Project Report on Processing of Loans and Ways to Minimize Non Performing Assets Submitted To


By: Rahul Singh (MMS)


We wish to take this opportunity to thank all those that have gone out of their way and helped us in ways more than we could have ever expected in completing this project. Though the list is endless, we would particularly like to express our gratitude towards our Project guide Professor S. Ganga for her critical but helpful comments and suggestions that have gone long way to make this study possible. The errors, if any, are the sole

responsibility of mine.



This is to certify that the study presented by Rahul Singh to Thakur Institute of Management Studies and Research, Mumbai, in part completion of Masters in Management Studies under Processing of Loans and Ways to Minimize Non Performing Assets has been done under my guidance in the year 2007-09.


The Project is in the nature of original work that has not so far been submitted for any other course in this institute or any other institute. S. Signature of the Candidate Signature of the Guide Rahul Singh Prof. Reference of work and relative sources of information have been given at the end of the project. Ganga 5 .

to minimize the Non Performing Asset figure in its record. offer letter and so on and finally ends with the disbursement of the final amount. Hence with this study. banks provide advances for various purposes like Housing. But with the recent Subprime Crisis in the US. in fact banks are not only lending at PLR (Prime Lending Rate) but also at SubPLR (lower than PLR) to tap the customers and ensure the survival. Negotiation in repayment of loan etc. Setting up of new business and all those activities which are permitted under the law. . In today’s competitive world. the most daunting problem i. Lending is very crucial to increase the revenue of a bank. it goes through various processes like field verification. But after the payment of advances.e. formation of RBI. acceptance and adherence to the Basel norms and so on. legal verification. which may help banks to keep a check on the increasing level of its NPAs. 2002. and it has crossed several phases like Nationalization. Vehicle. Banks are using various measures such as Active usage of SARFEASI Act. valuation of property. Credit Risk crops up in the picture.Executive Summary The history of Indian Banking Industry dates back to 1786. Sanctioning of loan does not happen just by filling up of the application of the form. followed by the worldwide meltdown has resulted in increase in level of NPAs of all the banks in the country and the situation is further expected to worsen in coming one or two years. some important suggestions have been given.

…23 Method of Assessment.....32 Nature of Facilities and Fixing of Credit Limit………………44 .……10 Chapter 4 Funding of Working Capital Working Capital. …………………8 Chapter 3 Lending Procedure……………….Turnover & MPFB System………..20 Management of Working Capital………………………. …………………2 Chapter 2 Basic Principles of Lending…….…….... ……………………......Meaning.…….. ………………………….INDEX Chapter 1 Overview of Banking Sector ………...27 Appraisal of Credit Proposal………………………………...……...

Chapter 5 Credit Risk in Bank…...53 Chapter 6 Non Performing AssetsFactors Affecting NPA………………….….…………..68 . ……………………………………….63 Steps Taken to reduce NPAs…………………………………63 SARFEASI ACT…………………………………………...66 Meaning……………………………..61 Bibliography……………………………………… . …………………..65 Suggestions for Reducing NPAs in India………………......

3 per cent of all ATMs. the RBI bill was introduced in the Parliament to give public .640 branches or offices. Taking into account all banks in India. The Reserve Bank of India was constituted as shareholder’s bank in 1935 and is now the Central Bank of the country. The Bank Of Bengal in the year 1809.356 employees and 27. A Glance at Development of the Banking Industry: History of Indian Banking Phase I The establishment of the General Bank of India in the year 1786 marked the development of a structured banking system in India. 893. Furthermore. The East India company established three banks. The Bank Of Bombay in 1840 and Bank Of Madras in 1843. Public sector banks made up a large chunk of the infrastructure. a report "Opportunities in Indian Banking Sector".3 per cent till 2011. The three banks were amalgamated in the year 1920 to form the New Imperial Bank of India. Later the bank of Hindustan and Bengal Bank came into existence. there are overall 56. having weathered the global economic slowdown and showing good numbers with strong support flowing in from the Reserve Bank of India (RBI) measures.088 ATMs. with 87.7 per cent of all offices.Overview of Indian Banking Sector: The Indian banking industry is currently termed as strong. The Imperial bank was nationalized and was renamed as State Bank of India with the passing of the State Bank of India Act 1955. It was set up as a joint stock company. forecasts that the Indian banking sector will grow at a healthy compound annual growth rate (CAGR) of around 23. After independence. 82 per cent of staff and 60. RNCOS. by market research company. According to a study by Dun & Bradstreet (an international research body)—"India's Top Banks 2008"—there has been a significant growth in the banking infrastructure.

As a result profitability and competition took a back seat. Objectives of Nationalization: • • • • Class banking to Mass Banking Reach out to unbanked areas Growth in deposit mobilization. United Commercial Bank Ltd 4. Central Bank of India Ltd 8. it has been operating as a state owned bank and state managed central bank. Further this credit facility was supposed to be extended at subsidized rates i. It exercises the power to control the Indian Banking Industry Phase II Nationalization: The major aim for nationalization was to give priority to meet the credit requirement of the neglected sectors. Canara Bank Ltd 7. 1949. The Allahabad Bank Ltd 2. Punjab National Bank Ltd 12. Bank of Maharashtra Ltd 6. deposit mobilization. Indian Overseas Bank Ltd 11. Dena Bank Ltd 9. Credit disbursals Loan portfolio to sectors identified as priority sectors Nationalization of 14 major banks in 1969: 1. Indian Bank Ltd 10. Since January 1. The Bank of Baroda Ltd 3. credit disbursals and employment. The Bank of India Ltd 5. Wholesale Banking paved the way for retail banking resulting in an all round growth in the branch network.ownership to the bank. Union Bank of India Ltd 14. United Bank of India Ltd The nationalization of six more banks took place in 1980 . Syndicate Bank Ltd 13.e rate of interest were to be lower than those charged to larger business units.

3.2.753 crores in 1992. banks are categorized in to 3 major types. The Andhra Bank Ltd Corporation Bank Ltd The new bank of India The Oriental Bank of commerce Ltd The Punjab & Sindh Bank Ltd Vijaya Bank Ltd Impact of Nationalization: The aggregate deposits of the banks increased from Rs. Categorization of Banks In India. State bank of India and associate banks – 08 . The quality of credit assets deteriorated as the sanctioning process became more mechanical instead of in-depth credit assessment. second is private banks and third is foreign banks. Banks in India Nationalized Banks Banks Private Banks Foreign Nationalized Banks: There are in total 27 nationalized banks in the country. 4.669 crores in 1969 to Rs. 5. 4. 6.Other Nationalized banks – 19 .33. Tremendous growth in the agricultural loans took place.1. 2. One is nationalized banks.

The foreign banks have brought with them the latest technology and latest banking practices in India. The latest banking reforms have got many things for the foreign banks to establish themselves in the Indian banking sector and become a major player and reap the benefits by capitalizing on the opportunities lying in this sector.. They have made Indian Banking system more competitive and efficient. Government has come up with a road map for expansion of foreign banks in India. ABN AMRO Bank American Express Bank BNP Paribas Citibank DBS Bank Deutsche Bank HSBC Bank Standard Chartered Bank Abu Dhabi Commercial Bank China Trust Commercial Bank Scotia Bank and many more. Some of them are ICICI Bank HDFC Bank Kotak Mahindra Bank IDBI Bank IndusInd Bank ING Vysya Bank Jammu & Kashmir Bank Karnataka Bank Kotak Mahindra Bank Foreign Banks: There are in total 40 foreign banks operating in our country. Few of them are…. .Private sector Banks: There are in total 30 Private sector banks in our country.

mortgages and investment services are expected to be strong. vehicle and personal loans. Fund Based Products: . This is the first time an investor has been allowed to hold more than 5% in a private sector bank since the RBI announced norms in 2005 that any stake exceeding 5% in the private sector banks would need to be vetted by them. In recent years critics have charged that the non-government owned banks are too aggressive in their loan recovery efforts in connection with housing. with minimal pressure from the government. Indian banks are considered to have clean. especially retail banking. banking in India is generally fairly mature in terms of supply.Currently. The stated policy of the Bank on the Indian Rupee is to manage volatility but without any fixed exchange rate-and this has mostly been true. There are press reports that the banks' loan recovery efforts have driven defaulting borrowers to suicide. The Reserve Bank of India is an autonomous body. takeovers. With the growth in the Indian economy expected to be strong for quite some time-especially in its services sector-the demand for banking services. In March 2006. product range and reach-even though reach in rural India still remains a challenge for the private sector and foreign banks. Functions Performed by Banks:      Accepting Deposits Fund Based and Non Fund Based Activities Transaction Banking Services Investment Banking Advisory Authorized Dealers Now we’ll be concentrating more on the Advance Part of Fund based activities in detail. One may also expect M&As. strong and transparent balance sheets relative to other banks in comparable economies in its region. the Reserve Bank of India allowed Warburg Pincus to increase its stake in Kotak Mahindra Bank (a private sector bank) to 10%. and asset sales. In terms of quality of assets and capital adequacy.

Cash Credit Bill Finance Loans/ Advances Overdraft Term Finance Retail Finance Different Types of Loans Available: Now a days. are providing financial support in almost all the areas possible ranging from Housing Finance to crop finance. The most common advance products available are Car Finance Two Wheeler Loan Housing Loan Personal Loan Commercial Vehicle Loan Loan against Property       . banks. in order to enhance the topline of the business.

which impacted the whole world’s economy. For a defined purpose. BASIC PRINCIPLES OF LENDING Objectives of Lending The basic objectives of lending are to grant credit facilities to the entities: i. Commercial Loan  Loan for Starting up of New Venture  Farm Equipment and Many more Lending is very important for bank in order to increase their business but at the same time it is very crucial decision as it may have adverse impact on the bank and lead to collapse due to the growing concern of increase in NPAs as was witnessed in the US. .Subprime crisis.

business ethics. Basic Principles To achieve these objectives. Borrower The Borrower should have the means. antecedents. respectability and capacity of the borrower before allowing them any credit facilities and by keeping a close watch on their dealings and on the operations in their accounts during the period of advance. the Bank has to follow a prudent policy and conduct the business on the basis of sound principles of lending namely.ii. income generating potential. It is therefore imperative to make a thorough investigation into the means. Safety Safety of the funds lent has to be ensured with respect to: i. These depend on factors like tangible assets. To deploy the Bank’s resources in a profitable manner and to achieve the statutory and regulatory norms. dependability. These aspects are further elaborated below. character. Character . ii.Indicating the borrower’s honesty. Safety. ability and willingness to repay the advance along with interest as per the terms of finance. regularity. Liquidity and Profitability. operational efficiency and integrity of the borrower. the fact remains that banks are profit making institutions. reputation and promptness to keep . promise. Profitability Notwithstanding the socio-economic objectives of lending. They have to be run on commercial integrity.

the advances could also be secured by obtaining collateral securities. provide for contingencies and risky assets. build reserves and pay dividend to the shareholders. It is. iv.considerations to meet the expectations of the shareholders and ensure their healthy growth. Wherever necessary. it is essential that the loans and advances are recoverable in full on demand or within a reasonable period. . iii. Security Though repayment in the ordinary course must come out of the surplus from business of the borrower. The assets purchased out of the credit facilities are obviously the first to be taken. therefore. have a proper mix of credit portfolio which would earn sufficient income to enable it to defray the cost of funds. meet establishment and other expenses. Adequate tangible security ensures safety of advance. It is a safeguard against disposal/alienation of such securities. Matching of Assets and Liabilities is very critical from this point of view. therefore. necessary to ensure that the funds lent are backed by securities that are easily marketable and realisable. Liquidity As the funds lent mostly belong to the depositors and as the Bank should always be in a position to meet the demands of the depositors. Security serves as a cushion or comfort to fall back upon in the event on the borrower’s failure or default in the repayment of advance. the security aspect cannot be neglected. The Bank should.

let’s have a look at the procedure involved in the issuance of a loan by financial institutions. The look of an application form may differ from bank to bank. but nearly 80 per cent of the information they need is similar. Most of this is basically your personal and professional information. Step 1: Application form Step 2: Personal Discussion Step 3: Bank's Field Investigation Step 4: Credit appraisal by the bank and loan sanction Step 6: Submission of legal documents & legal check Step 7: Technical / Valuation check Step 8: Valuation Step 5: Offer Letter Step 9: Registration of property documents Step 10: Signing of agreements and submitting post-dated cheques Step 11: Disbursement Step 1: Application form: Filling up the application form is the first step. Documents to be Submitted : . details of your financial assets and liabilities.Procedure of Lending: Hence.

Financial check: All the income-related documents one submits like past Profit and Loss Account with the Balance Sheet and expected/ forecasted cash flow statement with Profit and Loss . every bank asks for several documents. number of offices. etc may be needed. number of employees. then a short summary about the nature of the company. profit. Identification proof: Same as above. last three months salary slips. Form 16/Form 16A. but with photograph. Sometimes. And most banks these days provide doorstep service. its main customers. so that the customers don’t have to spend time visiting their office to submit the documents. where the prospect is working is not well-known. Other documents that needed to with the application form include age proof. Age proof: Copy of school leaving certificate/Driving license/Passport/ration card/PAN card/Election Commission's card/etc. Usually.While submitting the application form. address proof and identification proof. Address proof: Similar documents need to be provided to prove that one is actually staying there currently. are accepted as age proof. turnover. Proof of income: This will need to be backed up by proof such as copies of last three years Income Tax returns (along with copies of Computation of Income/Annual accounts. However. if any). its competitors. the company profile that is available on the standard website of the company is enough. some banks still insist on the customer visiting their offices at least once. copies of the last 6 months statements of all your active bank accounts in which the salary/business income details are reflected. the same document if it contains a photograph. Customers may also be asked to give their employment details. etc. its business lines. Employment details: If company. the current residential address and the correct age can be the proof for all 3 things.

Some banks have zero upfront fee loans.500 to Rs 5. and it is advisable to negotiate hard to find out the bank's 's minimum possible fees though it is unlikely that a bank will agree to provide a loan without any upfront fee at all. but is usually around 0. Regular periodic payments the existence of periodic payments to other finance companies/banks etc. The agent dealing with you earns a commission from the bank. they will be visible in the bank statement and again.000 as processing fee.25% to 0. The lending institution uses them to study the customer’s financial status. indicate an existing liability and you will need to provide full details to the lender. but that advantage may be negated as their other charges such as legal charges and 'stamp duty are normally higher. This fee varies from bank to bank. Customer’s Investments also come under the scanner. This helps the bank to estimate your ability to pay the down payment as well as your savings habit. Average bank balance a cursory glance at the average bank balances maintained in a savings bank account speaks volumes about the spending/saving habits of any individual. you will have to pay around Rs 2. The bank statements submitted are scrutinized for: Level of activity in the case of self-employed persons. Most banks have flexible fee structures. For instance. Cheque returns a small charge debited by the bank in the statement indicates that a cheque issued by the customer was returned by the bank. this gives a very good clue about the extent of business activities. Many such cheque returns can have a negative impact in the process of loan sanction. banks have specific norms as to how many such returns are acceptable in a period of one year. which to some extent is also affected by the amount of fees paid by you. . Cheque bounces if cheques deposited by customer are returned by the issuer's bank.and Balance Sheet which serve a specific purpose. Processing Fee Along with the application form and the credit documents. if you take a loan of Rs 10 lakh.50% of the total loan amount. banks ask for a processing fee.

banks are forced to undertake validation in the absence of any credit bureau. one has to wait till the home finance institution evaluates the documents submitted. The wait normally lasts only a day or two or sometimes even less. Once the credentials are validated. etc. And however eager a bank is to complete its targets. Step 3: Field Investigation: Thousands of people apply for loans everyday.This fee is collected to maintain the loan account. every loan is a risk. Step 4 : Credit appraisal And Loan Sanction: This is the make-or-break stage. it is only natural that it confirms or validates the details you provide. and before the loan sanction. some banks insist on meeting the applicant after receiving the application form. it helps establish trust between the two. The bank checks all your information including existing residential address. This is to gather more details that may not be mentioned in the application form and to reassure them of the applicant’s repayment capacity. However. If the bank is not convinced about the . and includes work like sending Income Tax certificates every year. this stage is insisted upon only in very few cases these days. Step 2: Personal Discussion After formally and successfully completing the application process. While this may sound irritating and an invasion of your privacy. place of employment. Even the references provided in the application form are checked out. employer credentials (if the applicant works for a small organization). So. Again. maintaining post-dated cheques. Representatives are sent to workplace or residence to verify the details. residence and work telephone numbers.

These normally include: The title documents of your seller. and the final loan amount is communicated. or it may ask for a further set of . works out the maximum loan eligibility. employer. the application may get rejected. etc. age. which prove the seller\'s title including the chain of title documents if he is not the first owner NOCs from the legal owners such as cooperative housing societies. Legal Check: Every bank conducts a legal check on the documents to validate their authenticity. This letter máy either be an unconditional letter. the lessor of the land in the case of leasehold land. nature of business (if self employed). or may have certain terms and conditions mentioned. Step 5: Submission of Legal Documents( Applicable for Property Loans): Now. The bank then issues a sanction letter.credentials. Once the property is selected. The bank or the home financier establishes the applicant’s repayment capacity based on his/her income. The documents are sent to a lawyer in their panel (either in-house or outsourced) for a thorough scrutiny. the focus of the bank's activities shifts from the applicant to the property he/she intend to buy. one needs to hand over the entire set of original documents pertaining to the property to the bank so that it can keep them as security for the loan amount given. If it is satisfied. etc. The lawyer's report either gives a go-ahead if documents are clear. and based on these. qualifications. Even the draft sale documents that the applicant will be entering into with his/ her seller will be scrutinized. NOCs are not required where the property is situated on freehold land and the entire land is being transferred along with the structure. experience. statutory development authorities. it sanctions the loan. These documents remain in the bank's custody until the loan is fully repaid. which have to fulfill before the loan disbursal.

The builder has the requisite certificates to start construction at the site. Layout of flats and area of property is within permissions granted by the governing authority. In the latter case. you are expected to hand over the additional documents to the bank for a clear title. This expert could either be a bank employee or he could belong to a firm of architects or civil engineers. Step 6: Technical/ Valuation Check: Banks are extremely careful about the property they plan to finance.documents. . Quality of construction Satisfactory progress of work. Site Visit: the The site visits to your property are conducted to verify following: In case of under construction property • • • • • • Stage of construction is the same as that mentioned in the payment notice given to you by the builder. They send an expert to visit the premises you intend to purchase. Valuation of the property in relation to other deals in the surrounding areas.

In case of ready/resale : • • • External / internal maintenance of the property. The age of the building. Will the building last the loan tenure? This has a direct bearing on your loan eligibility, since the loan tenure will be restricted to the maximum age of the property as decided by the bank's engineer and this will impact your loan eligibility. Quality of construction. Surrounding area (development). Whether the builder has received the requisite certificates for handing over possession of the flat. There is no existing lien or mortgage on the property. Valuation of the property in relation to other deals in the surrounding areas.

• • • • •

These inspections are carried out to protect consumer interests in terms of construction quality, adherence to local laws, approved building plans, etc. A technical inspection also lets the bank understand the progress of construction so as to release the staggered disbursements.

Step 7: Valuation: Since housing loans are cheaper than other loans, there have been cases where individuals have shown purchase of properties from related entities at inflated prices to obtain cheap loans. Since the risk associated with diversion of funds is higher than if the loan was used for genuine purposes, banks carry out an independent valuation to find out whether the transaction is in line with the existing market price of the area. Valuation has become a key parameter in determining the loan amount that can be sanctioned by the bank. The valuation process is quite subjective and depends on the quality and ability of the person sent by the bank for valuation. Valuation of real estate as a profession is still in its infancy in India and is still non-standardized. In many cases, the valuer determines the value of the property at an amount that is lower than the documented cost of the property and this would result in the loan amount being lower, since the bank funds a certain

percentage of the cost or valuation of the property, whichever is lower. This practice has led to severe consumer issues in an increasing number of cases, as the valuation is normally done only after the consumer takes a sanction (by paying a fee) and after identifying and committing to buy the property. The valuation issue rarely arises when a property is purchased through a reputed builder directly or if the property is pre approved. In both the cases, the banks would have already completed the valuation and therefore, you can safely assume that there is no difference between the documented cost of the property and the bank's valuation amount.

Step 8: Offer Letter: Once the loan is sanctioned, the banks sends an offer letter mentioning the following details: • • • • • • • • Loan amount Rate of Interest Whether fixed or variable rate oæ interest linked to a reference rate Tenure of the loan Mode of repayment If the loan is under some special scheme, then the details of the scheme General terms and conditions of the loan Special conditions, if any

Acceptance Copy: If the applicant agrees with what is mentioned in the offer letter from the bank, he/she will have to sign a duplicate letter of the same for the bank's records. Earlier, banks used to charge administrative fees along with the offer letter. However, with rising competition, administrative fees have virtually disappeared from the home loan market.

Step 9: Registration of property documents:

After the legal and technical / valuation check, the draft documents as cleared by the lawyer need to be finalised and signed and the stamping and registration of the documents need to be done. Also, if any NOCs are pending, these need to be obtained in the format approved by the bank's lawyer.

Step 10: Signing of agreements and submitting post-dated cheques: All borrowers need to sign the home loan agreement and need to submit post-dated cheques for the first 36 months (if that is the agreed mode of repayment). The original property documents have to be handed over to the bank at this stage. Some banks also create a document recording the handing over of the property documents to them as security for the due repayment of the home loan. This document is also called a memorandum of entry and attracts significant stamp duty depending on the amount of the loan in some states. The stamp duty payable on such a memorandum is naturally recovered from Not all banks create this memorandum and hence the stamp duty may or may not be payable, depending on the practice of the specific bank. However, even where no such memorandum of entry is created, the state government concerned may, in the future, demand a stamp duty on the loan transaction, which naturally is recoverable from the applicant as per the home loan agreement signed by the parties involved. Step 11: Disbursement: After the bank has ensured that the property is legally and technically clear, all the original documents pertaining to transfer of ownership of property in your favor have been submitted and all the necessary loan agreements have been executed, finally, it is payment time! The applicant will now actually receive the cheque and along with that one also need to submit documents to prove that he/she has paid his/her personal contribution towards the property, since

banks normally finance only up to 85-90 per cent of the total cost of the house. In case the applicant is expecting money from other sources to fund his/ her contribution, he/she need to provide sufficient evidence for the same. It is only after submitting this proof that the bank will release part-disbursement of the loan. The cheque will be in the name of the reseller (for resale flats), builder, society or the development authority. It is only in exceptional circumstances, that is, if the applicant provides documents to support that he/she has made an excess payment then only the cheque will be handed over to the applicant directly by the bank.

Disbursement in Stages: Usually, loans are disbursed on the basis of the stage of construction of the property. So, in case of resale or ready possession properties, the disbursement is full and final. However, in case of under-construction properties, the payment is made in parts, also known as part-disbursement. Each option would have different disbursement processes. Part disbursement: When a loan is partly disbursed, the bank does not start EMIs immediately, since it is calculated on the total loan amount at a particular rate of interest and for a given tenure. Moreover, it normally does not start breaking up the installments into its principal and interest components until the entire loan amount is disbursed. To overcome this difficulty, banks charge simple interest on the partly disbursed loan amount. For instance, if you have a sanctioned loan of Rs10 lakh, but the property is under construction and the bank has disbursed only Rs4 lakh, you will be charged a simple interest only on the disbursed amount. This process continues until the final disbursement takes place. The simple interest paid is called Pre-EMI interest or PEMI. At this stage, banks may take only around three to six post-dated cheques on account of PEMI.

he/she need to submit a letter letter from the employer accepting this arrangement and directly remitting the amount to the bank every month. therefore. 24 or 36 months as the case may be. to be handed over to the bank after the transfer takes place. he/she in turn is expected to hand it over to the reseller or the builder and should get a receipt from them for the payment and hand it back to the bank. Banks usually ask for 12. Some banks allow the monthly installments to be paid by convenient ECS facility. 24 or 36 PDCs (Post Dated Chques). Payment receipt: Once the bank hands over the pay order to the borrower. Repayment The loan is generally repaid by equated monthly installments. Some banks may also insist on a cheque for an amount equivalent to the loan outstanding at the end of PDC period to ensure timely replenishment of PDCs for the next 12. using post-dated cheques. Share certificates: In case the property is part of a society.Full and final disbursement: If it is a ready-possession property. In case the installments are to be deducted against the borrower’s salary. after which the customer need to repeat the process until the entire loan has been repaid. the bank disburses the entire loan amount in favor of either the reseller or the builder. This normally happens at the first AGM/EGM after the sale transaction. The transferred share certificate also happens to be a part of the mortgage documentation and has. Another possible mode of payment is by cash or demand draft . Some banks allow to give standing instructions to the bank to deduct money each month crediting the borrower’s home loan account. the customer will need to get the flat transferred in his/ her name by asking the society to issue the share certificate in his/ her name and recording the transfer of ownership in their books. as it will become part of the borrower’s mortgage documentation.

However. At this stage. One should also ask the bank for a No-Objection Certificate saying the account has been cleared. Loan pre-closure/satisfaction The customer also has the option of completely repaying the loan at any time. he/she must ensure that the entire set of original property documents are taken back. Until recently. you may discover that the original documents have yet not been received by the bank from the registrar. in some cases. After one has completely repaid the entire loan. As an option. Most banks levy a prepayment charge if one makes the full repayment and ask for release of the property documents. most banks have an upper limit on the number of times a person can prepay his loan in a year as well as on the minimum amount that can be prepaid each time. when it is only partly disbursed. It can also be prepaid. the loan will get completely paid off on the expiry of the tenure of the loan if one has paid all your installments on time. the bank will issue a separate letter for each of the guarantors stating that their liability has come to an end. If the borrower has guarantors. each bank has its conditions for preclosure.(not all banks offer this). the customer needs to follow up with the registrar and get the documents from them directly by . Also. the bank may issue a consent letter stating that the property is now free from mortgage. banks charged a penalty for part or full prepayment. Prepayment The borrowerr can prepay a loan either in part or in full at any given point of time. One can also deposit the EMI every month at the bank's office. In such cases. Of course. But increased competition has forced most banks to allow partial prepayment at nil charge.

Sometimes (and we must stress only sometimes) the bank may misplace the original property documents leading to avoidable stress. Remember that receipt will come in very useful when the loan is fully paid off. Hence the importance of insisting on a proper receipt of title documents while handing them over to the bank. the bank may claim that these documents were never given to them at all. In fact. . Also.showing them a copy of the bank's clearance certificate. it is extremely useful when one wants to shift the loan to a new lender.

these fixed assets They have to be run / would not produce / earn anything. Working Capital represents the money that is required for purchase / stocking of raw materials. Operating Cycle or Working Capital Cycle Working capital cycle of a manufacturing activity starts with the acquisition of the raw materials / stores & spares and ends with realisation of cash for finished goods. plant & machinery. Fixed Capital is utilized for acquiring the fixed assets such as land. wages. payment of salary.. the steps involved in the processing of a loan. fixed capital and working capital. viz. power charges etc.. . etc. and to meet capital expenditure connected with the setting to keep the wheels moving up of the industry or Concern. In worked for production. What is Working Capital: For running an industry or a Concern.. working capital. building. But by themselves.After having seen. The cycle is long in some cases and short in other cases depending upon the nature of business. two types of capital are required viz. In other words. This requires enough liquid sources. let’s us understand the main issues involved in the issuance of loan to meet the Working Capital Requirement. Working Capital Finance is the fund required to meet the cost involved during the working capital cycle or operating cycle. and also for financing the gap between the supply of goods and the receipt of payment thereafter.

In respect of trading concerns. The working capital cycle is illustrated as follows: Cash/Sundry Creditors Sundry Debtors Raw Materials / Stores & Spares Sales Stock-in-Process Finished Goods . Working capital cycle comprises of purchase of raw materials either in cash or credit basis.manufacturing units. operating cycle represents the period involved from the time the goods and services are procured and the same are sold and realized. converting raw materials into stock in process and then into finished goods and transformation of finished goods into book debts / cash.

eggs. inventory (consisting of raw materials. finished goods) and receivables. timber. Cycle is long in the case of tobacco. the working capital cycle of a manufacturing activity starts with the acquisition of raw materials and ends with realization of cash for finished goods. The cycle is long in some cases and short in others. the stocking of raw materials may be equivalent to one or three months’ raw materials consumption for most industries. These require . etc. Cycle is fast in consumer goods industries and slow in capital goods industries. fruits. Seasonal industries like manufacturers of umbrella. woollen fabrics. During the cycle. Thus. The conversion of raw materials into finished goods depends upon the technical requirements and manufacturing facilities available. the duration of each stage of process cycle is first decided upon having regard to the function it is supposed to perform... etc.The total working capital requirements for Industrial Units will depend upon the holding period of assets and the operation of the cycle. funds are blocked in various stages of current assets. fans. Thus. depending upon the nature of business. refrigerators. viz. beverages. Cycle is short in case of perishables such as food articles. fish. bills or cash could be related to factors like delivery schedule. etc. steel. As regards the operating cycle. Similarly. but say nil for a sugar mill. require higher stocks in some months and bare minimum in remaining months. distilling. stock in process. cash itself. business customs and competition. the turnover of finished products and their transformation into book debts.

current liabilities and Net working capital. Working capital cycle vary from industry to industry depending upon its nature of business. Factors which affect working capital cycle are: 1) Policy of the management on production and sales 2) Inventory management/ Receivables management 3) Nature of manufacturing activity/process 4) Policy of extending credit for purchases as well as sales 5) Government policy 6) Type of product The above factors are only illustrative and not exhaustive. Stagnation in any area effects turnover and profitability. liquid assets or floating assets. the less is the turnover. They change their form every now and then and ultimately are converted into MANAGEMENT OF WORKING CAPITAL Management of working capital Management of working capital involves management of current assets. Quicker the cycle more is the turnover normally and longer the cycle. Current Assets Current Assets are convertible assets. Current assets are such assets which are reasonably expected to be realised into cash within a . Finance involves costs.

It is a common banking practice that a business can not be granted bank credit. stores. The quantum and period. Cash and Bank Balance tied to or earmarked for long term use. Such part of the Cash and Bank Balances should be shown under Other Non-Current Assets. Holding of Cash or Bank Balances (or marketable securities / investments) beyond the normal needs of business necessitates critical evaluation. burdens the business with unnecessary interest and costs on such borrowings. They indicate short-term deployment of funds and form Gross Working Capital. stock in process.period of 12 months. finished goods. for example for a future expansion / diversification programme or investment outside business. should be reasonable and related to the requirement. for which each current asset is held. Current Assets mainly consist of: 1) Cash and bank balance 2) Stock in trade consisting of raw materials. if it has surplus / idle . cash lying with it. and 6) Other loans and advances. should be excluded from Current Assets. etc. Any asset held in excess. packing materials' 3) Book debts: including bills purchased & discounting (only upto 180 days) 4) Investments (Short term) 5) Cash margin from non fund based limit (L/C / guarantee) may be treated as a part of current assets.

which are considered realizable. The period of holding of each item should conform to its demand and supply position in the market. should be shown under Intangible Assets.e. The basis of valuation of each item of inventory should be the invoice value / cost or market value. including Bills Purchased and Discounted outstanding within the normal credit period allowed by the firm or six months. Only those stores and spares. "Dead Inventory" i. should be considered as Current Assets.Book Debts. slow moving or obsolete items should be excluded. or because the debtors are not financially sound and can not pay in the foreseeable future etc. . should be treated as Current Assets – Receivables. unless full provision has been made for them in the accounts. Machinery stores (with exception of certain items like consumable injection moulds etc. whichever is lower. The quality of stocks should satisfy the requirements of a good security. production requirements and ordering time. Debts which have doubtful realisability because of quality control disputes. The following items should not be treated as Current Assets and the same may be classified as Non-Current Assets. depressed market conditions. should be classified into Other Non-Current Assets. A break-up of the Receivables age-wise and party-wise may be quite informative. in some industries) should be a part of Other Non-Current Assets. Overdue debts. since these items are included in the capital cost. which are of consumable nature and are linked to the operating cycle. whichever is lower.

3) Sundry Creditors (for goods. Current Liabilities normally consists of: 1) Bank Borrowings for working capital 2) Other short term borrowings like Unsecured Loans. advances (machinery suppliers).) Working Capital Gap . They are normally raised for meeting the working capital needs and to acquire current assets. 6) Cash margin held for deferred payment guarantee Current Liabilities Current liabilities are short term liabilities which are repayable within a year. unclaimed dividend and provision for taxation etc. loans to directors / employees / partners. tools etc. Inter Corporate Deposits etc. Current liabilities are the main source of finance for working capital and are normally identified with the operating cycle of the business. machinery stores.1) Investments / loans to subsidiaries / associates (non-trade investments) 2) Other Investments (not marketable) 3) Overdue book debts (generally those more than six months old) 4) Deferred Receivables (maturity exceeding one year) 5) Others – fixed deposits with Government Departments. interest. expenses and others including advance payment against orders) 4) Term Loan / Debentures / Deferred Payments and Lease Rental instalments repayable within a period of one year 5) Statutory Liabilities (due within one year) 6) Other current liabilities and provisions (accrued expenses of wages.

. Current Ratio The ratio of current assets to current liabilities is known as Current Ratio. Banks do not grant advance to the full extent of working capital gap. It ensures continuous liquidity (current assets are prone to price fluctuations and should. Thus.This represents excess of current assets over current liabilities excluding bank borrowings. normally. have an in-built margin to absorb changes) and owner's stake in the current business operations. It is generally expected that the customer should meet about 25% of its Working Capital requirements or Current Asset from long term sources. It indicates the liquidity position whereby the capacity of unit to pay the creditors and short-term liabilities is determined. the current ratio should be minimum 1. Current Assets should be more than the Current Liabilities. The remaining portion of current assets which requires financing is called as working capital gap.33. therefore. It is always desirable rule that the borrower has to finance a part of working capital gap out of either capital or long term sources which reflects his continued commitment to the business that is necessary for the survival of the unit. A part of the Current Assets are financed by Current Liabilities (other than bank borrowings). It indicates the margin or long term sources provided by the borrower for financing a part of the current assets. Net Working Capital This represents excess of current assets over current liabilities (including bank finance). For successful operation of a business.

Thus banks are given greater operational freedom for dispensation of credit. and if there are current liabilities requiring urgent attention/payment. in April 1997. If a scrutiny of current assets reveals that they contain slow moving/non moving stock of raw materials. It is also essential that proper classification of current assets and current liabilities is ensured to arrive at need based permissible bank finance. Similarly. enunciated by Tandon Committee.The current ratio indicates only the quantitative coverage and by itself does not give any indication as to quality of current assets and current liabilities. work in process. METHODS OF ASSESMENT OF WORKING CAPITAL NEEDS Consistent with the policy of liberalization. based on MPBF. The adequacy of the ratio should. Consideration of factors such as valuation of stocks and guidelines on inventory. a certain fall in the price of materials would shrink the value of stocks thereby narrowing the margin of safety to creditors/banks. sundry debtors. even a high current ratio cannot be deemed adequate as liquidity may be affected. Banks are also free to evolve their own method of assessing working capital requirements of the . It is therefore always necessary to make an in depth study of the current ratio of the unit and not to take it at is face value. therefore be judged by examining the quality of the components of current assets and current liabilities. RBI withdrew the prescription in regard to assessment of working capital needs. borrowing and marketability of investments would substantially assist in determining the quality of the ratio. finished goods and non recoverable debtors.

Complacency and deteriorating management efficiency. book debts. Effects of excess supply . unhealthy speculation unwarranted expansion. which is not required for their normal operations. Working capital to business/industry is what blood is to human body. Diversion of funds.borrowers within the prudential guidelines and exposure norms already prescribed. business failure. frustration of the objective of enterprise. Short supply and excess supply will have adverse effects on the business. under utilization of men. Liberal Dividend Policy. The level of investment in an operating cycle depends upon changes in: 1) Terms of production and sales other factors remaining constant 2) The price of raw materials 3) Lead time for producing raw materials 4) The pattern of manufacturing expenses 5) The process time . Effects of short supply: It shall bring crunch in the working of the unit and thereby failure to utilize the created capacities which result in short fall in production. etc. machinery and management. extravagance. materials. short fall in sales.Builds up huge inventory. However the banks continue to adhere to various guidelines under Credit Monitoring Arrangement (CMA) for sanction of credit proposals and classification of current assets and liabilities as they still hold good and valid. inability to accept attractive opportunities etc.

merchants. Assessment of working capital shall normally based on the following: 1) Production / Processing cycle of the industry 2) Size of the business and quantum of working capital requirements 3) Financial and managerial capability of the borrower and the various parameters relating to the borrower. 4) Prevailing mandatory instructions of RBI 5) The trade and industry practice prevailing and other objective factors Assessment of the Working Capital requirement of a borrower shall generally be made under any one of the following three methods: 1) Turnover method (P R Nayak Committee recommendation) 2) Maximum Permissible Bank Finance (MPBF) (Tandon/Chore Committee recommendation) System Turnover Method Under this method working capital limit shall be computed at 20% of the projected gross sales turnover accepted by the bank. Under the turnover method bank should ensure that maintenance of minimum margin on the projected annual sales turnover. This system is normally applicable to traders. Normally turnover value 25% of the estimated gross sales shall be computed as working capital requirements. of which 20% shall be provided by the bank and .6) Policy of extending credit (both on purchase as well as sales) etc. exporters who are not having a pre determined manufacturing / trading cycle.

Rs. However if the available net working capital (NWC) is more.50 lacs Minimum margin to be provided by the borrower 0. - .00 lacs (or lesser. availability of raw materials and other infrastructural facilities . whichever is higher) Bank finance 2.10.the balance 5% by way of promoter contribution towards margin money. in case NWC is higher) As the working capital requirement are linked to projected turnover. the actual drawals should be allowed on the basis of drawing power determined after deducting unpaid stocks. the same shall be reckoned for assessing the extent of bank finance and lower limit/s can be considered.25.00 lacs 25% of the above 2. The turnover method may be applied for sanction of fund based working capital to the borrowers requiring working capital facility upto Rs 500 lakhs from the banking system for SSI units. In case of a traders. Rs. In respect of a new unit projected turnover should be analysed with regard to installed capacity. installed capacity of the units. while bank finance could be assessed at 20% of the projected turnover. the orders on hand. power. Rs. reasonableness of the projected annual turnover of the applicant company should be analysed by keeping in view of past performance of the unit. Under this method current ratio would be 1. Example Projected accepted annual Gross Sales Turnover Rs.50 lacs (or NWC.

drawals may be allowed basing on actual drawing power after excluding unpaid stocks. Under Method II. . it is necessary to understand the erstwhile Second Method of Lending under Tandon Committee Recommendations. and the balance i. In addition to the above. while the credit limit can be sanctioned at 20% of the projected turnover. the borrower should bring in a minimum margin of 25% of all current assets from owned funds and long term liabilities.e 75% be financed by the Bank. the same may be sanctioned. If the credit requirement based on MPBF method is higher than the one assessed on projected turnover basis. if the assessed credit requirement is lower than the one assessed on projected turnover basis. subject to the borrower submitting the required details in support of the need/justification and the sanctioning authority is convinced / satisfied with the borrower requirements. The assessment of working capital credit limits should be done both as per projected turnover basis and traditional methods based on production/processing cycle (MPBF). background of the promoters etc. performance of the similar unit in the industry. The projected turnover / output value is the gross sales which include excise duty. say upto 3-4 months. any other short term / adhoc Working Capital facilities to meet the emergent needs of the borrowers and other seasonal imperfections can be considered by the sanctioning authority. On the other hand. MPBF System Before the MPBF Method is explained.marketability of the products. Such short term finance / adhoc facilities shall be permitted for short term.

Item c minus d 128 g. 128 lakhs the actual borrowing is Rs. Permissible Bank Finance 128 (Item f or g whichever is lower) i. Bank Borrowings – 200) f. The borrower is required to bring 25% of current assets. 200 lakhs resulting in excess borrowing of Rs. current assets and current liabilities for the next year are reckoned in accordance with the usually accepted approach of bank. Current Assets 370 Less: b. Equity.The example given below will illustrate this:Current Liabilities Credit for purchase Other current liabilities Bank borrowings discounted including bill Current Assets Raw materials Stock-in-process Finished goods Receivables including bill discounted 350 Other current assets 100 50 150 200 200 20 90 50 10 370 Method II a. Actual / projected net working capital 20 (total current assets – 370 minus total current liabilities – 350 incl. unsecured loans or long term borrowings. Current Liabilities other than Bank 150 Borrowings c. Minimum stipulated net working 92 capital i. This excess borrowing is required to be brought from the long term sources i. In absence of any support from the borrower. Working Capital Gap 220 d. Excess borrowings 72 (representing shortfall in net working capital – item d minus e) As per past practice.e 25% of Current Assets e. Against the MPBF of Rs. Item c minus e 200 h. Max. 72 lakhs. the deficit in long term sources may be treated as working capital Term Loan .e.

Based on Kannan Committee recommendations. ability to absorb the cost of carrying such inventory and comparison of the other similar units in the industry shall be relied upon to decide the required and acceptable level for being supported by the bank. . which shall represent a reasonable build up of current assets for being supported by bank finance.repayable by the borrower by installments to be fixed while sanctioning the next year's limits. The assessment of credit requirement of the borrower shall be made based on the total study of the borrower's business operations vis-à-vis the production/processing cycle of the industry. Projected level of inventory and receivables shall be examined in relation to the past trend and based on inter firm comparisons. RBI has allowed freedom to the banks to decide the holding levels of various components of current assets for financial support to ensure efficient functioning of the unit. The existing norms are only indicative level of inventory and borrower specific operational needs to hold projected level of inventory and reasonable thereof. The levels of inventory and receivables shall be based on industry trend and closely related market developments.

viability. Goods / commodities offered as prime security to the Bank should relate to the borrower’s line of business. is necessary. before the proposal is sanctioned / forwarded. godowns and business place/s and acquaint himself with the process of production and infrastructure available to the industrial unit and business condition of the borrower (in the case of traders) and correctly assess the requirements and financial implications involved. feasibility. the Appraising officer should try to understand the production process involved.. Following factors need to be evaluated: 1. If it is an entirely new project.APPRAISAL OF CREDIT PROPOSAL Proposals have to be examined from various angles of safety. the proposed installed capacity. all have to be taken into account. the raw materials required. the various stages of production. Appraising officers should visit the factory. national priority and repaying capacity of each borrower. A critical study of the financial statements. number of shifts to be worked. easy availability or otherwise of it. economic viability and bankability of the proposal. availability of other external economies etc. project report and other information submitted by the borrower . Every credit proposal shall be subjected to an objective appraisal as per the policy and procedural guidelines laid down from time to time to establish technical feasibility.

viii)If any clearance from the local government authority like Factories Inspector. including the terms and conditions proposed. before accepting such commodities Branch has to satisfy that borrower is having valid licence / permit.. . Advances on commodities covered under RBI Selective Credit Control should be governed by RBI directives issued from time to time. If it requires any licence / quota / permission. Wherever licence / permit is required to deal in certain commodities. Following guidelines should also be adhered to: v. The proposed line of activity should be legal and not prohibited. Pollution Control Board. Corporation / Panchayat etc. 5. Commodities satisfying the following qualities are generally acceptable for our advance: a) absence of wide fluctuations in price b) easy marketability c) free from the risk of early deterioration d) easy ascertainability of value 3. it should be ensured that it has been obtained. conform to the basic lending principles. The Government policies relevant to the industry should be found out. 4. Copies of licence / permit should be obtained.2. Electricity Board. The request of the borrower is assessed properly and the Credit Proposal. For Advances on commodities on which duty is not paid. is required the same should be got.. rules governing such good should be adhered strictly. Sanitation Department etc.

x. xvii. viii. forward contracts. xii. Study the off balance sheet item. xvi. vii. deferred payment liabilities. Profit & Loss Account and other financial statements are analysed properly. All relevant ratios are calculated. xiii. non credit items like contingent liabilities. Limits proposed are within the borrowing powers of the company. xiv. methods and as per the applicable norms and guidelines. complete and correct picture. Diversion of funds Auditors Comments on the balance sheet Assessment of credit requirements is carried out by using appropriate formats. Level of inventory holdings (past and projections) Trends in sales & Profitability Production capacity and use – past and projected Estimated working capital gap with reference to acceptable current assets xi. Reasons for major variations in the Balance Sheet and other relevant ratios have been ascertained and commented upon. The information / comments about the borrowers. guarantees offered. Items of Assets and Liabilities are classified properly and projections made are reasonable and realistic. xviii. xv.Bank’s credit policy and norms & guidelines of Reserve Bank of India / other regulatory authorities. Balance Sheet. pending claims. swaps etc and its impact in the case of crystallization. guarantors and the project given in the Proposal display a fair. ix. build-up of inventory/receivables/other . vi.

as also those of the co-obligants / guarantors at the time of sanction / renewal of limits. the branch should make an independent enquiry of the market value of the assets declared taking into account the nature of property. its market value. To ensure that the particulars relating to the assets declared are genuine. xx. Adequate and suitable collateral security may be obtained as warranted. However. Besides. for confirming the veracity of the declarations. branches should also call for IT/WT assessment orders wherever. branches should obtain the tax paid receipt or such other documentary evidence in the case of immoveable properties. This is more relevant in the case of immovable properties where the value of properties continue to appreciate and declaring the original purchase value gives a distorted picture. Computation of Net Worth For computing the outside networth and means branches should obtain the details of assets and liabilities of the proprietor / partners / directors etc. market value of similar properties etc. besides verifying the existence of such property. Norms and documents proposed are appropriate. the networth under WT Act is restrictive in nature and will not depict the correct picture of the value of the assets held by the assessee. Appropriate and adequate primary security is available for the advance. In such cases. etc. xxi.. location. .xix. such persons are assesses under IT/WT.

preferably at the time of renewal of the limits / review of the accounts. .Branches should verify and satisfy themselves every year. the assets declared . For this purpose. on an ongoing basis. so as to ensure that there is no erosion or dilution in the outside networth / means of the proprietor / partner / director / co-obligant / guarantor etc. branches should compare the latest declaration with the one earlier obtained form the borrower.

company deposits. intangible . d) Out of the above properties / assets i. existing borrowings. should be reduced to arrive at the net value of assets.. total value of self acquired immovable properties of each partner.e. etc. debentures.e.For computing the networth. investment in shares. b) Personal unencumbered immovable properties like self acquired property. the following guidelines should also be adhered to: A. cash deposits. if any. jewellery. if any accumulated losses. (a) to (c) deduct borrowings. Partnership & Joint Hindu Family (HUF) concerns a) Capital invested in the business by all the partners b) Undivided profits c) Total worth of individual partners i. assets. B. share in the ancestral property acquired on division of Joint Hindu Family as per Hindu Succession Act / Indian Succession Act. investment. stock. Individuals and proprietory concerns a) Moveable assets like Bank Deposits. d) Out of the above items. (a) to (c).e. This net value of the assets shall be the net estimated worth or means of the borrower. c) Capital investment in the business including Investment in partnership. stake in sister concerns. i. Gold ornaments. total value of liquid assets of the partners.

e) However. held by partners. C. Limited Companies a) Apart from paid capital and free reserves as appearing in the balance sheet. and any other reserves (not being the reserve created for repayment of any future liability for depreciation in assets. which have been continuously making good profits in the past and whose existing liabilities do not our-weigh their easily realizable assets. his investments should be ignored. if the scrip is not quoted in the stock exchange and / or is not readily marketable.. balance of deferred revenue expenditure and other intangible assets should be deducted from the capital as in (a) above. capital and debenture redemption reserves. f) Further while assessing the worth of a partner. . of these firms should not be included at the face value. The full face value of shares can be taken into account in assessing the holders’ means only if the companies whose capital these shares represent are first rate running concerns. b) Accumulated balance of loss. balance in the share premium account. proprietor. while computing the liquid assets of the partner the value of shares in the Private / Public Limited companies. as the investment in such firm is included in the firm. for bad debts or reserves created by revaluation of assets) shall also be taken into account. etc.

keeping in view the financial position of the borrowing company. It should be ensured that the system of obtaining the guarantee is not used by guarantors (not only by directors) as a source of income from company. stake of the proposed guarantor in the company. etc. The purpose of obtaining such guarantees is that the borrowers are more amenable to financial discipline if the directors / promoters or other persons interested in the borrowing concern . obtention of personal guarantee from such managerial personnel may be decided on case to case basis. wherever the sanctioning authorities feel that the guarantee from third parties is required (through such persons are not directors in the company). Apart from this.Obtention of Personal Guarantees of Directors Wherever loans / advances are granted to corporate borrowers the sanctioning authorities are required to obtain guarantees from Directors (excluding nominee directors) and other managerial personnel in their individual capacity. whether by way of commission. wherever felt necessary. a stake in the ownership / management of the company concerned. Managerial personnel are those who may not be called as promoters / directors but who have otherwise. they may stipulate the guarantee of such persons. An undertaking from the borrower company as also the guarantors should be obtained to the effect that no consideration. However. brokerage or fees or in any other form will be paid by the former or received by the latter directly or indirectly.

the proposal should make specific mention as to the continued availability or otherwise of his personal guarantee. the branches should also obtain from the borrowing company. This apart. Borrowers are required to furnish the documents indicated along with the application for financial assistance.. has been paid to the guarantors by the company. When credit facilities are extended to borrowing units in the same group. etc.. etc. A flash report on the proposal is prepared and submitted to Zonal Committee / Credit Committee depending upon the exposure. brokerage/fees. during their periodic inspection of the borrower’s unit. If the same is not available. guarantees of the parent / holding company may be insisted.have given their personal guarantee. Flash report on the proposal is prepared basically to . the proposal to relieve him from the personal guarantee should be specifically mentioned in the proposal. A suitable clause in the sanction memorandum to the branches should be incorporate. should also verify their books of account / financial statements to ensure that the borrowing company has not paid any commission / brokerage / fees. When a director whose personal guarantee has already been obtained resigns from the directorship. an auditor’s certificate annually. Branches / offices. to the guarantors for extending such guarantee. to the effect that no commission.

The credit risk of the company is broken down into risk categories as under: 1. Presently. funding risk etc. For other cases. The risks and the mitigation mechanism needs to be suitably highlighted.consider eligibility of the proposal for assistance. Credit Rating All proposals brought before the Zonal Committee/Credit Committee for sanction to be assessed by Internal Rating System. market risk. supply risk. Once the committee decides that the proposal is "in principle" eligible for financial assistance. participant risk. It may be mentioned that credit rating is one of the critical inputs considered for sanction of assistance. Proposal with a rating of atleast BBB are normally considered for appropriate credit decision by the Sanctioning Authority. as soon as the request for assistance is received. operating risk. Business Risk . our internal risk rating is being done on the RAM (Risk Assessment Model) software. The various risk relating to the project (sponsor risk. engineering risk. It is a software designed to assess credit risk in structured and comprehensive manner which ultimately helps in assessing the credit quality of the borrowers. which has been devised by CRISIL. Rating exercise to commence either outside or in house for new companies after flash report. Detailed appraisal is being undertaken. ) needs to examined.

proximity to customers and employee attrition rate. Industry Risk 1. Financial Risk . product range/mix. 2. energy cost. It also covers operating efficiency factors such as availability of raw materials. Management Risk 3. diversity of markets. management proactiveness 3. employee cost. bargaining power with suppliers. Business Risk It mainly covers market position factors such as access to patents. management of input price volatility. credibility. Financial Risk 4. brand equity. vulnerability of event risks.2. selling costs. consistency in quality. Management Risk This risk mainly covers Track Record. adherence to environmental regulation. capacity utilization. distribution set up. financial ability to withstand price competition. customisation of product/product design. cost of effective technology. Multi locational advantages. payment record and other factors like group support. extent of integration. project management skills and size related pricing advantages. support service facilities/after sales service. efficient raw material usage. long term contracts/assured offtake.

operating margins. Input related risk and Quantitative factors such as Return on capital employed. These risks are measured on a scale of 1-6 points. Extent of competition. slope of operating margin trendline. Grade Degree of safety Comments Comments . variability of operating margins. Government Policy.This risk is evaluated through a combination of the following ratios (both past and projected) → Interest Coverage → Return on capital employed → Operating Margins → Operating income/short term borrowings → Current Ratio → DSCR → Total Outside Liabilities/Total Networth → Free cash flow from operations/Total debt. 4. Industry Risk The factors covered under industry risk are qualitative factors such as demand supply gap. 6 being the highest score and results in ten grades as under: Grade Degree of safety with regard to servicing debt Grade I (AAA) obligations Very High The fundamentally strong debt servicing capacity of such companies is most unlikely to be adversely affected by changes in circumstances.

Debt servicing capacity could weaken in view of changing circumstances. The main objectives of conducting pre-sanction inspection are: i. While such companies are less susceptible to default than those in lower grades. Such companies differ in safety from those in Grade only marginally. To establish the identity of the customer. . Pre-sanction Inspection and Credit Reports Pre-sanction inspection should be conducted and credit reports collected for considering the credit request. Debt servicing capacity is highly vulnerable to adverse changes in circumstances. Timely payment of debt would continue only if favourable circumstances continue.with regard to servicing debt Grade – II (AA+) Grade – III (AA) Grade – IV (A) Grade – V (BBB) Grade – VI (BB+) Grade – VII (BB) Grade – VIII (B) Grade – IX (CC) Grade – X (C) Substantial Risk Default Inadequate Low High Risk Adequate Average Below Average obligations High Adverse business conditions are unlikely to affect debt servicing capacity. Debt servicing capacity in default and returns from this may be realized only on reorganization or liquidation. Adverse business or economic conditions are likely to lead to lack of ability or willingness to service debt obligations. Changes in circumstances are more likely to affect debt servicing capacity than for higher grades. Uncertainty faced by issuer could lead to inadequate capacity to make timely debt repayments. uncertainties faced by them could adversely affect debt servicing capacity.

iv. xii. vi. sales tax. cycle. Buyers etc. To analyse conduct of business . efficiency of operations). To ensure Proper maintenance of records / accounts.ii. To inspect immovable property (location. xv. payment of taxes and dues. To verify the correctness of particulars given in the Credit Application Form and its enclosures To verify / get information on the customer and their business unit. reputation). To verify machinery (original purchase invoice. To judge Management / business abilities (availability of technical / experienced staff. vii. area. ownership. To evaluate standing (year of establishment. experience and abilities of the parties concerned. To validate market information with regard to means. v. viii. the correctness of stocks. competitors. problems. To understand the nature of activity. present value). experience. Manufacturing Process.sound or over trading (low cu . standing. ix. Suppliers. targets. To verify adequacy of internal controls. encumbrance. production. licences etc. xi. To verify / ascertain from records. iii. To verify meeting of statutory obligations (income tax. business integrity. Working Capital xiv. x. excise. xiii. approximate value etc. marketing facilities.). To ascertain working of the unit prospects). (installed capacity.).

). creditors exceeding debtors.xvi. Main types of . Current ratio. trading than the resources may NATURE OF FACILITIES AND FIXING OF CREDIT LIMITS Credit facilities can be funded or Non-funded. frequent excess drawings etc. Non funded based limits are those where the Bank endorses the commitment / promise made by the borrower and the Bank need to meet only if the borrower fails to honour it. under trading (lower permit). The funded limits are those where outlay of the Bank's funds is involved.

Overdraft and Cash Credit In Overdraft/Cash Credit. Usually the security offered. Cash Credit and Bills Purchased / Discounted. finished goods and stock-intrade. the borrower is allowed to carry out debit and credit transactions upto a limit. occasional overdrawings / debits in current accounts and also for continuing limits granted for personal purposes. including stores and spares. Though there is no hard and fast rule to determine this. "Cash Credit" is generally used for regular limits granted for working capital requirements of commercial establishments. work-in-process. repayment terms and requirements of a customer decide the type of facility to be granted. there are well set practices. drawings to be regulated within the drawing limit permissible which is arrived at on the basis of composition of current assets and current liability based on the declaration in the stock statement in the prescribed format submitted by the borrower. CC is granted by way of a running account. Cash Credit (CC) is granted against hypothecation of stock such as raw materials. . These are more operative accounts and have cheque book facility. the purpose and size of advance.facilities under fund based limits and non funded based limits and the related guidelines for granting advances against them are discussed below in brief. Fund Based Limits Fund Based limits are generally granted by way of Overdrafts. The term "Overdraft" is generally used for continuing limits granted against the security of term deposits and other financial securities.

Branches are required to exercise utmost care while considering for CC limits as possession of the goods will remain with the borrower. Borrowers to whom CC limits have been extended should maintain proper stock books. ii. Branches should bear in mind the following aspects while fixing / recommending CC limits. these parties have to remit the sale proceeds to their CC accounts and payment for all purchases of stock are to be made by cheques drawn on these accounts. The borrower must be creditworthy The borrower’s dealings with the Bank should be satisfactory The borrower must be prepared to submit the correct and authenticated stock statement as per the format prescribed by the Bank and at the periodicity stipulated by the Bank iv. If proper books are not maintained. In other words. The borrower must be agreeable to hypothecate the entire stock belonging to him and to insure the stock for its full value for fire and other risks at his own cost . it would be difficult to check the stock at any time with reference to their books and stock statements.Branch will obtain periodical stock statements at the stipulated intervals from the borrower to have a watch over the stock position and also will check the goods at irregular intervals to satisfy about the correctness of the declaration of the stock by the borrower. Borrowers enjoying CC limits should route all purchase and sale transactions through their CC accounts. iii. i.

300 Lacs (Lower of sanctioned limit Rs. 450 lacs (value of security – margin i. 300 lacs (400-100) Cash credit / overdraft limits are repayable on demand. 500 lacs against hypothecation of stocks. It is the lower of Sanctioned Limit and Drawing Power. and subject to the stipulation of periodic (generally annual) review / . Drawing Power is Value of Security less Margin. 400 lacs. However. 600 lacs (800-200) → For the 3rd month Rs. thus be: → For the 1st month Rs. by the branch officials and / or by the Inspecting Officials of the Bank as and when required.v. 450 lacs (Lower of sanctioned limit Rs. The value of paid stocks as per the stock statement submitted by the borrower and verified by the Bank Officials at the beginning of three consecutive months were Rs. The Drawing Limits (i. ABC is sanctioned a Cash credit limit of Rs. The limit upto which the drawings are allowed in the cash Credit / Overdraft account is called Drawing Limit. 600 lacs. Rs. An illustration for this is given below: M/s. unless a decision is taken to recall the advance. The borrower must agree for the periodical inspection of stock and the books of accounts maintained by him.e. The margin stipulated is 25%. 500 lacs (Lower of sanctioned limit Rs. the extent to which the drawals can be allowed in the account would.e 600150) → For the 2nd month Rs. 500 lacs and drawing power Rs. 800 lacs and Rs. 500 lacs and drawing power Rs. 500 lacs and drawing power Rs.

Non-Fund based limits i. In other words. iv. II. In certain cases. stocks in process. ii. Cash Credit (CC) including WCDL wherever permitted Packing Credit (PC) Overdraft Vendor financing Finance against Receivables (Post-Sales) i. iii. There are also cases when a phased reduction in limits is prescribed. finished goods. Inventory Limits (Pre-Sales) i. No repayment is generally stipulated for such limits.renewal. ii. Letter of Credit (LC) Bank Guarantee (BG) Working Capital finance is made available for financing Current Assets which consist mainly of: 1) 2) Inventory (Raw materials. the seasonal limits (higher limits during the peak period of the activity / credit requirement of the borrower and lower limits during the slack season ) are stipulated. stores & spares etc) Receivables (Sundry Debtors) . Working Capital Finance is extended in different forms basing on the requirement as follows: I. ii. based on the realization/working capital cycle of borrower’s produce. the limits are of continuous nature. however. Book Debts Bills Purchased / Discounted/Negotiated III.

4.00.After having assessed the Permissible Bank Finance (PBF) that could be extended to a borrower as per the method as applicable. the average time taken for realization of sale proceeds be ascertained.00. For fixing the post sales limit. The following are the other financial parameters: Current Assets Raw Materials Rs.00.000 Sundry Debtors Rs.50.000 Cash Rs. 5. The following example will illustrate the above: M/s ABC has projected a sales turnover of Rs.000 Working Capital Gap (CA-CL) Less 25% on CA Rs.00. 3.000 Holding Levels (Assumption) 2 months’ consumption 1 month cost of production 2 ½ months’ cost of sales 2 months’ sales 2 months’ purchases . the various types of limits that can be considered are arrived at as follows: The finance required would depend on the period between the purchase of raw materials / goods till the finished goods are sold and realized. are fixed basing upon the levels of Inventory held and the period between the purchase of raw materials and its sale as finished goods.000 Work-in-process Rs..000 Finished Goods Rs.50. the holding levels for raw materials. 3. 3. PC etc.15. Further.12.75. Out of the Permissible Bank Finance (PBF) assessed. 1.2.50 lakhs per month.000 Rs. The level of Sundry Debtors in relation to sales will indicate the finance provided.00. the quantum pre-sales limits like CC.00.000 Current Liabilities Sundry Creditors Rs. stock-in-process and finished goods depend on the lead periods for which they remain in the working capital cycle.000 Rs. 1.

DALC.75. advance payment guarantees / suppliers credit etc. Unpaid stocks (on account of sundry creditors for purchases. Book Debts Total amount of inland credit sales (debtors) not exceeding the period permitted by the sanctioning authority LESS. considering a margin of 25% on stocks.000 Rs.50.50 lakhs could be considered.3.9. bills limit of Rs.000 Similarly.00.3.PBF Rs. a CC limit of Rs.000 Rs.00.000 In the above example. Inventories Total inventory (excluding non usable non moving.25. slow moving stocks) (period to be specified) LESS.) and stock hypothecated to any other facilities Value of paid stock (A – B) LESS: Stipulated margin on stocks as per sanction DP / DL on stocks (C-D) 2.6.000 Sundry Debtors Less 25% margin Bills Limit Rs.000 Rs.4. lakhs could be considered as follows: Total Stocks (inventory) Less Sundry Creditors Less 25% margin CC Limit Rs.4.000 Rs. 8. BE) discounted by the Bank/Factors duly adding back the margin (on the date of stock statement) & advance received against suppliers Net bills receivables / debtors unfinanced by the Bank / Factors (F-G) LESS: Stipulated margin on book debts as per sanction DP / DL on Book Debts (H-I) or stipulated sub limit under Book Debt whichever lower H I J F G C D E A B . keeping a margin of 25% on receivables. Rs. Value of bills (Supply Bill.000 Rs.3.1.75 Computation of Drawing Power 1. SDB.5.00.25.

If there is reduction in the stock. penal interest be charged and a suitable letter be addressed to borrower to bring in borrowing discipline. Normally margin on book-debts is kept higher than the inventory. Such submission in between due dates should be permitted only on very very exceptional basis for meeting urgent business requirements as otherwise parties would be submitting stock statements every alternate day / very frequently which would result in difficulties in monitoring movement of stocks. Stock Statement is an important monitoring tool and nonsubmission of Stock Statements for a period of one month from the due date for submission are to be treated as irregularity and are to be followed up with the company for early submission. Drawing should be within the permissible drawing limit as per the latest stock statement. . finished goods and book-debts would vary depending upon nature of industry. In case of persistent default. semi-finished goods. period of operating cycle and standing of the borrower in the market. Margin on raw materials. the borrower should work within the reduced limit arrived at. they have to submit fresh statement declaring sufficient additional stock to cover the additional advance required. Borrower must be asked to regulate drawings strictly within the limit available on the stock held from day to day.The total drawing power / drawing limit against stocks and Book Debts shall be E+J or sanctioned limit whichever is lower. However if they want to draw beyond the drawing limit of the previous statement before next statement falls due.

The process of assessing LC limits is intimately related to the appraisal of other working capital facilities to the customer. In the above case purchase cycle would be 4 months. the customer (buyer of the material) would prefer an LC limit. Therefore. There are always a number of factors at work which impact the computation of the LC limit as a part of the overall working capital credit requirements of an enterprise. the role of a commercial bank as an intermediary considerably enhances the level of comfort required for trading for buyer and seller. However. Further. if the supplier of material does not insist on advance payment. We denote the .Assessing Letter of Credit (LC) Limit A limit for a letter of credit facility for working capital purposes enables an enterprise to procure raw materials and other important ingredients for production on credit terms. An alternative to the LC limit is to sanction a fund based credit facility in favour of the enterprise. C and D can be called as purchase cycle. However a letter of credit issued by the bank on behalf of its customer is an off balance sheet item in the books of the client which enables the latter to prepare a more appealing balance sheet. following major factors should be taken into account in any quantitative method of assessment: A B C D Annual consumption of the material being purchased Lead time from opening of credit to shipments Transit period for goods till it arrives at the factory Credit Period available 120 (Rs lacs) ½ (months) ½ (months) 3 (months) The sum of B. It is therefore difficult to prescribe a standard method to work out the exact amount of LC limit to be provided to a manufacturing unit.

As a security against funds provided in advance.purchase cycle by P (months). In these cases. the buyer of goods (supplier of raw material) may require security in the form of bank supplying products/services to a parent company. It is common practice to provide mobilisation advance by the principal to contractors/vendors executing turnkey projects or civil projects which may take considerable time for completion. The quantum of LC limit may now be worked out using the expression (P X A/12). . construction etc. Mobilisation advance may be provided both before the commencement of the project and at various stages of progress in respect of plant layout design. This represents the cost of the material that will be consumed in one working cycle. the contractors are often required to submit bank guarantees. The cycle commences at the point of placement of order whereas the final payment is made at the end of the cycle. which would work out to Rs 40 lacs. where the latter suppliles raw material against submission of bank guarantee. auctions etc are generally required to submit bank guarantees for a minimum 2) stipulated amount in lieu of security deposits/earnest money deposit etc. drawings. 3) Sometimes raw material ar supplied by the buyer to the manufacturing units with whom supply orders are placed by the former. Assessing BG Limit Banks usually issue guarantees in the following circumstances: 1) Enterprise participating in tenders.

Here we will assume 5% Expected value of the new contract (25% of A). 5) Supplier of goods and services often proved warranty period to the buyers of such products. Machinery Advance etc.50 100. The retained amount is released only after a bank guarantee for an equivalent amount is submitted by the supplier. On submission of such performance guarantee.00 25. It may vary from company to company Performance Guarantee (Normally 10% of C) Advance Payment / Security Deposit Guarantee (5% of C).00 12. the suppliers may request the bank to issue performance guarantees in favour of the buyers. APG.00 50. It is generally observed that guarantees are mainly required by the construction companies for the purpose of EMD.4) Even after the goods have been supplied in terms of the contract. A B C D E Particulars Value of contracts expected to be bid EMD Guarantee (generally 3% to 5% of A). . the buyers may hold a portion of the supply bills till they are finally satisfied about the quality of the material supplied. Bid Bond.00 250. In these cases.50 337. the suppliers receive the proceeds without waiting for the expiry of the warranty period.00 25. F Fresh Guarantees required (B+C+D+E) G Existing bank guarantees (Assumption) H Guarantees expiring during the year I Guarantees requirement (F+G-I) J Total guarantees limits required In other cases where guarantees are to be issued for the procurement of raw materials. No. An indicative way of assessing the guarantee limits may be assumed as under: Sr.50 412.00 412. Amount 1000.50 This may vary from project to project. the assessment will be case specific and no formal way of assessment can be applied.

Alternatively. 3. settlement and other financial transactions. In a bank’s portfolio. . losses result from reduction in portfolio value arising from actual or perceived deterioration in credit quality.1 Meaning of Credit Risk Credit risk is defined as the possibility of losses associated with diminution in the credit quality of borrowers or counterparties.2 Bifurcation of Credit Risk The study of credit risk can be bifurcated to facilitate better cognition of the concept.Introduction to Credit Risk 3. losses stem from outright default due to inability or unwillingness of a customer or counterparty to meet commitments in relation to lending. trading.

. While risk decides the fate of overall portfolio. or customer – specific factors. Both firm credit risk and portfolio credit risk are impacted or triggered by systematic and unsystematic risks.Overall Credit Risk Firm Credit risk Portfolio Credit Risk A single borrower/obligor exposure is generally known as Firm Credit Risk while the credit exposure to a group of similar borrowers . industry. is called portfolio Credit Risk This bifurcation is important for the proper understanding and management of credit risk as the ultimate reasons for failure to pay can be traced to economic. portfolio risk in turn determines the quantum of capital cushion required.

Sources of Credit Risk Credit risk emanates from a bank’s dealings with an individual. corporate. The second type of credit risks is unsystematic risks and is controllable risks. .Firm Credit Risk Portfolio Credit Risk Credit risk Systematic Risk Socio-political Risks Economic Risks Other Exogenous Risks Unsystematic Risk Business Risks Financial Risks External forces that affect all business and households in the country or economic system are called systematic risks and are considered as uncontrollable. 3. financial institution or a sovereign.3. They do not affect the entire economy or all business enterprises/households. bank. A creditor can diversify these risks by extending credit to a range of customers. Such risks are largely industry-specific and /or firm specific.

4 Components of credit risk: The credit risk in a bank’s loan portfolio consists of three components. 3.Credit risk may take the following forms:  in the case of direct lending: principal/and or interest amount may not be repaid  in the case of guarantees or letters of credit: funds may not be forthcoming from the constituents liability  in the case of treasury operations: the payment or series of payments due from the counter parties under the respective contracts may not be forthcoming or ceases  in the case of securities trading businesses: funds/ securities settlement may not be effected  in the case of cross-border exposure: the availability currency restrictions sovereign. (1) Transaction Risk (2) Intrinsic Risk (3) Concentration Risk (1) Transaction Risk: Transaction risk focuses on the volatility in credit quality and earnings resulting from how the bank underwrites individual and funds may free may be transfer either imposed of foreign or the by cease upon crystallization of the .

predictive. and lending risk factors that characterize an industry or line of business. It allows a bank to avoid disaster. (3) Concentration Risk: Concentration risk is the aggregation of transaction and intrinsic risk within the portfolio and may result from loans to one borrower or one industry. Intrinsic risk addresses the susceptibility to historic. geographic area. selection. Bank must define acceptable portfolio concentrations for each of these aggregations. Transaction risk has three and dimensions: operations. Predictive elements focus on characteristics that are subject to change and could positively or negatively affect future performance. Concentrations within a portfolio will determine the magnitude of problems a bank will experience under adverse conditions. underwriting (2) Intrinsic Risk: It focuses on the risk inherent in certain lines of business and loans to certain industries. Portfolio diversify achieves an important transactions. or lines of business. Commercial real estate construction loans are inherently more risky than consumer loans. Lending elements focus on how the collateral and terms offered in the industry or line of business affect the intrinsic risk.5 Selecting a Risk Strategy: . 3. Historic elements address prior performance and stability of the industry or line of business.

(i) Conservative: Accepts relatively low levels of transaction. (ii) Managed: Accepts relatively low levels of risk in two categories but high levels in one category. A selection of risk strategy with specific implementation plans provides a much better idea of the future risk profile. The selection of the appropriate strategy depends on a bank’s priorities and risk appetite. Using the risk profile as a frame of reference. the choice is not made as part of a formal process but evolves as the bank seeks its desired risk posture through its lending practices. For example: a bank that takes conservative levels . Banks must constantly monitor the risk profile to determine its future lending practices are consistent with the desired risk profile. The three variable risk strategies in order of riskiness are: Conservative. few banks have a clear picture of the risk profile that will emerge. Managed and Aggressive.The bank does have an opportunity to reduce their concentration in one line of business or industry. which strategy best serves managements intent. intrinsic and concentration risk. Outstanding would have to be replaced with more lending focused on lower risk lines of business and borrowers. Most often. management should select a risk strategy that will be consistent with long-term objectives for portfolio quality and performance. The strategy normally supports a values-driven culture. Consequently. The following guidance should help in understanding.

Exposure Ceilings: Prudential Limit is linked to Capital Funds -say 20% for individual borrower entity. This strategy is normally employed in a production driven culture. The aggressive danger zone. (iii) Aggressive: Accepts relatively low levels of risk in one category. strategy requires more careful management because it operates closer to the 3. through which credit risk management is carried out. If risk in all three categories reaches high levels. An example would be a bank that closely manages transaction risk but accepts higher levels of intrinsic and concentration risk. credit volatility rises as the levels and categories of risk are increased.13 Tools of credit risk management The instruments and tools. the bank’s credit volatility becomes so great in a downturn that capital adequacy and survival could become real issues. . The strategy normally promotes the immediate performance culture. 45% for a group with additional 5%/10% for infrastructure projects.of concentration and transaction risk but is more aggressive with intrinsic risk. subject to approval of the Board of Directors. are detailed below: a. Obviously. more aggressive risk in two categories.

Adopt the RAROC framework. b. Risk based scientific pricing: Link loan pricing to expected loss. . d. sanctioning authority’s higher delegation of powers for better-rated customers. Hurdle rates and Bench marks for fresh exposures and periodicity for renewal based on risk rating. Build historical data on default losses. High-risk category borrowers are to be priced high. which is the sum total of the exposures beyond threshold limit should not exceed 600% to 800 % of the Capital Funds of the bank (i. Clearly define rating thresholds and review the ratings periodically preferably at half yearly intervals. Substantial Exposure.threshold limit is fixed at a level lower than Prudential Exposure. to be graduated to quarterly so as to capture is to be risk without to delay. etc c. discriminatory time schedule for review / renewal. Rating the migration mapped estimate expected loss. Review/Renewal: Multi-tier Credit Approving Authority. 6 to 8 times).e. Risk Rating Model: Set up comprehensive risk scoring system on a six to nine point scale. constitution wise delegation of powers. Allocate capital to absorb the unexpected loss.

f. compliance status. distribution of borrowers in various industries & business group. size of operation. other financial services activities spread over a wide spectrum of region. management cover exposures on account of lending. industry. There should be a quantitative ceiling on aggregate exposure on specific rating categories. sector or industry.e. It should target all loans above certain cut-off limit ensuring that at least 30% to 40% of the portfolio is . etc. review of risk rating. investment. Credit Audit/Loan Review Mechanism This should be done independent of credit operations. Rapid portfolio reviews are to be carried on with proper & regular on-going system for identification of credit weaknesses well in advance. pick up of warning signals and recommendation for corrective action with the objective of improving credit quality. technology adoption. Steps are to be initiated to preserve the desired portfolio quality and portfolio reviews should be integrated with credit decision-making process. covering review of sanction process. Portfolio Management The need for credit portfolio management emanates from the necessity to optimize the benefits associated with diversification and to reduce the potential of adverse to a impact of concentration’ Portfolio exposures shall particular bank-wide borrower.

proper & prompt reporting to Top Management should be ensured.37 1. The focus of the credit audit needs to be broadened from account level to overall portfolio level.20 Q1 FY09 Q2 FY09 Q3 FY09 FY09E 2. Regular.10 3.54 2.60 1.10 2.A cause of Worry for Banks: A non-performing asset can be defined as a credit facility in respect of which the interest and installment of principal has remained past due for a specified period of time.90 FY 08 3. at the branch that has appraised the advance and where the main operative limits are made available.subjected to LRM in a year so as to ensure that all major credit risks embedded in the balance sheet have been tracked and to bring about qualitative improvement in credit administration as well as Identify loans with credit weakness.10 4.70 3.60 .82 1.60 2.53 1.e.68 2.43 2. Ensure adherence to lending policies and procedures.30 1. Non Performing Asset.64 2.00 2.60 1.51 2. i.65 1.93 2.08 2.30 2.68 4. Determine adequacy of loan loss provisions. Credit Audit is conducted on site. Gross NPA: In % SBI PNB BOI UBI FY 07 2.90 3.15 FY 10E 4. An asset is classified s NPA if borrower does not pay dues in the form of principal and interest for a period of 180 days.95 2.

Standard.57 6. Standard Assets: .91 1.70 Axis Bank 0.e. Agricultural Advances: In case of advance granted for agricultural purposes including agricultural gold loan. An account may belong out of order if the balance outstanding remains continuously in excess of the sanctioned limit.00 4.80 Classification of NPAs: Various assets can be classified as NPA.90 4.00 2.10 0. if the assets satisfy the following conditions: Term Loans: A term loan is a loan repayable by installments. all the advance accounts are classified into four categories i.HDFC Bank 1.10 1. It is treated as NPAs if interest/ installmeIt is nt.90 0. the loan will balance NPAs if interest/ installment as the case may be remains unpaid after it has become due for two harvest season. Bills Purchased/ Discounted: A bill including chq/ Draft purchased/ discounted is treated as NPA if it remains overdue for two quarters as more as in the date of Balance Sheet.92 1. SubStandard and doubtful or loss Assets. An amount is considered as past due when it remains outstanding for 90 for 90 days beyond the date of payment. Cash Credit/ Overdraft: It is treated as NPAs only if the account remains out of the order for two quarter or more.20 0. Provisioning: For the purpose of provision.15 3. An amount remains past due for a period of six months or two quarters or more.07 0.57 4. but for a period not exceeding two half years.70 Source: Business Standard 1.70 1.50 3.91 1.10 ICICI Bank 2.90 2.

Loss Assets: Those NPA accounts where loss has been identified by the bank/ internal inspector/ external auditor/ RBI inspector or are those NPAs where there is no realizable value of security. The Indian economy has been much affected due to heavy fiscal deficit. The origin of the problem of burgeoning NPAs in the quality of management of credit risk by banks. poor infrastructure facilities. Sub-Standard Assets: These are those accounts which have been classified as NPAs for a period not exceeding two years means upto two years. But the problem of NPAs in more in Public Sector Banks as compare to private sector and foreign banks. which do not disclose any problem and do not carry more than normal risk and are regular in all respect. Factors affecting the NPAs in India: The principal challenge of banking soundness emanates from the persistence of the significant amount of non performing assets on bank’s balance sheet. mounting unemployment etc. it goes without telling that banks are no exemptions and they are bound to bear the crisis. Doubtful Assets: The assets which have remained NPAs for a period of above two years. The main causes of increasing NPAs are Causes of increase in NPAs .Are those assets. commerce and industry in the wake of new economic policies. sticky legal system. under such situation. The banking sector has been facing the serious problem of non-performing assets. dislocation of trade.

. Persistent losses due to shift in competition. Change in government policies IV. labor problems etc. Poor Credit appraisal system by the banks Improper SWOT analysis Non-compliance with the norms of lending Stackness in post credit appraisal Inefficient management of funds Absence of regular industry visits and monitoring Poor Delivery mechanism of banks External Factors: They are I. Non viability of unit/ project III. IV.Internal Factors Factors External Internal Factors: The internal factors include I. VII. V. lack of demand. III. Industrial stickiness II. Diversion of funds and willful defaults V. II. VI.

In principle acceptance of the proposal would be considered against the commitment by the borrower to settle the dues. Example: Syndicate Bank has Synd Adalat is a process wherein the borrowers are given opportunity to settle their dues under compromise.Steps taken to Reduce NPAs: The financial institutions and banks are coming up with the various innovative ways to reduce the mounting level of NPAs . The date and place finalized for organizing such Adalats would be made known in advance. such proposals are placed before the Competent Authority for obtaining final sanction. . Publication of defaulters name as per the RBI’s direction in line to change in Banking Secrecy Act Special onetime scheme for small and marginal farmers as was put place. Enforcement of SARFEASI ACT 2002. The proceedings of the Adalat would be drawn to firm up the discussion and for taking further follow up action. Such Adalats would be organized at General Manager’s Office / Regional Office/cluster centres to enable the borrowers to participate in person and put forth his views. The Regional Manager or the Executives from Corporate Office would chair these Adalats. Later. Settlement Advisory committee are in operation. Other Measures are: • • • • • • • Credit appraisal skills are being upgraded. some of them are stated below… • Negotiated settlements are encouraged to ensure recovery with minimum time delay and expenses. Setting up of Asset Reconstruction company limited RBI also introduced Corporate Debt Restructuring schemes in a bid to avoid further accumulation of NPAs in banks and financial institutions.

e. lender by giving a notice of 60 days can take steps to recover their dues. Takeover of the management of assets or their disposal expeditiously. which enable secured lenders to enforce their rights. the level of Non. III. • Take possession of secured assets. was needed to handle this problem. a new act.Performing Assets of banks and financial institutions was estimated at Rs. Alternative Mechanism to deal with NPAs in India: .A Brief About SARFEASI Act: In the year 2002. Setting up and securitization of Asset Management Companies.000 crores. To stop this burgeoning level of NPAs. • Transfer problem learn to asset management companies. interest remained due for more than 180 days) and the assts have been classified as nonperforming by the lenders. which has various negative impacts on the performance of Banks. It covers loan assets wherein a default has occurred (i. II. The act provides the mechanism to deal with defaulting enviable companies. which is at the discretion of secured tender and can be pursued without the intervention of courts. Enforcement of Security interest created in favor of any secured creditors without the intervention of the courts provided 75% of the secured creditors are in agreement. This act is a unique mechanism for settlement of dues. This act is seen as a landmark measure in the process of legal reforms. Under this act. 1.00. This provides for: I. • Dispose off these assets by sale or lease etc. • Change management or takeover business. This act is seen as most potent weapon being handled by banks and financial institutions to manage the NPAs.

Suggestions for reducing NPAs in India: Management of NPA is a giant problem calling for multidimensional strategy. Banks have to display professionalism and scientific temperament in appraisal. Debt Recovery tribunals were set up. monitoring and supervision of loans account. With a view to speeding up the debt recovery process.One channel was referring problem of companies to a semi judicial body i. system overload and fragmented nature of supervisory functions in public sector banks really hamper the recovery efforts. the Board of Industrial and Financial Reconstruction (BIFR). The need for early identification of problem loans has been established as one of the principles of the Basel Committee for the management of credit risk.e. Following are some of the important measures to reduce the level of NPAs. (1) Early Warning Signals: It is essential to identify signs of distress or early recognition of problem loans. Once a unit was referred to BIFR lenders were required to bide by BIFR procedure. Problem . The criteria for doing so were related to the unit registering lesser in successive year and erosion of its Net Worth.

Warning Signs f. As the crisis develops. Scheduled Loan Reviews c. An objective and reliable database has to be built up for which bank has to analyze its own past performance data relating to loan defaults. A typical Early Warning Signals process is listed below: a. (3) Redesigning the Internal Rating System: In order to ensure a systematic and consistent credit assessment process within the bank. there is also need for building in a risk orientation in individual officers at the operating level. to create awareness about credit assessment skills and risk mitigation processes . Continuous Monitoring by Loan Officers most commonly arise from a cash crisis facing the borrower. Loan Covenants e. internal and external signs emerge. computerization and networking of the branch activities. External Examination d. often subtly. Besides training in the ‘hard’ aspects of understanding risk and using software. (a) Added to IT expenditure is the cost and effort of training and redeployment of manpower. Asset Classification and Downgrade Report (2) Establishing Risk Management Information System (RMIS): The effectiveness of risk management depends on efficient information system. operational losses etc. a .

. The Basel Committee set up by BIS has been urging banks to set up internal systems to measure and manage credit risk.buzinessstandard. It is important that Indian banks use credit ratings available from agencies in conjunction with their internal models to measure credit .robust and auditable rating system must be in place. industry prospects etc. Bibliography: Websites: www. A list of credit drivers or factors that influence the creditworthiness of a borrower / company with a weight assigned on measurable element data like financial ratios and subjective elements like management quality.

org www. Jain Textbooks: Management of Non Performing Assets in Banks By: Sugan www.

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