him in future, it has
legal right to appropriate that amount.
(Details contained in R B I circular D B O D.No.BP.BC.No.37 /21.04.132/2008-09
dated August 27, 2008)
Banks may restructure the accounts classified under 'standard', 'sub-standard'
and 'doubtful' categories. Banks can not reschedule/restructure/renegotiate borr
accounts with retrospective effect.
Normally, restructuring can not take place unless alteration or changes in the
original loan agreement are made with the formal consent or application of the d

However, the process of restructuring can be initiated by the bank in deserving
subject to customer agreeing to the terms and conditions.
No account will be taken up for restructuring by the banks unless the financial
viability is established and there is a reasonable certainty of repayment from t
borrower, as per the terms of restructuring package. The viability should be det
ermined by the banks based on the acceptable viability benchmarks determined by
them, which
may be applied on a case-by-case basis, depending on merits of each case. The
accounts not considered viable should not be restructured and banks should accel
the recovery measures in respect of such accounts. Any restructuring done withou
looking into cash flows of the borrower and assessing the viability of the proje
cts or
activity financed by banks would be treated as an attempt at ever greening a wea
credit facility and would invite supervisory concerns/action. BIER cases are not
for restructuring without their express approval.
The objective of the Corporate Debt Restructuring (CDR) framework is to ensure
timely and transparent mechanism for restructuring the corporate debts of viable
facing problems, outside the purview of BIER, DRT and other legal proceedings, f
or the
benefit of all concerned. In particular, the framework will aim at preserving vi
corporates that are affected by certain internal and external factors and minimi
ze the
losses to the creditors and other stakeholders through an orderly and coordinate
restructuring programme.
The CDR Mechanism has been designed to facilitate restructuring of advances of
borrowers enjoying credit facilities from more than one bank/Financial Instituti
on (F I) in
a coordinated manner. The CDR Mechanism is an organizational framework
institutionalized for speedy disposal of restructuring proposals of large borrow
availing finance from more than one bank/Fl. This mechanism will be available to
borrowers engaged in any type of activity subject to the following conditions:
(1) The borrowers enjoy credit facilities from more than one bank or F l under m
banking or syndication or consortium system of lending.
(2) The total outstanding (fund-based and non-fund based) exposure is Rupees 10
crores or above. C D R system in the country will have a three tier structure
(a) C D R Standing Forum and its Core Group.
(b) C D R Empowered Group.
(c) C D R Cell.
C D R Standing Forum
The C D R Standing Forum would be the representative general body of all
financial institutions and banks participating in C D R system. All financial in
and banks should participate in the system in their own interest. C D R Standing

will be a self-empowered body, which will lay down policies and guidelines, and
the progress of corporate debt restructuring.The Forum will also provide an offi
cial platform for both the creditors and
borrowers (by consultation) to amicably and collectively evolve policies and gui
for working out debt restructuring plans in the interests of all concerned.
Forum shall comprise of Chairman & Managing Director, Industrial Development
Bank of India Ltd; Chairman, State Bank of India; Managing Director & CEO, ICICI
Limited; Chairman, Indian Banks' Association as well as Chairmen and Managing
Directors of all banks and financial institutions participating as permanent mem
bers in
the system. Since institutions like Unit Trust of India, General Insurance Corpo
Life Insurance Corporation may have assumed exposures on certain borrowers, thes
institutions may participate in the C D R system. The Forum will elect its Chair
man for a
period of one year and the principle of rotation will be followed in the subsequ
ent years.
However, the Forum may decide to have a Working Chairman as a whole-time officer
guide and carry out the decisions of the C D R Standing Forum.
The R B I would not be a member of the C D R Standing Forum and Core Group.
Its role will be confined to providing broad guidelines.
The C D R Standing Forum shall meet at least once every six months and would
review and monitor the progress of corporate debt restructuring system. The Foru
would also lay down the policies and guidelines including those relating to the
parameters for restructuring (for example, maximum period for a unit to become v
under a restructuring package, minimum level of promoters' sacrifice etc.) to be
by the C D R Empowered Group and C D R Cell for debt restructuring and would
ensure their smooth functioning and adherence to the prescribed time schedules f
debt restructuring. It can also review any individual decisions of the C D R Emp
Group and C D R Cell. The CDR Standing Forum may also formulate guidelines for
dispensing special treatment to those cases, which are complicated and are likel
y to be
delayed beyond the time frame prescribed for processing.
A C D R Core Group will be carved out of the CDR Standing Forum to assist the
Standing Forum in convening the meetings and taking decisions relating to policy
, on
behalf of the Standing Forum. The Core Group will consist of Chief Executives of
Industrial Development Bank of India Ltd., State Bank of India, I C I C I Bank L
td, Bank
of Baroda, Bank of India, Punjab National Bank, Indian Banks' Association and De
Chairman of Indian Banks' Association representing foreign banks in India.
The C D R Core Group would lay down the policies and guidelines to be followed
by the CDR Empowered Group and CDR Cell for debt restructuring. These guidelines
shall also suitably address the operational difficulties experienced in the func
tioning of

the CDR Empowered Group. The CDR Core Group shall also prescribe the PERT chart
for processing of cases referred to the CDR system and decide on the modalities
enforcement of the time frame. The CDR Core Group shall also lay down guidelines
ensure that over-optimistic projections are not assumed while preparing/approvin
restructuring proposals especially with regard to capacity utilization, price of
profit margin, demand, availability of raw materials, input-output ratio and lik
ely impact
of imports/international cost competitiveness.
CDR Empowered GroupThe individual cases of corporate debt restructuring shall be
decided by the CDR
Empowered Group, consisting of E D level representatives of Industrial Developme
Bank of India Ltd., ICICI Bank Ltd. and State Bank of India as standing members,
addition to E D level representatives of financial institutions and banks who ha
ve an
exposure to the concerned company. While the standing members will facilitate th
conduct of the Group's meetings, voting will be in proportion to the exposure of
creditors only. In order to make the CDR Empowered Group effective and broad bas
and operate efficiently and smoothly, it would have to be ensured that participa
institutions/banks approve a panel of senior officers to represent them in the C
Empowered Group and ensure that they depute officials only from among the panel
attend the meetings of CDR Empowered Group. Further, nominees who attend the
meeting pertaining to one account should invariably attend all the meetings pert
aining to
that account instead of deputing their representatives.
The level of representation of banks/financial institutions on the CDR Empowered
Group should be at a sufficiently senior level to ensure that concerned bank/F I
by the necessary commitments including sacrifices, made towards debt restructuri
There should be a general authorization by the respective Boards of the
participating institutions/banks in favour of their representatives on the CDR
Empowered Group, authorizing them to take decisions on behalf of their organizat
regarding restructuring of debts of individual corporates.
The CDR Empowered Group will consider the preliminary report of all cases of
requests of restructuring, submitted to it by the CDR Cell. After the Empowered
decides that restructuring of the company is prima-facie feasible and the enterp
rise is
potentially viable in terms of the policies and guidelines evolved by Standing F
orum, the
detailed restructuring package will be worked out by the CDR Cell in conjunction
the Lead Institution. However, if the lead institution faces difficulties in wor
king out the
detailed restructuring package, the participating banks/financial institutions s

decide upon the alternate institution/bank which would work out the detailed
restructuring package at the first meeting of the Empowered Group when the
preliminary report of the CDR Cell comes up for consideration.
The CDR Empowered Group would be mandated to look into each case of debt
restructuring, examine the viability and rehabilitation potential of the Company
approve the restructuring package within a specified time frame of 90 days, or,
at best
within 180 days of reference to the Empowered Group. The CDR Empowered Group
shall decide on the acceptable viability benchmark levels on the following illus
parameters, which may be applied on a case-by-case basis, based on the merits of
each case:
(a) Return on Capital Employed (R O C E)
(b) Debt Service Coverage Ratio (D S C R)
(c) Gap between the Internal Rate of Return (I R R) and the Cost of Fund (C o F)
(d) Extent of sacrifice..
The Board of each bank/Fl should authorize its Chief Executive Officer (C E O)
and/or Executive Director (E D) to decide on the restructuring package in respec
t of cases referred to the CDR system, with the requisite requirements to meet t
he control
needs. CDR Empowered Group will meet on two or three occasions in respect of eac
borrowal account. This will provide an opportunity to the participating members
to seek
proper authorizations from their C E O or E D, in case of need, in respect of th
ose cases
where the critical parameters of restructuring are beyond the authority delegate
d to
The decisions of the CDR Empowered Group shall be final. If restructuring of
debt is found to be viable and feasible and approved by the Empowered Group, the
company would be put on the restructuring mode. If restructuring is not found vi
able, the
creditors would then be free to take necessary steps for immediate recovery of d
and, or liquidation or winding up of the company collectively or individually.
CDR Cell
The CDR Standing Forum and the CDR Empowered Group will be assisted by a
CDR Cell in all their functions. The CDR Cell will make the initial scrutiny of
proposals received from borrowers/creditors, by calling for proposed rehabilitat
ion plan
and other information and put up the matter before the CDR Empowered Group, with
one month to decide whether rehabilitation is prima facie feasible. If found fea
sible, the
CDR Cell will proceed to prepare detailed Rehabilitation Plan with the help of c
and if necessary, experts to be engaged from outside. If not found prima facie f
the creditors may start action for recovery of their dues.
All references for corporate debt restructuring by creditors or borrowers will b
made to the CDR Cell. It shall be the responsibility of the lead institution/maj
stakeholder to the corporate, to work out a preliminary restructuring plan in co

with other stakeholders and submit to the CDR Cell within one month. The CDR Cel
l will
prepare the restructuring plan in terms of the general policies and guidelines a
by the CDR Standing Forum and place for consideration of the Empowered Group
within 30 days for decision. The Empowered Group can approve or suggest
modifications but ensure that a final decision is taken within a total period of
90 days.
However, for sufficient reasons the period can be extended up to a maximum of 18
days from the date of reference to the CDR Cell.
The CDR Standing Forum, the CDR Empowered Group and CDR Cell is at
present housed in Industrial Development Bank of India Ltd. However, it may be s
to another place if considered necessary, as may be decided by the Standing Foru
The administrative and other costs shall be shared by all financial institutions
banks. The sharing pattern shall be as determined by the Standing Forum.
CDR Cell will have adequate members of staff deputed from banks and financial
institutions. The CDR Cell may also take outside professional help. The cost in
operating the CDR mechanism including CDR Cell will be met from contribution of
financial institutions and banks in the Core Group at the rate of Rupees.50 lakh
and contribution from other institutions and banks at the rate of Rupees.5 lakh
Other Features
The scheme will not apply to accounts involving only one financial institution o
one bank. The CDR mechanism will cover only multiple banking accounts or syndica
tion or consortium accounts of corporate borrowers engaged in any type of activi
ty with
outstanding fund-based and non-fund based exposure of Rupees. 10 crore and above
by banks and institutions.
The Category 1 CDR system will be applicable only to accounts classified as
'standard' and 'substandard'. There may be a situation where a small portion of
debt by
a bank might be classified as doubtful. In that situation, if the account has be
classified as standard'/ 'substandard' in the books of at least 90 per cent of cr
(by value), the same would be treated as standard/substandard, only lot the purp
ose of
judging the account as eligible for CDR, in the books of the remaining 10 per ce
nt of
creditors. There would be no requirement of the account/company being sick, N P
A or
being in default for a specified period before reference to the CDR system. Howe
potentially viable cases of N P As will get priority. This approach would provid
e the
necessary flexibility and facilitate timely intervention for debt restructuring.
any milestone(s) may not be necessary, since the debt restructuring exercise is
triggered by banks and financial institutions or with their consent.
While corporates indulging in frauds and malfeasance even in a single bank will
continue to remain ineligible for restructuring under CDR mechanism as hitherto,

Core group may review the reasons for classification of the borrower as wilful d
specially in old cases where the manner of classification of a borrower as a wil
defaulter was not transparent and satisfy itself that the borrower is in a posit
ion to rectify
the willful default provided he is granted an opportunity under the CDR mechanis
Such exceptional cases may be admitted for restructuring with the approval of th
e Core
Group only. The Core Group may ensure that cases involving frauds or diversion o
funds with malafide intent are not covered.
The accounts where recovery suits have been filed by the creditors against the
company, may be eligible for consideration under the CDR system provided, the
initiative to resolve the case under the CDR system is taken by at least 75 per
cent of
the creditors (by value) and 60 per cent of creditors (by number).
BIER cases are not eligible for restructuring under the CDR system. However,
large value B I F R cases may be eligible for restructuring under the CDR system
specifically recommended by the CDR Core Group. The Core Group shall recommend
exceptional B I F R cases on a case-to-case basis for consideration under the CD
system. It should be ensured that the lending institutions complete all the form
alities in
seeking the approval from B I F R before implementing the package.
Reference to CDR System
Reference to Corporate Debt Restructuring System could be triggered by (1) any
or more of the creditor who have minimum 20 per cent share in either working cap
ital or
term finance, or (2) by the concerned corporate, if supported by a bank or finan
institution having stake as in (1) above.
Though flexibility is available whereby the creditors could either consider
restructuring outside the purview of the CDR system or even initiate legal proce
where warranted, banksor Fls should review all eligible cases where the exposure
of the
financial system is more than Rupees.100 crore and decide about referring the ca
se to CDR system or to proceed under the new Securitization and Reconstruction o
f Financial
Assets and Enforcement of Securities Interest Act, 2002 or to file a suit in D R
T etc.
Legal Basis
CDR is a non-statutory mechanism which is a voluntary system based on DebtorCreditor Agreement (D C A) and Inter-Creditor Agreement (I C A). The Debtor-Cred
Agreement (D C A) and the Inter-Creditor Agreement (I C A) shall provide the leg
basis to the CDR mechanism. The debtors shall have to accede to the D C A, eithe
r at
the time of original loan documentation (for future cases) or at the time of ref
erence to
Corporate Debt Restructuring Cell. Similarly, all participants in the C D R mech
through their membership of the Standing Forum shall have to enter into a legall
binding agreement, with necessary enforcement and penal clauses, to operate the

System through laid-down policies and guidelines. The I C A signed by the credit
ors will
be initially valid for a period of 3 years and subject to renewal for further pe
riods of 3
years thereafter. The lenders in foreign currency outside the country are not a
part of
CDR system. Such creditors and also creditors like G I C, L I C, U T I, etc., wh
o have
not joined the CDR system, could join CDR mechanism of a particular corporate by
signing transaction to transaction I C A, wherever they have exposure to such
The Inter-Creditor Agreement would be a legally binding agreement amongst the
creditors with necessary enforcement and penal clauses, wherein the creditors wo
commit themselves to abide by the various elements of CDR system. Further, the
creditors shall agree that if 75 per cent of creditors by value and 60 per cent
of the
creditors by number, agree to a restructuring package of an existing debt (i.e.,
outstanding), the same would be binding on the remaining creditors. Since Catego
ry 1
CDR Scheme covers only standard and sub-standard accounts, which in the opinion
75 per cent of the creditors by value and 60 per cent of creditors by number, ar
e likely to
become performing after introduction of the CDR package, it is expected that all
creditors (i.e., those outside the minimum 75 per cent by value and 60 per cent
number) would be willing to participate in the entire CDR package, including the
additional financing.
In order to improve effectiveness of the CDR mechanism, a clause may be
incorporated in the loan agreements involving consortium or syndicate accounts
whereby all creditors, including those which are not members of the CDR mechanis
agree to be bound by the terms of the restructuring package that may be approved
under the CDR mechanism, as and when restructuring may become necessary.
One of the most important elements of Debtor-Creditor Agreement would be
'stand still' agreement binding for 90 days, or 180 days by both sides. Under th
is clause,
both the debtor and creditor(s) shall agree to a legally binding 'stand-still' w
hereby both
the parties commit themselves not to take recourse to any other legal action dur
ing the
'stand-still' period, this would be necessary for enabling the CDR System to und
the necessary debt restructuring exercise without any outside intervention, judi
cial or
otherwise. However, the stand-still clause will be applicable only to any civil
either by the borrower or any lender against the other party and will not cover
criminal action. Further, during the stand-still period, outstanding foreign exc
hange forward contracts, derivative products, etc., can be crystallized, provide
d the borrower is
agreeable to such crystallization. The borrower will additionally undertake that

the stand-still period the documents will stand extended for the purpose of limi
tation and
also that he will not approach any other authority for any relief and the direct
ors of the
borrowing company will not resign from the Board of Directors during the stand-s
Sharing of Additional Finance
Additional finance, if any, is to be provided by all creditors of a 'standard' o
'substandard account' irrespective of whether they are working capital or term c
on a pro-rata basis. In case for any internal reason, any creditor (outside the
75 per cent and 60 per cent) does not wish to commit additional financing, that
will have an option in accordance with the provisions of exit option.
The providers of additional finance, whether existing or new creditors, shall ha
a preferential claim, to be worked out under the restructuring package, over the
providers of existing finance with respect to the cash flows out of recoveries,
in respect
of the additional exposure
Exit Option
As stated in para above a creditor (outside the minimum 75 per cent and 60 per
cent) who for any internal reason does not wish to commit additional finance wil
l have
an exit option. At the same time, in order to avoid the 'free rider' problem, it
is necessary
to provide some disincentive to the creditor who wishes to exercise this option.
creditors can either (a) arrange for its share of additional finance to be provi
ded by a
new or existing creditor, or (b) agree to the deferment of the first year's inte
rest due to it
after the CDR package becomes effective. The first year's deferred interest as
mentioned above, without compounding, will be payable along with the last instal
of the principal due to the creditor.
In addition, the exit option will also be available to all lenders within the mi
75 per cent and 60 percent provided the purchaser (of their share) agrees to abi
de by
restructuring package approved by the Empowered Group. The exiting lenders may b
allowed to continue with their existing level of exposure to the borrower provid
ed they tie
up with either the existing lenders or fresh lenders taking up their share of ad
The lenders who wish to exit from the package would have the option to sell thei
existing share to either the existing lenders or fresh lenders, at an appropriat
e price,
which would be decided mutually between the exiting lender and the taking over l
The new lenders shall rank on par with the existing lenders for repayment and se
of the dues since they have taken over the existing dues to the exiting lender.

In order to bring more flexibility in the exit option, One Time Settlement can a
be considered, wherever necessary, as a part of the restructuring package. If an
account with any creditor is subjected to One Time Settlement (O T S) by a borro
before its reference to the CDR mechanism, any fulfilled commitments under such
S may not be reversed under the restructured package. Further payment commitment
s of the borrower arising out of such O T S may be factored into the restructuri
Category 2 CDR System
There have been instances where the projects have been found to be viable by
the creditors but the accounts could not be taken up for restructuring under the
system as they fell under 'doubtful' category. Hence, a second category of CDR i
introduced for cases where the accounts have been classified as 'doubtful' in th
e books
of creditors, and if a minimum of 75 per cent of creditors (by value) and 60 per
creditors (by number) satisfy themselves of the viability of the account and con
sent for
such restructuring, subject to the following conditions:
(a) It will not be binding on the creditors to take up additional financing work
ed out under
the debt restructuring package and the decision to lend or not to lend will depe
nd on
each creditor bank or F I separately. In other words, under the proposed second
category of the CDR mechanism, the existing loans will only be restructured and
would be up to the promoter to firm up additional financing arrangement with new
existing creditors individually.
(b) All other norms under the CDR mechanism such as the standstill clause, asset
classification status during the pendency of restructuring under CDR, etc., will
to be applicable to this category also.
No individual case should be referred to R B I. CDR Core Group may take a final
decision whether a particular case falls under the CDR guidelines or it does not
All the other features of the CDR system as applicable to the First Category wil
also be applicable to cases restructured under the Second Category.
Incorporation of 'Right to Recompense' Clause
All CDR approved packages must incorporate creditors' right to accelerate
repayment and borrowers' right to pre-pay. The right of recompense should be bas
ed on
certain performance criteria to be decided by the Standing Forum.
Apart from CDR Mechanism, there exists a much simpler mechanism for restructurin
of loans availed by Small and Medium Enterprises (S M Es). Unlike in the case of
Mechanism, the operational rules of the mechanism have been left to be formulate
d by
the banks concerned. This mechanism will be applicable to all the borrowers whic

have funded and non-funded outstanding up to Rupees. 10 crores under

multiple/consortium banking arrangement. Major elements of this arrangement are
(1) Under this mechanism, banks may formulate, with the approval of their Board
Directors, a debt restructuring scheme for S M Es within the prudential norms la
id down
by R B I. Banks may frame different sets of policies for borrowers belonging to
sectors within the S M E if they so desire.
(2) While framing the scheme, banks may ensure that the scheme is simple to
comprehend and will, at the minimum, include parameters indicated in these guide
lines.(3) The main plank of the scheme is that the bank with the maximum outstan
ding may
work out the restructuring package, along with the bank having the second larges
(4) Banks should work out the restructuring package and implement the same withi
n a
maximum period of 90 days from date of receipt of requests.
(5) The S M E Debt Restructuring Mechanism will be available to all borrowers en
in any type of activity.
(6) Banks may review the progress in rehabilitation and restructuring of S M Es
accounts on a quarterly basis and keep the Board informed
As per the definition, a unit is considered as sick when any of the borrowal
account of the unit remains substandard for more than 6 months or there is erosi
on in
the net worth due to accumulated cash losses to the extent of 50 per cent of its
worth during the previous accounting year and the unit has been in commercial
production for at least two years. The criteria will enable banks to detect sick
ness at an
early stage and facilitate corrective action for revival of the unit. As per the
the rehabilitation package should be fully implemented within six months from th
e date
the unit is declared as potentially unviable. During this period of six months,
identifying and implementing rehabilitation package, banks or F Is are required
to do
'holding operation' which will allow the sick unit to draw funds from the cash c
account at least to the extent of deposit of sale proceeds
Following are broad parameters for grant of relief and Concessions for revival o
potentially viable sick S S I units:
(1) Interest on Working Capital - Interest 1.5 per cent below the prevailing fix
ed or
prime lending rate, wherever applicable
(2) Funded Interest Term Loan - Interest Free
(3) Working Capital Term Loan - Interest to be charged 1.5 per cent below the
prevailing fixed or prime lending rate, wherever applicable
(4) Term Loan - Concessions in the interest to be given not more than 2 per cent
more than 3 % in the case of tiny or decentralized sector units) below the docum

(5) Contingency Loan Assistance - The Concessional rate allowed for Working
Capital Assistance
(Details available in R B I circulars RPCD.No. PLNFS.BC.57/06.04.01/2001-02 date
16, January 2002, and RPCD. SME&NFS. BC.No.102/06.04.01/2008-09 4, May 2009)
The need of credit information system was felt in order to alert the banks and
financial institutions (F Is) and put them on guard against borrowers who have d
in their dues to other lending institutions. It was also imperative to arrest ac
cretion of fresh N P As in the banking system through an efficient system of cre
dit information on
borrowers as a first step in credit risk management. In this context, the requir
ement of
an adequate, comprehensive and reliable information system on the borrowers thro
an efficient database system was keenly felt by the Reserve Bank/ Government as
as credit institutions. A Working Group (Chairman: Shri N.H. Siddiqui) with
representatives from select public sector banks, I D B I, I C I C I, Indian Bank
Association and Reserve Bank was constituted by the Reserve Bank in the year 199
to explore the possibilities of setting up a Credit Information Bureau (CIB). Th
e Working
Group had recommended to set up a C I B under the Companies Act, 1956 with equit
participation from commercial banks, F Is and NBFCs registered with the Reserve
Bank. As per the recommendations made by the Working Group, Credit Information
Bureau (India) Ltd., (CIBIL) was set up by State Bank of India in association wi
in January 2001.
In order to get over the legal constraints of customer confidentiality vis-a-vis
providing information on banks' customers to CIBIL, pending enactment on the Cre
Information Companies (Regulation) Act, the Reserve Bank advised banks and finan
institutions on October 1, 2002 to obtain consent from all existing borrowers an
guarantors at the time of renewal of loans and consent of all the new borrowers
guarantors for sharing the credit information in respect of non-suit filed accou
nts with
the CIBIL. A Working Group (Chairman: Shri S.R. Iyer) set up in 2002 observed th
while some modalities like 'consent clause' could be adopted as a base to begin
for limited operations of a C I B, such modalities cannot be a substitute for a
legislation. The Working Group, therefore, recommended the enactment of an
appropriate legislation by the Government of India expeditiously, in consultatio
n with the
Reserve Bank. With a view to strengthening the legal mechanism and facilitating
Bureau to collect, process and share credit information on the borrowers of cred
institutions, the Credit Information Companies (Regulation) Act, 2005 was passed

May 2005 by Parliament and notified in the Gazette of India on 23, June 2005. Th
Government of India also notified the rules and regulations for the implementati
on of the
Credit Information Companies (Regulation) Act, 2005 on December 14, 2006 making
the Act operational. In terms of Section 15(1) of the Act, every credit institut
ion has to
become member of at least one credit information company within a period of thre
months from commencement of the Act or any extended time allowed by the Reserve
Bank on application As per R B I guidelines, each credit institution should prov
ide credit
data (positive as well as negative) to the credit information company in the for
prescribed by the credit information company.
Sub section (1) of Section 21 of the Credit Information Companies (Regulation)
Act, 2005, which provides; ,any person, who applies for grant or sanction of cre
facility, from any credit institution, may request such institution to furnish h
im a copy of
the credit information obtained by such institution from the credit information
company '.
Further, sub-section (2) of the said Section also specifies that every credit
institution shall on receipt of request, as indicated in sub-section (1), furnis
h to such
person a copy of the credit information subject to payment of charges specified
by the
Reserve Bank R B I has prescribed a maximum fee of Rupees. 501- (Rupees fifty on
Credit Information Bureau (India) Ltd (CIBIL) was set up by State Bank of India
association with HDFC in January 2001. Presently, Dun and Bradstreet Information
Services India (P) Ltd. is also their equity holder as well as technology partne
r. As,
presently, this is the only approved credit information company, all credit inst
itutions are
required to be its members. The purpose of setting up of CIBIL is information sh
aring on
defaulters as also other borrowers as comprehensive credit information, which pr
details pertaining to credit facilities already availed of by a borrower as well
as his
payment track record, has become the need of the hour.
CIBILs aim is to fulfill the need of credit granting institutions for comprehens
credit information by collecting, collating and disseminating credit information
to both commercial and consumer borrowers, to a closed user group of Members.
Banks, Financial Institutions, Non Banking Financial Companies, Housing Finance
Companies and Credit Card Companies use CIBIL:s services. Data sharing is based
the Principle of Reciprocity, which means that only Members who have submitted a
their credit data, may access Credit Information Reports from CIBIL. The relatio
between CIBIL and its Members is that of close interdependence.
R B I and CIBIL disseminate information on non-suit filed and suit filed account

respectively, as reported to them by the banks or F Is and responsibility for re
correct information and also accuracy of facts and figures rests with the concer
banks and financial institutions. Therefore, R B I has advised the banks and fin
institutions to take immediate steps to up-date their records and ensure that th
e names
of current directors are reported. In addition to reporting the names of current
it is necessary to furnish information about directors who were associated with
company at the time the account was classified as defaulter, to put the other ba
nks and
financial institutions on guard. Banks and F Is may also ensure the facts about
wherever possible, by cross-checking with Registrar of Companies.
As per R B I guidelines, bank and FIs are required to submit the list of suit-fi
accounts of willful defaulters of Rupees 25 lakh and above as at end-March, June
September and December every year to Credit Information Bureau (India) Ltd.
The data on borrowal accounts against which suits have been filed for recovery
of advances (outstanding aggregating Rupees. 1.00 crore and above) and suit file
accounts of wilful defaulters with outstanding balance of Rupees 25 lakh and abo
based on information furnished by scheduled commercial banks and financial
institutions is available at
Even with best of loan policies adopted by a bank and with high standards of
appraisal, the quality of a few loan accounts may deteriorate as the time passes
. This
may give rise to actual default or possibility of default in repayment of princi
pal and
interest in some of the accounts. As per R B I directives, banks in India have t
o classify
their assets into Performing (standard) assets or Non performing assets (N P As)
. N P
As are further classified into Sub-standard, doubtful and loss assets. The optio
available to banks in regard to the assets where the quality has deteriorated, a
re Rescheduling and Restructuring, Rehabilitaion, Compromise, Legal action or Wr
ite off.
As per R B I guidelines, forums are available for restructuring of debts of Corp
and S M Es, in deserving cases. There are also guidelines on rehabilitation of s
ick S S I
units. Credit information system has also been introduced to share information a
borrowers committing defaults with any of the banks. Under this system, CIBIL wa
formed in January 2001 with the purpose of information sharing on defaulters as
other borrowers by providing details pertaining to credit facilities already ava
iled of by a
borrower as well as his payment track record.
Rescheduling; Restructuring; Rehabilitation; Compromise; Legal action; Write off

Corporate Debt Restructuring (CDR); S M E Debt Restructuring; CREDIT
INFORMATION SYSTEM; CIBIL; Performing (standard) assets; Non performing
assets(N P As); Sub-standard: Doubtful assets; Loss assets
Check Your Progress
State true or False:
1. In the case of fund based lending, credit default means that principal/and or
amount may not be repaid as per the terms of repayment.
2. In the case of guarantees or letters of credit, credit default means crystall
ization of
the liability. False.
3. As per R B I directives, banks in India have to classify their assets into Pe
( standard ) assets or Non performing assets(N P As). N P As are further classif
ied into
Sub-standard, doubtful and loss assets
4. The amount of provision required to be made on the asset portfolio of a bank
depends on the classification of assets. True.
5. No provision is required to be made by a bank on its Standard Assets.
6. The default due to the reasons beyond the control of the borrower, is referre
d to as
wilful default.
7. The default in payment as per agreed terms could be intentional or due to the
reasons beyond the control of the borrower.
8. Writing off a loan means that the borrower is no longer liable to pay the amo
unt to the
bank. False.
9. In case of finance under government sponsored schemes, responsibility for rec
lies with the government.
10..Banks reschedule or restructure the loans in accordance with the revised ca
sh flow
estimates of the borrower. True.
11. The Debt Recovery Tribunals are meant for recovery of dues of the banks and
financial institutions only. True.12. For filing cases in the Debt Recovery Trib
unals, the amount of claim must be more
than Rupees 10 lacs. True.
13. SARFAESI Act provides for enforcement of security interest for realization o
f dues
without the intervention of courts or tribunals.
14. Banks can settle disputes involving amounts up to Rupees.20 latch through th
forum of Lok Adalats.
15. As per R B I directives, banks can reschedule/restructure/renegotiate borrow
accounts with retrospective effect.
16. For restructuring of SME loans, no forum like CDR is available.
17. Credit Information System was started with the objective of sharing informat
about borrowers committing defaults with any of the banks. True.
Select the Correct Answer:
18. The aim of a rehabilitation programme is: The choices are:
(a) To make the operations of the enterprise viable again
(b) To help in employment generation
(c) To comply with R B I guidelines
(d) To increase bank's advances
The correct answer is
(a) To make the operations of the enterprise viable again
19. Banks enter into compromise with borrowers in case of default, because:


choices are:
Recovery through legal action is time consuming
Adequate security is not available
Realization or security may be difficult
All the above
correct answer is
(d) All the above
OF CHAPTER 33-Rehabilitation and Recovery, ADVANCED BANK