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Journal of Business Management & Social Sciences Research (JBM&SSR)          ISSN No: 2319‐5614   

Volume 2, No.7, July 2013                                                                                                                                 
_________________________________________________________________________________
 
Credit Is Inevitable In Banking: A Case Study Of Premier
Bank On Credit Appraisal & Assessment
 
Dr. Ram Jass Yadav, Assistant General Manager & Vice-Principal at Staff College, Bank of Baroda, Ahmedabad

Introduction Credit risk assessment and appraisal has been


Credit risk simply means the risk of default being studied taking SME credit account in sample to
made by a customer owing to non repayment of the observe various parameters and stages in risk
credit obtained by him from a bank. Proper assessment and appraisal process exist in one of the
evaluation of the customer measures the financial largest public sector banks in India. The bank has
condition and the ability of the customer to repay been named ‘Premier Bank (PB)’ in the study to keep
loan in future. Credit appraisal is a process of original identity of the bank undisclosed.
collecting related information of customers and
projects to undertake risk assessment exercise by the Credit Risk Assessment & Appraisal – An
bank prior providing any loans & also checks the Overview
technical, economical & financial viability of the Risk is inability or unwillingness of borrower-
project proposed. It also includes verification of customer or counter -party to meet their repayment
primary & collateral security available for recovery obligations/ honor their commitments, as per the
of such funds being lent to the customer. Credit stipulated terms. Numerous tasks and activities
Appraisal thus ascertains the risks associated with associated with risk assessment are summarized
lending functions in banks. It is generally carried out below in the matrix –
by the banks which are engaged in providing finance
to its customers. In the present case, process used in

Lender’s task Credit & Risk are Twins


1. Both are two sides of the same coin.
1. Identify the risk factors
2. All credit proposals have some inherent
2. Measurement of Risk
risks
3. Mitigate the risk
3. Go hand in hand
Probable reasons of risk Factors for good credit
1. Managerial ability
1. Deficiencies on the part of the management
2. Favorable business & industrial
2. Uncertainties in the business & industrial
environment
environment
3. Adequate financial strength
3. Weaknesses in the financial position
4. Proper due diligence & hedging of risk
4. Un-hedging market risks etc.

Lending being the core banking function, banks evaluates four major risks such as Industry Risk,
should not deter from financing merely because of Business Risk, Financial Risk and Management
risks in credit. A banker’s task is to identify the risk Quality / Risks. To arrive at the overall risk rating,
parameters & to mitigate them on a continuous basis. the parameters are duly weighted & calibrated to
It is prudent to have some idea about the degree of arrive at a single point indicator of risk associated
risk associated with any credit proposal and banker with the credit decision.
should take calculated risk, based on risk-absorption
& hedging capacity of the Bank. Industry Risk
The characteristics of an industry which pose varying
Credit risk assessment models adopted by the degrees of risk are built into Bank’s risk assessment
Premier Bank take into account all possible factors model such as competition, industry outlook,
which go into appraising the risks associated with a regulatory risks, contemporary issues. The
loan. For assessment of risk, the rating structure assessment of this part is external to the borrower and
is done through assessment of Industry related macro

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Journal of Business Management & Social Sciences Research (JBM&SSR)          ISSN No: 2319‐5614   
Volume 2, No.7, July 2013                                                                                                                                 
_________________________________________________________________________________
 
- economic parameters like demand supply gap, the parameters related to the management such as
capacity utilization level, financial ratios like ROCE / integrity (corporate governance), track record,
OPM etc. applicable to the specific Industry and managerial competence / commitment, expertise,
having different risk weights. structure & systems, experience in the industry,
credibility - ability to meet sales projections, ability
Business Risk to meet profit (PAT) projections, Payment record,
The assessment of this factor is based on internal Strategic initiatives, Length of relationship with the
working of the borrower and relates to parameters Bank and many more. Thus, internal being the factors
such as after sales service, distribution set up etc. The to assess this parameter the score would base on
parameters, which are only relevant to a particular internal working of the Borrower’s management and
industry, are selected for scoring having different risk relates to parameters such as past repayment record,
weights. quality of information submitted, group support etc.

Financial Risk Taking above broad parameters into account, the


The assessment of financial risk includes appraisal of bank assesses the risk under three dimensions such as
the financial strength of the borrower based on obligor rating to determine investment grade and
performance & financial indicators. The overall worthiness of the customer based on the assessment
financial risk is assessed in terms of static ratios, of past and projected cash flows of the borrower and
future prospects & risk mitigation (collateral security it indicates probability of default (PD). It’s grading
/ financial standing). The assessment of this range from PB-1 to PB-10. Facility rating evaluates
parameter is based on internal working of the the riskiness of facilities assessed on the basis of
borrower and relates to parameters such as past (not security coverage for a given facility indicating the
in case of a green field / infrastructure company Loss Given Default (LGD) and its grades range from
under implementation stage) and projected financials. FR-1 to FR-8. The composite rating is the
The CMA based data input sheet is uploaded into the combination of PD and LGD indicating the expected
software and the same allows computation of loss (EL) in case the facility defaulted which is
financial rating automatically based on the worked out automatically by the software based on
computation of financial ratios like Net Profit the matrix of obligor & facility rating. The rating
Margin, Current Ratio, DSCR, Interest Coverage etc. grades and their description for credit risk assessment
is tabulated below-
Management Quality
The management of an enterprise / group is rated on

Obligor Rating Facility Rating Composite Rating


PB-1 Highest Safety FR-1 Highest Safety CR-1 Lowest Expected Loss
PB -2 High Safety FR-2 Higher Safety CR-2 Lower Expected Loss
PB-3 High safety FR-3 High Safety CR-3 Low Expected Loss
PB-4 Adequate Safety FR-4 Adequate Safety CR-4 Reasonable Expected Loss
Adequate Coverable expected
PB-5 Moderate Safety FR-5 Reasonable Safety CR-5
Loss
PB-6 Moderate Safety FR-6 Moderate Safety CR-6 Moderate Expected Loss
PB-7 Inadequate Safety FR-7 Low Safety CR-7 Extra Expected Loss
PB-8 High Risk CR-8 High Probability of Loss
Lowest Safety /
Default Substantial
PB-9 FR-8 Clean Loans / Totally CR-9 Higher Probability of Loss
Risk
Unsecured
PB-10 Default CR-10 Highest Expected Loss
Note – Obligor rating from PB-1 to PB-6 are considered to be investment grade

Besides the above risk assessment module (RAM) exposure of INR 20 Mn. Applicability and grading
applicable for loan exposure of INR 2.5 Mn and under this module is tabulated below-
above, the Premier Bank has also separate risk
assessment model for SME customers with

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Journal of Business Management & Social Sciences Research (JBM&SSR)          ISSN No: 2319‐5614   
Volume 2, No.7, July 2013                                                                                                                                 
_________________________________________________________________________________
 

Exposure Level (FB+NFB) Credit Module Rating Grade


Obligor Facility Composite
INR 0.2 Mn to INR 20 Mn MSME Score type CR 1 / MSME 1 to 10
Over INR 20 Mn PBRAM PB 1-10 FR-1 to 8 CR 1 to 10

For new borrowers of SME segment with new Control Board has been obtained to set the unit. Firm
projects, scoring to be done based on parameters of has commenced its operations from May 2012 and its
Financial Performance and Adequacy of tangible product is largely consumed by the associate concern
security of the module. The interest rate applicable M/s Indian Batteries Private Limited which is already
will be based on actual rating subject to the in the field of trading of batteries for last 10 years.
applicable rate to the rating worked out actually or Besides, other important clients of the firm are M/s
applicable to CR 3 – whichever is higher. This New Super Power House, Jaipur; M/s Bharat Battery
parameter of adequacy of Tangible collateral security House, Jaipur; M/s Pawan Battery House, Jaipur thus
is not applicable to the existing advance accounts, if the firm has no problem for marketing its products.
not stipulated in sanction specifically. This parameter Main raw materials of the firm is Lead, Lead Oxide,
is also not applicable in case of accounts covered Red Oxide, Acid, Tub Bag 115 MM, Tub Bag 250
under credit guarantee fund trust for micro & small MM, Battery P P Container, Peg Separator, I T
enterprises (CGTMSE) scheme and Government separator, Indicator. Some of the main suppliers of
sponsored schemes wherein obtaining of collateral raw material to the firm are M/s Manoj Metal,
security is not permitted. Kanpur; M/s Luxmi Industries, Ghaziabad; M/s
Siddharth Traders; M/s Accum Bags, Delhi; M/s j G
Credit appraisal process begins from generating the Exports, Delhi, M/s Associated Traders, Delhi.
business lead and ends while lead is closed i.e. Proprietor of the firm has rich experience of this line
amount is disbursed. Numerous layers of credit of activity and she will be closely assisted by her
appraisal are depicted in appendix -1 which explains husband Mr. K S Jha who along with the proprietor
the flow of activities involved in proposal appraisal. of the borrowing firm is director of associate concern
Both credit risk assessment and appraisal have been M/s Indian Batteries Private Limited. Firm is
studied taking a real case of SME client M/s maintaining current account with our Jaipur Branch
Hindustan Industries which was processed by SME & the conduct of account is satisfactory. Factory
Loan Hub (SMELH) of the Premier Bank. land value of INR 7 Mn is in name of the firm and
would be available for the security in loan from bank.
Credit Appraisal & Assessment – A Case of Besides firm is eligible to be covered under collateral
SME unit: M/s Hindustan Industries free lending scheme of finance under CGTMSE
M/s Hindustan Industries is a proprietorship firm Scheme and customer is agreed for the same.
constituted in April 2012 engaged in manufacturing Customer has requested for a term loan of INR 7 Mn
of Lead Acid Batteries. Firm is registered with and working capital limit of INR 3 Mn for purchasing
District Industries Center (DIC) Jaipur as Small plant & machines and cash credit to run her unit
enterprises (manufacturing) and it is also registered successfully. SMELH needs to take decisions on the
with Central Sales Tax department for the purpose of proposal (received 17.02.2013) to adhere to
manufacturing & trading of Cell, Batteries, turnaround time (TAT) which is 14 days at present.
Invertors, Electric transformers, Lead Plates, The cost of project and means of finance for the
stabilizers etc. Firm has power connection of 50HP proposed term finance is given below: -
from State Electricity Board. NOC from Pollution

INR Mn
Cost of Project Amount Means of Finance Amount
Land Development & Building 3.00 Promoters Contribution 9.50
Plant & Machinery 11.65 Term Loan 7.00
Margin Money of Working Capital 1.85
Total 16.50 Total 16.50
1. DE ratio of the project works out 0.74, which is favorable for bank finance.
2. Firm has requested Term Loan only for Plant & Machinery as other items of the project would be self

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Journal of Business Management & Social Sciences Research (JBM&SSR)          ISSN No: 2319‐5614   
Volume 2, No.7, July 2013                                                                                                                                 
_________________________________________________________________________________
 
financed by the firm.
3. Overall margin on cost of project is 57.57% as against normally acceptable margin between 25-30%.

The firm proposed to repay the term loan amount of


INR 7 Mn in 80 monthly installments on ballooning moratorium) and ending in January 2020. The
pattern commencing from June 2013 (after 4 months implementation schedule is given below:

Particulars Date of Commencement Date of Completion


Land Already acquired from RIICO
Building Construction Already Completed
Order for Plant & Machinery Orders already placed March 2013
Installation of P & M March 2013 March 2013
For Additional power Load (existing February 2013 March 2013
Load is 50 KVA)
Trial Run March 2013 March 2013
Commercial Production April / May 2013
The synopsis of estimated / projected financial has been depicted in appendix -2

Findings of the Case 5. Being the first year of its operation firm has
1. Proprietor of the firm has rich experience of this estimated to achieve sales of INR10.65 Mn for
line of activity and she will be closely assisted the period ending 31.03.2013. Firm has so far
by her husband Mr. K S Jha who along with the achieved sales of INR5.33 Mn till January
proprietor of the borrowing firm is director of 2013(as per sales VAT/Tax returns, & firm’s
associate concern M/s Indian Batteries Private book of accounts) which is over 50% of the total
Limited which is in the business of trading of estimated sales. Firm has also mentioned that
batteries for last 10 years. summer season commences from last week of
March thus demand of batteries will be high
2. Firm has commenced its operation from May from current month and firm has confirmed
2012 and its product is largely being consumed orders of batteries for February & March 2013
by the associate concern M/s Indian Batteries for INR2.57 Mn & INR 2.78 Mn respectively
Private Limited besides firm has tied up with from M/s Indian Batteries Private Ltd well in
good number of buyers of its product thus the advance hence the firm will easily surpass the
firm has no problem for marketing its products. estimated sales target.

3. Firm has all necessary infrastructure including 6. Firm has installed capacity of manufacturing
power connection, water, manpower to meet the 1250 batteries per month i.e. 50 batteries per day
demand of the market & after installation of but to be on conservative side it has projected
following capacity which is reasonable
4. proposed additional plant& machinery the
capacity of the firm will further increase to 150
batteries per day.

Year 2014 2015 2016 2017 2018 2019 2020


Installed capacity 50 50 50 50 50 50 50
(No. of batteries per day)
Capacity utilization (%) 28% 32% 36% 40% 44% 48% 52%
Projected capacity 14 16 18 20 22 24 26
(No. Of batteries per day)
Sales price per battery (INR) 5050 5050 5050 5050 5050 5050 5050
Total Sales (INR in Mn) 21.21 24.24 27.27 30.30 33.33 36.33 39.39
(assuming 300 working days in a year)

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Journal of Business Management & Social Sciences Research (JBM&SSR)          ISSN No: 2319‐5614   
Volume 2, No.7, July 2013                                                                                                                                 
_________________________________________________________________________________
 
7. With the increase in capacity after proposed Card type Credit rating from time to time as per
installation of additional machines firm has Bank’s extant guidelines
estimated to increase capacity from 7 batteries
per day to 14 batteries per day in first year of its Conclusion
operations after installing the new machines i.e. Credit appraisal is done to assess the technical,
year 2014 and hence projected to achieve sales economical and financial viability of the project.
of INR21.21 Mn for the year ending 31.03.2014 Loan policy of Bank contains various norms for
based on the assumptions that average sales price sanction of different types of loans under SME
per battery is INR5050. Looking to the high segment and all these norms do not necessarily apply
demand of the product in the market, reputed to each & every case. The credit risk assessment
name of the associate concern in this field, rich models adopted by the bank take into account all
experience of the proprietor the possible factors which go into appraising the risk
estimated/projected sales is reasonable & thus associated with a loan. These have been categorized
acceptable. broadly into financial, business, industrial, and
management risks. Rating of the account is being
8. Being the regulatory manufacturing MSE Unit, worked out under three dimensions such as Obligor,
guarantee cover of INR 6.25 Mn is available Facility and Composite rating to determine
under CGTMSE Scheme besides bank’s charge investment grade and also to charge rate of interest.
on primary securities. The assessment of financial risk includes appraisal of
the financial strength of the customer based on
9. Firm has already acquired the land situated at performance & financial indicators. Non financial
D-2, Industrial Area, Sitapura, Distt- Jaipur parameters are also being considered in person
admeasuring 2110.50 sq. mtrs standing in the appraisal and credit scores of the credit information
name of M/s Hindustan Industries through its bureau / companies are also given due weight age in
proprietor taken on 90 years lease from RIICO, appraisal of credit business. Credit risk arising from
Jaipur lending business in banks is therefore, two sides of a
coin and bankers should never deter from financing.
10. Firm has already constructed the building on it Banks need to strengthen their credit risk assessment
and had commenced its operation of mechanism and appraisal process for qualitative
manufacturing of batteries from May 2012. Also growth in credit and also to mitigate risks effectively.
orders of proposed machines have been placed so
that their supply could take place in time.
 
References
[1] Gombola, M. J, and Ketz, J. E., 1983, A note on
11. All necessary approvals & licenses/ registration
cash flow and classification patterns of financial
have already obtained by the firm to run the unit
ratios, The Accounting review LVIII, 105-14
successfully.
[2] Hsiu-Kwang W. (1969), “Bank Examiner
Criticisms, Bank Loan Defaults, and Bank Loan
12. Project has been assessed from financial point of
Quality” The Journal of Finance, Vol. 24,
view and repayment capacity gauged in terms of
September, 697-705.
DSCR & ICR of the project assessed over the
[3] I.M.F (International Monetary Fund) (1997),
bank’s norms of average DSCR of 1.75 (not
“Banking Soundness and Monetary Policy in a
below 1.25 in individual year) and ICR of 5
World of Global CapitalFlows", Proceedings of
times thus proposal is financial and
the Seventh Central Banking Seminar, Jan. 27-31
economically viable.
Washington D.C.
[4] Martin Omara – Credit assessment process and
13. Minimum margin towards working capital and
repayment of bank loans in Barclays Bank
capital goods to be kept at least 25%. Also
Uganda Ltd, A research report submitted to
SMELH to observed policy guidelines of the
Makerere University Business School (MUBS)
bank for working capital financé to SMEs.
in Partial fulfillment of the requirements for the
award of a degree of Masters of Business
14. Rate of Interest would be @ 3.25% over
Administration (MBA) of Makerere University,
Base Rate i.e.13.50 % p.a. at present with monthly
June, 2007
rest subject to change in Base Rate and MSME Score
[5] Nancy Arora – ‘Credit Appraisal Process of SBI
– A Case Study of Branch of SBI in Hissar’ :

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Volume 2, No.7, July 2013                                                                                                                                 
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Arth Prabhand: A Journal of Economics and Working Paper 4785 on “Bank Financing for
Management, Vol.2 Issue 1, January 2013, ISSN SMEs around the World Drivers, Obstacles,
2278‐0629 Business Models and Lending Practices; The
[6] Sathya Varathan & others- ‘Credit policy and World Bank, Development Research Group,
credit appraisal of Canara bank using ratio Finance and Private Sector Team, November
analysis’ - International Multidisciplinary 2008
Research Journal 2012, 2(7):19-28, ISSN: 2231- [10] Yadav Ram Jass (Dr) – Issues in SME
6302 Financing, Macro Research Project, Indian
[7] SIDBI Report on MSME Sector – 2010. Extract Institute of Banking & Finance, Mumbai, June
of studies / survey on Contemporary studies 2012
taking 200 MSMEs (42 Micro, 114 Small & 44 [11] Yadav Ram Jass (Dr) – MSME Finance :
Medium Enterprises) into its sample from all Viability study from Bankers’ perspective,
over India. International Journal of Advanced Research in
[8] Sun, J., & Li, H, (2008).Data mining method for Management and Social Sciences ISSN: 2278-
listed companies’ financial distress prediction. 6236 Vol. 1 | No. 1 | July 2012 www.garph.co.uk
Knowledge-Based Systems, 21(1), 1–5. IJARMSS | 50
[9] Thorsten Beck, Asli Demirgüç-Kunt,María
Soledad Martínez Pería, Policy Research

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Journal of Business Management & Social Sciences Research (JBM&SSR)          ISSN No: 2319‐5614   
Volume 2, No.7, July 2013                                                                                                                                 
_________________________________________________________________________________
 
Credit Appraisal Process Appendix -1
1. Generating Business Leads

2. Receipt of application from applicant

3. Receipt of documents (Balance sheet, KYC papers, Different govt.


registration no., MOA, AOA, and Properties documents)

4. Due diligence of Loan Arranger & customer

5. Pre- sanction visit by bank officers

6. Check for RBI defaulters list willful defaulters list CIBIL data, ECGC
caution list etc.

7. Title clearance reports of the properties to be obtained from empanelled


advocates

8. Valuation reports of the properties to be obtained from empanelled valuer


/engineers

9. Activity & Industry Analysis –Viability assessment

10. Verify authenticity of Financial statement from various sources –


MCA21, diligence report etc.

11. Preparation of financial data (CMA Data)

12. Risk Assessment – Credit Rating

13. Proposal preparation (MCB Note)

14. Assessment of Limit – Quantum of loan

15. Sanction / approval of proposal by appropriate sanctioning authority –


Also PSR note

16. Documentations, agreements, mortgages

17. Disbursement of loan

18. Post sanction activities such as receiving stock statements, review of


accounts, renew of accounts, etc
Synopsis Of Balance Sheet Appendix-2

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Journal of Business Management & Social Sciences Research (JBM&SSR)          ISSN No: 2319‐5614   
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(INR in Mn)
Particulars 31.03.13 31.03.14
Estimated Projected
Period (months) 11 12
Paid up Capital - Firm’s Capital 9.26 9.37
Reserves & Surplus (Excl. Revaluation reserves and net 0.35 0.27
of intangible assets)
Tangible Net worth 9.61 9.64
Term Liabilities of which. Unsecured loan 6.50 5.78
Capital Employed 16.11 15.42
Net Block 14.41 13.54
Current Assets 5.42 6.04
Current Liabilities 3.71 4.16
b) Operational Data
Net Sales 10.61 21.21
Manufacturing expenses 9.27 17.05
Adm. & Selling expenses 0.52 1.06
Depreciation 0.25 1.57
Interest 0.21 1.25
Profit before tax 0.36 0.28
Net Profit After Tax 0.35 0.27
Profitability Ratio
Net Profit/Sales (%) 3.30 1.27
NP/capital employed (%) 2.17 1.75
PAT/TNW (%) 3.64 2.80
Current Ratio 1.46 1.45
DE Ratio (TTL / TNW) 0.68 0.60
  DE Ratio (TOL / TNW) 1.06 1.03
 
Profitability and Repayment Trend of Term Loan
                      (INR in Mn) 
Year 31st March 2014 2015 2016 2017 2018 2019 2020
PAT 0.27 0.76 1.33 1.72 2.23 2.73 3.13
Depreciation 1.57 1.41 1.26 1.23 1.12 1.00 1.00
Interest on T/L 0.87 0.81 0.72 0.60 0.45 0.30 0.15
T/L installments 0.50 0.72 0.96 1.20 1.20 1.20 1.22
  3. To list various items of due diligence while
Suggestive Notes for the Case appraising the borrower and proposal
4. To get acquaintance of methods of lending for
Administrator in Class working capital finance prevailing in the Bank
Trainees should be given adequate time to thoroughly and based on the understanding of methods need
read the case with basic objectives – based working capital limit to be worked out for
1. To be aware of the flow of credit appraisal and funding
various parameters associated with the credit risk 5. To know various norms of term lending such as
assessment. margin, verification of project cost envisaged in
2. To understand modalities how the credit risk the proposal, important factors to be kept in
assessment module (RAM) functions in the mind during pre-sanction visit of the site.
Bankto determine investment grade of the 6. To recommend ways for making the credit risk
proposal and also to ascertain pricing (ROI) in assessment & appraisal more effective at
account operating units of the branches. 

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