JAIIB/CAIIB

CREDIT MONITORING

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VRDDHI CONSULTING & TRAINING SERVICES (VRDDHI CTS)

Mobile: 7034372121 WhatsApp: 7034382121 Gmail: vrddhicts@gmail.com
 CREDIT MONITORING

1. Introduction:

Credit Appraisal, Credit assessment, Credit monitoring and Recovery are the major
areas in management of credit portfolio of commercial banks. Like appraisal,
assessment and recovery, monitoring also has a vital role in ensuring the asset
quality of a bank. Without monitoring, the asset quality will remain vulnerable with
burgeoning stresses in the asset portfolio and may lead to a weak earning profile.

1.1 What is Credit Monitoring?

The dictionary meaning of the word monitoring includes maintaining regular

surveillance. Credit monitoring can be defined as supervision of a loan account, on
an ongoing basis keeping in mind a continuous watch/vigil over the functioning of a
borrowal unit, to confirm that the borrowal accounts conform to the various
assumptions made at the time of sanction/last renewal. This definition underlines
three points. First, credit monitoring implies supervision of loan accounts. Second,
this supervision is to be on a continuous basis and not a onetime affair. Third, the
purpose of this continuous watch is to ensure that the borrowal unit is conforming to
the various assumptions made at the time of sanction. Monitoring is a continuous
supervision process enabling the bank to ensure the quality of loan assets.

2. Credit monitoring at different stages:

2.1 We can divide the monitoring process into three different stages:

i) Credit monitoring after sanction and before disbursement

ii) Credit monitoring during disbursement
iii) Credit monitoring after disbursement

2.2 Stage I: Credit monitoring: Pre-disbursement stage: Once the credit facilities
are sanctioned by the respective sanctioning authority, the disbursing official can
initiate the steps for the release of the sanctioned credit facility. Necessary
precautions to be taken as part of credit monitoring process at the pre-disbursement
stage are as under:

i) Read the sanction order and understand the sanction terms and conditions.
ii) Check for any variation/changes that have happened to the borrowal unit
internally or externally.
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iii) Convey the sanction terms and conditions to the borrower and get the duplicate
copy duly signed by the borrower and guarantor (if any) as a token of
acknowledgement of the terms and conditions.

2.3 Stage II: Credit monitoring – During disbursement:

i) Ensure the validity of sanction order

ii) Educate the borrower about the use of credit facility and compliance with the
terms and conditions of the bank
iii) Documentation
iv) Margin – Owner’s stake / money
v) Drawdown schedule – Normally in stages depending upon the type of credit
facility

2.4 Stage III: Credit monitoring – After disbursement:

i) All the fees like the processing charges, charges for Lawyers, Engineers,
documentation charges etc., to be collected.
ii) Registration of charges to be done in a proper way.
iii) Fresh search report to be obtained after the registration of charges.
iv) Collection of regular reports to ensure flow of information(like stock statement,
market reports, financial statements, etc)
v) Field visits – Monthly, quarterly as the case may be. Preferable that field visits
are undertaken at irregular intervals to bring in surprise element.

3. Ways in which credit monitoring / post-sanction follow up can be done:

i) Physical follow-up
ii) Financial follow-up
iii) Operational follow-up
iv) Legal follow-up

3.1 Physical follow-up:Physical follow-up ensures that the assets financed by the
bank are in existence (physically available) during the currency of the loan. The
authorized officer of the branch has to periodically visit and ensure that securities
charged to the bank are physically available and that they are properly serviced and
maintained. In case any fall in value of the security is noticed/contemplated,
necessary corrective measures are to be immediately initiated by the branches with
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the borrower. The matter is to be kept informed to the higher authorities. The
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following aspects are to be remembered by the branches while making physical
follow-up.

i) Inspection visits shall be at irregular intervals to ensure that the assets created
out of bank finance are existing. Surprise visits undertaken may bring to light any
serious irregularity in the maintenance of the securities.

ii) At periodical intervals, branch must ensure that the securities charged to it are in
good condition and do not show any sign of depletion in value. Market rate
register is to be maintained by the branches to note down the value of the
securities from time to time. Wherever depletion in value of the securities is
noticed, timely corrective action is to be taken to improve the value of the
securities by calling for additional securities or additional margin money.

iii) Whenever the loan amount is to be released in stages, before the disbursal at
each stage, the progress of the project is to be examined by calling for a report. It
should be ensured that the funds released earlier are being properly utilized and
subsequent stage release is considered.

iv) Whenever specific releases are made for purchasing machinery/vehicle, it should
be ensured that the assets are created in time. Direct payment be made to the
suppliers of vehicle / machinery, etc

v) In case of project finance, constant follow-up is to be made to ensure that the

project starts commercial production as scheduled, to avoid cost/time overrun. In
fact schedule of implementation obtained at the time of commencement of project
be securitized to check for deviation, if any.

vi) In case of cash credit, it should be ensured that the borrower submits the
stock/book debts statements at prescribed intervals without any delay in the
format prescribed by the bank. The stock/book debts statements are to be
properly examined/studied to ensure that sufficient paid up stocks are available at
all times as security. Fixing of DP, ensuring operations within DP and verification
of stocks and book debts at monthly intervals are to be meticulously attended to
by the branches. It should be ensured that the stocks are not over valued or stale
or unsalable or obsolete.

vii) In respect of borrower’s enjoying credit limits of Rs.50 lacs and above under
OCC/HPCC/CCBD/PCL, the copies of the monthly stock/debtors statement are to
be forwarded to CMD - Central Office. In all other cases, copies of these
statements are to be forwarded to the respective Divisional Office for scrutiny.
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viii)It is also the primary responsibility of branches to make a through scrutiny and
bring to the notice of the borrower all discrepancies or short comings as the case
may be with copies to respective sanctioning authority.

ix) Stock Audit should be conducted every year for all borrowal accounts enjoying
fund based working capital limits exceeding Rs.5.00 crores. For fund based
working capital limits of Rs.3.00 cores to Rs.5 crores, the stock audit should be
conducted once in two years, unless there are compelling reasons to conduct it at
a shorter intervals. In case of consortium advance, stock audit is to be in line with
the decision of the consortium.

x) It is also necessary to look into the methods of storage of goods and manner of
stacking to ensure that the quality of the stocks do not get affected due to climatic
variations. It also enables the bank to verify the stock easily.

xi) In case of KCC/Ware house receipt loans, the godowns are to be visited at
periodical intervals to ensure that the goods are intact and have not deteriorated
in quality.

xii) It should be ensured that excessive stocks are not maintained by the borrowal
account. Branches should note that excess stock is a drain on the profitability of
the firm. It does call for proper inventory management.

xiii)Proper examination/verification of other securities (like immovable properties,

shares, deposit receipts, NSCs, LIC policies, etc.) is to be made at regular
intervals to ensure that the marketability/value of the securities have not been
adversely affected and ensure that they remain intact and provides full cover for
the facility sanctioned.

xiv) Branch Managers shall physically verify all securities (other than stock
hypothecated) once in a year and a report thereof should be prepared and kept
along with the relevant loan documents. Any adverse features observed shall be
immediately brought to the notice of the sanctioning authority and branches
should take up the matter with the borrower for corrective action.

xv) System of Credit Audit is to be taken-up for new limits with an aggregate fund
based limit of Rs.5 Crores and above. The system of credit audit is to be
entrusted and taken-up through approved panel auditors of the bank. In case of
consortium advances, the credit audit is to be in line with the decision of the
consortium.

3.2 Financial follow-up: Financial follow-up implies the control exercised by the
branches through the help of financial statements. There must be constant rapport
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between the banker and the borrower so that the adverse features noticed during
financial follow-up are rectified immediately. The relationship between the banker
and the borrower is like that of a Doctor & Patient. The borrower should feel free to
discuss all his/her problems about the business with the banker without any
reservation. The branch has to insist the following statements to review the account
at systematic intervals.

a. Stock/Book Debts statements for working capital limits.

b. Financial follow-up statement
c. Annual Balance sheets and Profit & Loss Account. (Audited Statements)
d. Cash flow/Funds flow statements.

3.3 Branch should review the account thoroughly by making appropriate analysis of
financial statements obtained and ensure the following aspects:

a. Current ratio is satisfactory.

b. Profits/ sales are showing improving trends.
c. The financial position of the business is stable. There is increase in the net worth
from year to year.
d. There is no internal or external diversion of funds.
e. The financial results are in line with the industry / business trends.

3.4 Operational follow-up: The accounts maintained by the borrower and his/her
dealings with the branch are the main sources for ensuring operational follow-up.
Operational follow-up should be made to identify the early warning signals of
sickness. If warning signals are noticed, they should not be ignored. Timely steps are
to be taken to set right the situation. The operational follow-up should ensure the
following aspects:

a. The transactions in the accounts are to be properly matched to ensure that they
are commensurate with the business activity. Purchase/Sales figures
corroborate with debits and credits in the bank account. Any abnormality or over
drawings not adjusted in time is to be looked into with disfavor and corrective
steps initiated.

b. The transactions which are suspicious in nature are to be probed to ascertain the
genuineness. The bank finance is meant for genuine trade transactions.

c. Regular over drawing/non utilization of limit are indicate early warning signals of
incipient sickness. The account should show brisk operations. Irregularly in
working capital limits indicate signs of incipient sickness.
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d. In case of bills/cheque purchased, the branches must ensure that the
instruments are genuine and not accommodative in nature.

e. Returns of bills/cheques, for whatever reason, have to be seriously taken note of

and further purchases shall be undertaken with utmost care and caution. Record
of all such returns be made and followed up with the borrower.

f. It is advisable not to entertain further requests from the borrower where there are
frequent instances of devolvement of LCs or invocation of Bank Guarantees.

g. It should be ensured that funds are not diverted to unapproved purposes. Any
cheque given to parties who are not connected with borrower’s line of business
is to be probed into.

h. Wherever installments /interest are not paid in time, the branches shall contact
the borrower and prevail upon him/her to clear the dues. The branches should
undertake this follow-up in a systematic and ongoing basis. Steps are to be
ensured to collect arrears on time and avoid allowing arrears to get accumulated.

i. Besides all the above, Branch Head should discretely get the market report on
an ongoing basis about the borrower. Adverse reports are to be probed in depth
to ascertain the facts and suitable remedial actions to be initiated to safeguard
the interests of the bank. Every single instance of default shall be taken serious
note of and utmost endeavor be taken to effect timely recovery.

3.4 Legal follow-up: The legal follow-up mainly revolves round the process of
keeping the validity/enforceability of the documents obtained by the branches at the
time of releasing the credit facility. The following aspects are part of legal follow-up:

a) Branches should obtain Initial Certificate of Correctness (ICC) and Final

Enforceability Certificate (FEC) as per the schedule given below:

Pre-
Credit Post-disbursement
disbursement
Limit stage
stage

Rs.10 No condition is Copy of documents

lacs and stipulated executed to be sent to
above but Legal Consultants at
below the respective DOs.
Rs.25 They shall issue FEC
lakcs to the branch marking
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a copy to the
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respective sanctioning
 authority

Above Draft documents

Rs.25 to be produced to
lacs and Legal
upto Consultants at
Rs.100 DOs and ICC to
lacs be obtained.
Based on ICC,
Same as above
sanctioning
authority will
issue formal
sanction
communication

Above Same as above Upon receipt of formal

Rs.100 sanction, copies of
lacs documents executed
should be forwarded to
CO:Legal Dept at the
post sanction stage,
who shall issue FEC to
the branch marking a
copy to the respective
sanctioning authority

b) Branches should obtain revival letter for DPN once in three years in respect of all
borrowers so as to ensure that the documents do not get time barred by
limitation. For this, branches should not wait until the expiry of the documents.
Proper diarizing the due dates for each DPN be undertaken and follow up for
getting revival letter at least 6months in advance of the expiry date is
recommended. Branches should keep a continuous watch and take up renewal of
DPN well in advance.

c) Branches should obtain balance confirmation for all the accounts/facilities on half
yearly basis, irrespective of the limits enjoyed, duly signed by the borrower(s) or
by authorized person.

d) Encumbrance Certificate is to be obtained once in a year to ensure that no further

encumbrance has been created on the immovable securities offered as security
to the bank. Bank itself can apply for EC and keep it on record.

e) Search report from ROC for companies account shall be obtained on annual
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basis
4. When does monitoring commence?

4.1 Monitoring commences immediately after the advance is disbursed. However in

many cases, only when the account shows signals of sickness, monitoring exercise
is taken by branches. Instead, monitoring of advance should begin even at the time
of sourcing of the account i.e., at the time of conducting credit investigation of the
applicant and continue in all other stages of credit cycle viz., putting up the proposal
with right terms and conditions, pre-disbursement care, observations on the conduct
of the account from the records available and the most importantly during ‘On-Site’
visits.

4.2The first source is the client himself (though this may not constitute market
information in a very strict sense). When banker discusses with the client about the
business in general, in a very informal manner, lot of things come out or ascertained.
The only way a banker can ascertain reliable information is by asking the right
questions.

4.3 In fact, the art of asking the right questions that would elicit information without
the customer getting offended or suspicious, is something that a banker picks up
over a period of time and this art will help the bankers in a very crucial way.

4.4 The second source is the borrower’s suppliers and buyers. In smaller places,
particularly the SME clients, many times, both the supplier and the buyer of the
borrower will also be banking with the same bank. In such cases, it is definitely
easier for the banks together information. Even in cases where the supplier and the
buyer are not dealing with the same bank, still it is possible for the banker to get
information.

4.5 The third source is the employees. This can be a very powerful source of very
reliable information that will help the banker to understand the borrower. Information
from employees can be gathered through informal chats or conversations during unit
visits or when the employee of the customer visits the branch for tendering bills /
cheques or transacting any banking business.

5. Pre-Disbursement Care

5.1 Once a proposal for granting of credit facilities to a client is sanctioned /

approved, before disbursement, lot of care has to be taken.

5.2 Disbursement is a term used by bankers to indicate actual release of money to

the client in respect of credit facilities sanctioned. Monitoring commences right at the
time of client sourcing and hence naturally plays a vital role at the time of
disbursement. Bankers generally refer to this monitoring as the ‘care and caution’
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exercise to be undertaken during the stage of disbursement.

5.3 Since bankers are sanctioning credit facilities both for working capital
requirements and acquisition of capital assets, the disbursement care depends on
the nature of facility sanctioned.

5.4 Irrespective of the nature of facility, there are a few aspects, which, a banker
should take into cognizance before releasing the facilities.

5.5 The first and the foremost is the time gap between the time of initiation of
proposal and the actual date when credit facilities are sanctioned. Acts of nature
(Tsunami or an earthquake affecting either the supplier or the buyer though not the
client himself), extraneous environmental factors, etc., do exert influence on the
continuance of business.

5.6 Credit monitoring implies exercising of constant watch over the functioning of the
unit so as to ensure that the amount lent continues to be safe and income yielding. It
is natural that whenever the unit is experiencing certain difficulties, its financial
indicators are likely to be affected. No doubt the financial imbalances will reflect in
operations in the accounts. Hence it is necessary to exercise watch over operations.

5.7 Post sanction review is to be done to ensure that the financial health of the
borrower continues to remain good. Also the securities available do not depreciate
in value or subject to wide fluctuations.

5.8 It should be ensured that proper documentation is obtained as this protects our
rights as also minimises chances of litigation at the recovery stage.

5.9 All the sanction terms and conditions are to be complied with before
disbursement of the loan. In case of any genuine difficulty in compliance of terms
and conditions, the same shall be reported to the sanctioning authorities for
waiver/doing the needful. This process ensures that there is no deviation in
compliance of terms and conditions of sanction.

5.10 All the follow up / control statements must be reviewed meticulously. The
warning signals identified by the branch should be thoroughly examined/understood
and appropriate measures are to be taken to see that the unit continues to be
healthy. The important feedback statements are Stock Statement cum MSOD,
QOS- I & II, FFS-1 & II, Production and Sales statements, sundry debtors, sundry
creditor’s statements etc.

5.11 Constant review is to be made to ensure that the borrower maintains financial
discipline. Monitoring of the transactions in the operative accounts is to be done to
see that the borrower does not resort to over-trading or diversion of funds.
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5.12 Mid-term reviews are to be done effectively to ensure that the financial health of
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the unit has not deteriorated.

5.13 Periodical review of returns provides useful information for monitoring. These
are to be scrutinised thoroughly so that the status of the unit can be assessed
correctly.

5.14 Monitoring is a continuous process. Once a decision to extend financial

assistance to a borrower is taken, an enduring relationship with borrower gets
established. This relationship, to be healthy, demands a systematic review of
activities to be undertaken by the bank.

5.15 Monitoring is a logical step. It is a systematic examination of activities like

execution of documents, creation of securities, perfection of registration of charges,
obtention of operational data, fixation of drawing limits and lastly obtention and
meticulous scrutiny of control statements. Branches should ensure that all these
activities are done as per laid down procedure.

5.16 A small checklist is indicated below where different conditionalities are specified
to take care of various types / modalities of disbursement:

Type of Working Capital Term Loan/Project

Disbursement Facilities Finance
Direct 1. If fresh facility, Collect the margin
Disbursement issue Pay Order / from the borrower &
Demand Draft in issue PO / DD in
favour of suppliers. favour of suppliers
2. Check for the
invoices, verify
receipt of goods,
work out the
drawing power &
credit the a/c.
Reimbursement Verify the original Verify the original
invoices, confirm invoices, confirm
receipt of goods, receipt of machinery /
inspect, credit the asset, obtain
amount, take valuations & life
necessary letter from certificate wherever
customer necessary, conduct
inspection, credit the
amount, take
necessary letter from
customer
Cash Depends on the Generally does not
Reimbursement nature of business arise.
provided it is the
business practice,
obtain proof / receipt,
undertaking, credit the
account
Disbursement in Generally not done, Done in projects.
phases except in housing and Obtain progress
project finance. If reports / value the
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done, follow the same progress, do direct

steps asdescribed for disbursement in
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direct disbursement stages

5.7 In case of non-fund based facilities, since no parting of funds is involved, the
banker will have to ensure that necessary conditions that warrant establishment of
LC or issuing of BG is fulfilled (like finalisation of contract, Credit Report on the
suppliers, etc.)

6. Post-Disbursement Monitoring

Following is the check list for monitoring the important facilities extended by banks.

6.1 Off Site Supervision: Off-site supervision refers to monitoring of the borrowal
accounts without visiting the unit or meeting the borrower in person. This can be
accomplished in two ways:

a) By monitoring operations in the account and

b) By study of QOS, MSOD, Cash Budget and Financial Statements.

6.2 What one can observe and draw conclusions on the scrutiny of the operations in
an account can be well understood if we analyze facility-wise - particularly debits,
credits, servicing of interest, repayment of principal, bringing to credit cash credit /
overdraft accounts once in a while, meeting cheque payments for supplies received,
purchase of bills and prompt realisation of bills /cheques; meeting all trade
obligations without default, etc.

6.3 On-Site Inspection: On-site inspection is the actual visit to the unit of the
borrower. Before envisaging unit visit, certain preparatory work is needed.

6.4 Study the operations in the account during the intervening period (as between
last inspection date and current inspection date).

6.5 Take a copy of latest Stock Statement and Book Debts Statement submitted by
the borrower. Verify whether goods are properly stored and capable of easy
verification and also look to the stacking order.

6.6 Verify the previous unit inspection report to find out if any deficiencies have been
observed; if so,whether these have been set right.

6.7 Verify the approved proposal viz-a-viz sanction order and find out if any of the
covenants/terms and conditions are not fulfilled so that the same could be discussed
during the unit visit for rectification.

6.8 Take a copy of the MSOD, while visiting the unit

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6.9 Verify the conduct of non-fund based limits viz., Guarantees and Letters of Credit
and discuss about any adverse features noticed / observed for immediate
rectification.

6.10 Verify if the internal / external / concurrent auditor has made any
comments/observations about the conduct of the account which needs to be
discussed.

6.11 Verify the validity of the insurance cover against stocks, godown as also other
assets such as buildings, machinery, etc, offered as collateral security, if any.

6.12 Books and records to be verified:

a) Purchase Register – Details of cash purchases, credit purchases

b) Production Register – Compare actual capacity with installed capacity
c) Excise records, Sales Register, Vat records
d) Invoices ( Sales and Purchases),
e) Stock Register,Outstanding Debtors and Creditors
f) Job Works Register, if any
g) Power and other utility bills – Compare the monthly bills
h) Validity of licenses and permits
i) Meeting of statutory obligations / payment of utility - other dues

6.13 The above records are to be verified to confirm that the transactions as found in
the Bank’s books are correlated with that maintained by the unit. It is needless to say
that 100% checking of every entry in the books and documents is neither possible
nor feasible. A random checking of various items outlined above should suffice.

6.14 Physical Verification of Assets

a) Verify whether the company’s name board is prominently displayed and it tallies
with that in Bank’s records.

b) The building and other structures are well constructed. The buildings have easy
access. In case of rented buildings, access letter be obtained from owner of the
building, permitting the bank to have access at all times.

c) Verify whether all the machineries are working. If any machinery is found idle,
find out the reasons for the same.
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d) Whether all the machineries are working to full capacity. Identify the idle capacity
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if any.
7. Scrutiny of Stocks and Receivables statements

7.1 Stock statements and Receivables statements are important returns received by
the banks from the borrowers who avail of working capital credit facility against
hypothecation of stocks and receivables. The points to be verified in a stock
statement are:

a) The stock statement should be in the standard format of the bank.

b) Should bear date just after the date on which the stocks are detailed out.

c) Name and address should be spelt as recorded in the bank (or as specified in
credit proposal).

d) Godown address should tally with the address as recorded in the bank.

e) All columns should be properly filled in. No columns should be left blank.

f) Stocks should be related to the type of business for which the credit facilities are
sanctioned.

g) The value of paid stocks is to be properly arrived.

h) Stocks should be adequately insured against all risks. The policy must be in the
name of bank and the policy should bear the correct identification marks of the
business premises.

8 Drawing Power (DP)

8.1 The “drawing power” for Open Cash Credit (OCC) is arrived at on the basis of
the value of stocks reflected in the monthly stock statement submitted by the
borrower. Stock statement should contain all the details of stocks in the possession
of the borrower. The details of stocks should be entered in the system to arrive at the
eligible drawing
power on monthly
basis.

8.2 The Drawing

Power can be
manually arrived at
as follows:-

Note: Where the

branches are permitted
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to take book debts also

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for arriving at DP,

branches should calculate DP as per the guidelines mentioned in our credit policy.

8.3 The following items are to be excluded while arriving at DP:

Stocks:
a) Goods purchased under LC/BG
b) Unpaid stock i.e. Sundry Creditors (goods procured under market credit)
c) Stocks of sister /group concerns
d) Goods covered by Trust Receipts/allied concerns
e) Old/ obsolete/nonmoving stock
f) Goods received for job works and on consignment.
g) Old stock which are outstanding for more than the period permitted
h) Received under Channel financing stock of stores, spares.

Book Debts:
a) Bad and doubtful debts – debts which are difficult to recover or time barred.
b) Debts outstanding beyond the period permitted in the sanction letter.
c) Debts in respect of which bill finance has been given
d) Debts assigned to factoring agency
e) Debts under supply chain financing
f) Receivables from sister/group concerns (unless specifically permitted in the
sanction).

8.4 Operations in OCC account are to be allowed within the drawing power arrived at
as per the latest stock statement or the limit sanctioned whichever is less. Branches
should clearly bear in mind that if the stock position reflected in the latest stock
statement is not updated, the system will continue to allow operations basing only on
existing DP. Hence, if stock statements are not obtained in time and the collateral
master is not updated promptly, the bank may run the risk of allowing higher/lower
limit to the borrower which may prove to be detrimental to the interest of the
bank/borrower.

9. Insurance

9.1 Maintain insurance due date register in excel file and note down:

a) Borrower wise insurance details.

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b) Insurance company wise details of insurance policies.

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c) Insurance falling due for any given period.

d) Insurance details—security wise.

9.2 Verify that

a) all the assets charged to the bank are fully insured.

b) it is in the joint names of the bank and the borrower. (in fact it must be taken in
bank’s name)

c) the full description of the goods, place of storage and nature of risks covered are
properly mentioned.

d) the policy document leaves no scope for any ambiguity, as otherwise, it will be
difficult to entertain the claim.

e) where the hypothecated goods/stock are stored in more than one godown, the
description of the goods/stock and the location of the godowns are correctly
mentioned in the policy;

f) that the place of storage of each godown is covered separately clearly

mentioning all the details in the insurance policy.

g) the insurance is for the full value of the hypothecated security, irrespective of the
loan amount.

9.3 Average clause:The insurance company will be liable only for that portion of
loss which the amount of policy bears to the total value of the goods. This is called
“average clause”.

Example:If the stock worth is.Rs.10 lakhs and it is insured only for Rs.4 lakhs and if
the loss amounts to Rs.2 lakhs, the insurer will settle the claim for Rs.80,000/- only,
which is arrived as under:

Rs.2,00,000 X 4,00,000 = Rs.80, 000/

10,00,000

The remaining loss amount of Rs.1.20 lakhs is to be borne by the borrower. Hence
there should be no case of under insurance.

10. Inspection of Securities

10.1 Inspection of securities implies physical examination of the assets created out
of the bank finance and also the other assets offered as either primary or collateral
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security. Securities may be moveable or immoveable. Inspection of securities is an

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essential and effective credit monitoring tool, and has to be done properly /
meticulously with great care.

10.2 General norms for inspection of securities:

a. Inspection visits shall be conducted at irregular intervals to ensure that (i) the
assets created out of bank finance are existing (ii) they are in good condition and
(iii) do not show any sign of depletion in value.
b. Wherever depletion in value of the securities is noticed, timely corrective action is
to be taken to improve the value of the securities by calling for additional
securities. The matter has to be discussed with the borrower.
c. Surprise visits may also be undertaken which may bring to light any serious
irregularity in the maintenance of the securities charged to the bank.
d. Whenever the loan amount is to be released in installments, before the disbursal
of each installment, the progress of the project is to be examined by on- site visit.
It should be ensured that the funds released earlier have been properly utilized. A
record of findings of each visit will help to ensure proper monitoring.
e. In case of cash credit, it should be ensured that liability is backed by adequate
drawing power, which has to be arrived at from stock statements. So obtention of
stock statements on time and visiting the business place for stock verification
assume great significance
f. Inspecting officials shall carry out inspection of securities as per guidelines given
by CO: IAD as to the percentage of securities to be covered in each inspection.
g. Stock audit shall be conducted as per credit policy guidelines.

10.3 What are the types of securities to be inspected?

i) Immoveable properties like Land and Building, Plant and Machinery, etc.
ii) Moveable properties like stocks, vehicles, etc.
iii) Book Debts(verification of books of account)
iv) Apart from verifying physically, books and records also need to be verified.
11. Unit Visit

11.1 All the stocks charged to the Bank under hypothecation should be inspected.
Inspection should be done regularly, at irregular intervals, on surprise basis by the
Branch Head/Officer on rotation basis.

11.2 What to do?

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a) The godown/business conforms to the terms of sanction communication.

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b) Godowns in which good/stocks are stored are in good condition – There is a
need for proper stacking

c) Godowns are easily accessible – have independent access

11.3 Check

a) Whether name board is displayed prominently.

b) That the bank’s hypothecation name board is displayed at a prominent place.

c) Adequate paid stocks are available during the unit visit.

d) The nature and quality of goods available is saleable / marketable. The stock
does not show deterioration in quality and value.

e) The stocks are stored in countable manner to facilitate easy checking –in short,
proper stacking arrangements.

f) Details in the stock register and those available in the godown should tally with
each other. The inspecting official must ensure this during the personal visit.

g) The records such as purchase register, sales register, stock register, sales tax
records, and excise duty records be checked on random basis to ensure that the
figures furnished by the borrower through stock statement tally with the
concerned register/records maintained.

h) Stock inspection registers are to be maintained at the branch and at the

customer’s godown. Both must be similar and indicate the same level of stock.

12. Inspection of land and building securities - Points to be observed:

12.1 Land:

a) Whether the land is an agricultural land or industrial land or residential land?

(residential site)

b) If it is an agricultural land, whether the land is taken as security for agricultural

loans?

c) If agricultural land is taken for non-agricultural loans, verify whether there is any
restriction as per State Law.

d) Whether the land is freehold or leasehold? Whether the lease is valid and does
not contain any restrictive covenants? In case of tenanted property, whether rent
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is paid up-to-date?
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e) Verify the land with respect to the land documents, a copy of which should be
carried while visiting the landed property.

f) Survey numbers cannot be verified by physical verification alone; take the

assistance of local authorities. Better to obtain an authentic record from land
revenue authorities.

g) Whether the land is land-locked or there is free access to the land?

h) What is the guideline value and market value? Ensure that there is no wide gap
between the two.

i) Whether any construction or hutments etc., are noticed in the land which is taken
as security. Sometimes hutments would have been raised in an unauthorized
way.

j) Whether the land is nearer to burial ground, temple, school, mosque or church
and if so, appropriate additional precautions need to be taken.

k) Whether the land is nearer to railway lines, highways etc., & whether prone to
acquisition by land revenue authorities.

12.2 Building:

a) Whether the construction is as per approved plan

b) Whether there is urban land clearance
c) Type of construction and quality of construction
d) Whether the branch holds copy of valuation report by a qualified engineer who is
in our Bank’s panel.
e) Whether the building is maintained properly
f) Free accessibility and availability of insurance to cover all risks.
Note: Besides the above, all other relevant points mentioned to godown are also
equally applicable to loans against land and building.

13. Inspection of plant and machinery - Points to be observed:

a) Whether the machinery installed is as per descriptions in the invoice.Stamped

receipts need to be kept along with loan papers.
b) Whether technology applied will become out of date or obsolete quite soon.
c) Whether AMC is available and if so, whether the machinery maintenance aspects
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are taken care of in a systematic and proper way at regular intervals.

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d) Whether the machinery is in good working condition at the time of visit.

e) Whether the residual life of machinery is more than the period of credit facility.
f) Whether there are frequent break downs as per records
g) Whether the machinery is put to full capacity utilization/ planned capacity
utilization. If idle capacity is observed, extent of such unutilized capacity.
h) Verify the electricity meter readings and if there is abnormal variation, ascertain
the reasons thereof. If the machineries are not put into use, electricity
consumption will be low and it is an indication that there is under utilization.
i) When additional machineries are noticed, ask for the source; it could be diversion
from short term sources to long term uses. Additional machineries are to be kept
in a separate place or portion of the building.
j) Availability of pollution control clearance, wherever required. It is necessary to
obtain clearances from various other agencies as required for the type of
business.
k) In case of imported machineries, whether spare parts are available locally; if the
same are to be procured from abroad, whether supplies are coming in time and
machinery is not kept idle due to this reason.
l) Whether servicing facilities are available for the machineries locally in case of
repairs, as otherwise maintenance will be a problem.
14. Stock inspection - Points to be observed

a) All aspects relating to the godown like construction, suitability, accessibility,

security etc.
b) Whether the goods are stored in an orderly manner
c) Whether there is adequate space for moving between the rows to facilitate easy
verification of stocks? In other words stacking arrangements must be satisfactory.
d) Whether the stocks are stored loose in open condition or packed in
bags/tins/drums etc.
e) If the stocks are kept in an open compound, whether there are walls on all sides
with entrance gate with locking facilities to ensure safety.
f) Whether the non-moving stocks are moving or only getting piled up.Better to
keep old / obsolete / non moving stocks separately. Such stocks should not be
included in the stock statement.
g) Whether proper records are available in respect of goods in transit, goods with
third party for processing,etc.
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h) Whether goods of sister/associate concerns are also stored in the same godown
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and if so, whether they are clearly demarcated/kept separately.

i) When borrower has availed both domestic and export finance, whether the goods
are stored in a segregated manner and easily identifiable so that concessional
finance is not availed for domestic sales? (Concessional finance is applicable for
export finance only)
j) Whether stocks are piling up or there is faster movement. In other words, a
prudent businessman with endeavor to keep minimum inventory.
k) Whether FIFO (First in first out) or LIFO (Last in First Out)method is followed?
l) Whether the borrower is undertaking job work also and if so, goods received for
this purpose are kept separately.
m) Whether the borrower is following ABC method in procuring stock. Whether
goods of large value are stocked unnecessarily beyond a reasonable period as it
will be a drag on borrower’s resources.
n) Whether goods not related to his line of business are stored separately.
o) Whether godown card, BIN card and registers are maintained properly.
p) Whether the goods are insured for the peak level of inventory.
15. Inspection of vehicles taken as securities - Points to be observed:

a) During the currency of the loan, Branch Head/Officer should inspect the vehicle
at least once in a year.

b) Original RC to be verified every time when we go for inspection of all types of

vehicles viz., two wheelers, four wheelers, autos, tempos, lorries, tractors, etc.

c) Ensure that hypothecation clause is in favor of our Bank and clearly mentioned in
the RC.

d) Verify whether payment of taxes is up-to-date

e) Call for insurance policy and verify as to the validity, bank clause, sufficiency of
cover, etc.

f) Verify the engine number/chassis number on the vehicle. Ensure that these
correspond to the entries in the copy of the RC kept in the bank.

g) Verify all necessary licenses, route permits, FC (certificate of fitness), etc.

h) Verify the general condition of the vehicle and its maintenance

i) Whether name of our bank is visibly painted in case of commercial vehicles

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16. Books and records generally to be called for whenever godown inspection
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is conducted:
16.1 The following books are to be verified during godown inspection:

• Stock Register
• Sales Register
• Purchase Register
• Receivables Book
• Dispatch Register
• Records for old and obsolete stocks

16.2 In case the registers are maintained in electronic form, the same are to be
verified through the system and copies taken wherever required.

16.3 The following records may be called for and verified:

• Invoices
• Excise Duty /Sales tax records
• Latest tax receipts
• Electricity Bills
• Rent paid receipts
• Licenses and permits
• Insurance policies
• RC books in case of financing of vehicles

17. Monitoring of Term Loans:

17.1 Monitoring of term loans begins from the very start i.e. with the release of the
loan. In every stage of the term loan (from the stage of release to the stage of
closure), close monitoring is required.

17.2 Pre-disbursement phase: All the terms and conditions stipulated in the formal
sanction letter are to be complied with before disbursement. No disbursement shall
take place without proper documentation.

17.3 EM should be created before disbursement. If for any reason, creation of EM is

not possible before disbursement, specific permission from the sanctioning authority
should be available and the time or period when charge would be created should be
diarized.

17.4 Extra care needs to be exercised in the case of take-over of loans. NOC for
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handing over the security documents directly to us from the transferor bank should
be obtained beforehand. Such documents need to be scrutinized by our approved
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lawyer to ensure clear, valid, marketable title over the property. Our lawyer must
certify that the property is free from encumbrances and can be accepted as security.

17.5 Whenever we handover DD or send the loan proceeds through NEFT/RTGS to

other banks, ensure obtention of related security documents from the transferor bank
simultaneously. Instances are not uncommon when the transferor bank exercises
their lien subsequently on the securities for some other commitments of the borrower
either directly or indirectly.

17.6Disbursement phase: Term loan would normally be disbursed in stages in

conformity with the terms of sanction, after completion of documentation formalities.
In big projects where huge amount is involved, payments are to be made to
equipment suppliers, civil contractors and various suppliers. The disbursements
should be commensurate with the progress of the project / business activity, as also
taking into account the extent of margin brought in by the promoters up to the given
point of time.

17.7For loans like TL(B) / TL(O) / home loan, loan amount is released in stages
based on the draw down schedule and hence, get hold of stage-wise certificates
issued by the Bank’s panel engineer. Branches should release according to the draw
down schedule of amounts such as the first date of disbursal, the stages in which the
monies are required to be drawn and the last date of disbursal.

17.8 In such cases, visit by the branch officials to the construction site before and
after the draw down schedule would be of immense use to monitor the account.

17.9When term loans are sanctioned, the proceeds of the loan be disbursed by
issuing a Pay Order / Demand Draft / NEFT / RTGS favouring the seller i.e. directly
crediting the account of the seller. E.g., if a borrower has been sanctioned with a
vehicle loan, the proceeds of the loan are to be paid to the automobile dealer, who
has issued the quotation and who will eventually deliver the vehicles. In case of
purchase of machineries, similar procedure is to be followed for payment directly to
the vendor.

18. Project Implementation/Completion phase:

18.1 The following aspects, wherever applicable, may be kept in mind by branches
for monitoring during project implementation phase:

a) Obtention of schedule of implementation – a time table for project implementation

schedule.
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b) Actual project schedule viz a viz the current status

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c) Possibility of time or cost overrun – if so, how this will be met by the borrower.
d) Adequacy of arrangements to meet cost overruns

e) Impact of time overrun on timely cash generation of the project – whether it will
alter the supply-demand position, marketability, etc.

f) Periodical verification of records such as invoices, stamped receipts, account

books, records to verify proper utilization of the money lent

g) Periodical inspection of the unit to check promptness in implementation schedule.

18.2 Branches shall obtain the following documents during implementation

stage:

a) Statement of progress report covering both physical and financial progress shall
be obtained at periodical intervals and analyzed. Periodical status report on the
project shall be obtained by way of Project Implementation Progress Report
(PIPR), Lenders’ Independent Engineer’s Report (LIE report), etc. Sanctioning
authority may stipulate obtention of PIPR or LIE Report, as the case may be,
depending upon the need and project size.

b) To ensure the upfront infusion of equity by the borrower, a Certificate from

Chartered Accountant is to be obtained for confirming the proportionate infusion.

c) Opening of Trust & Retention account (TRA) / Escrow accounts is one more
means to monitor the project finance / term loans. The objective is to pool both
equity and debt drawls into common account, wherefrom sanctioned expenses
would be met.

19 Verification of end use

19.1 Loan funds should be used for the purpose for which it is sanctioned. End use
can be ensured by verifying the original invoice, receipt and other documents.

19.2 Security verification after purchase of the securities for which loan is given is a
must for all types of term loans.

19.3 Once a project is completed, Project Completion Certificate should be obtained.

This should be followed by a visit by branch officials to ensure that the loan proceeds
are spent for the purpose for which it is intended.

20Credit monitoring aspects to be seen in respect of new projects

20.1 Whether necessary infrastructure for the proper functioning of the unit /
machinery like power connection, water, etc., is in place at the unit.
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20.2 Whether power connection is given to the machinery installed; if not, by what
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time?
20.3 Whether the machinery is in good condition as per the terms of sanction. In
case machinery has been imported from abroad, Bill of Entry can be verified. In case
machinery has been procured locally, verify whether it is old machinery or new
machinery. Where sanction has permitted term loan for purchase of old machinery,
more due diligence is required. Residual life of the old machinery shall be looked into
and an independent chartered engineer’s certificate be insisted.

20.4 Whether the unit has started trial run or commercial production; whether the
same is as per schedule? (in fact schedule of implementation is the TIME TABLE for
project execution)

20.5 Probable dates of trial production and commercial production should be called
for. Before the unit goes into trial production, it should be verified whether all
arrangements for procurement of material, power, fuel, men and money have been
made. The interval between trial production and commercial production varies from
industry to industry. However, it should be ensured that the interval is reasonable
with reference to the nature of the industry.

20.6 Whether working capital is released only after machinery installed is put to test
for commercial operations

20.7 During subsequent visits, it is essential to verify whether the machinery is in

working condition and the unit is functioning; in case the borrower mentions about
periodical maintenance’ or `break down’ etc.. during our visit, it is advisable to look
into the frequency of breakdowns and steps taken to set right the same.

21Importance of scrutiny of operations in the account:

21.1 Scrutiny of account operations, be it in OCC or PC or SOD or any other working

capital facility, may provide early warning signals. If the early warning signals are
identified at the right time, it will protect the interest of the Bank. Monitoring through
scrutiny of account operations does not mean a mere glancing of debits and credits
but one should develop the habit of reading beyond the figures, interaction with
borrower, understanding the market trends, etc.

21.2 Scrutiny of account operations in a working capital account is to ensure that

operations are as per the assumptions made at the time of sanction of credit facility.
Scrutiny of operations in a term loan account helps us to find out whether the
disbursements made are in accordance with the sanction terms, whether interest is
being serviced during holiday period (wherever stipulated), whether interest and
installments are being paid promptly on respective due dates, etc.
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21.3 Aspects to be seen during scrutiny of operations

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a) Frequent inward cheque returns – proper record of returns

b) Frequent outward cheque return– proper record of returns
c) Frequent request for exceedings
d) Stagnancy in account operations or absence of fluctuations
e) Extraneous transactions
f) Diversion
g) Cash withdrawals

22. Early Warning Signals that may surface during credit monitoring activity:

22.1 Non submission / delayed submission of stock statements and poor records
maintenance

22.2 Unwillingness or fraudulent intention, not to mention the age of book debts in
book debts statement. It would mean only carryover of debts outstandings in books
over a long period of time.

22.3 Increase in inventory which may include large quantity of slow and non-moving
items – not consistent with the type of business or business practices.

22.4 Huge procurement of raw materials more than what was projected in the credit
proposal, that is what was really needed to maintain the scale of operations.

22.5 Downward trend in sales indicating fall in demand for the product.

22.6 Production noticeably below projected level of capacity utilization – may be due
to power shortages, raw material shortages or machinery breakdowns.

22.7 Labour problems and frequent interruptions to manufacturing activity.

22.8 Transactions monitoring may reveal diversion of funds or extraneous

transactions in the account not related to the actual business activity.

22.9 Not routing the entire sales transactions through the account possibly indicating
accounts with some other banks without our permission – internal diversion of funds.

22.10 Frequent over drawings/cheque returns in the account, devolvement of LCs

and invocation of BGs, indicating severe liquidity strain

22.11 Non-payment of property tax/rent, electricity charges, water tax and lease rent,
failure to remit statutory dues like PF, etc.

22.12 Non-payment of premium for LIC policies assigned to us(when LIC policies are
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offered as security), non- payment of tax

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22.13 Unplanned outside borrowings – lacking financial discipline

22.14 Increasing creditors velocity indicating delayed payment for supplies

22.15 Increasing debtors velocity indicating poor collection mechanism or poor

quality of receivables.

22.16 If borrower often approaches the Bank for adjustment of bills purchased or
cheque returns by debit to their operative account, additional care needs to be
exercised, since he would have collected the proceeds directly or transactions may
not be bonafide / genuine (may be of accommodative nature)

22.17 Utilization of the working capital limit to the brim/ maximum and no subsequent
operations of debit or credit, or absence of swings in operation – these are clear
signs of mismanagement or over trading.

22.18 Undue delay in project implementation, leading to time/cost over runs.

Breakeven level is extended and which affect cash flows.

22.19 Installation of substandard machinery or machinery not as per sanction terms.

In fact old machineries, wherever permitted by us during sanction, need to be
certified by our panel engineer/chartered engineer for its continued good
performance without frequent breakdowns.

22.20 Frequent breakdown in plant/machinery and non-availability of spare parts.

These instances must not be ignored.

22.21 Frequent attrition of employees especially key personnel/managerial

personnel. Such exit of key personnel with affect even continuity of business.

22.22 Delay or failure to pay statutory dues in time. Government may have a hand
over the unit.

22.23 Acquisition of new assets without infusion of capital/ through unsecured loans
from outside or term loan from other Banks, indicate diversion of funds. Funds may
be diverted internally from working capital or resort to heavy outside borrowings
without bank’s knowledge.

22.24 Unjustified rapid expansion within a short time without appropriate financial tie-
up or without getting consent from the bank.

22.25 Lack of transparency in borrower’s dealings with the Bank/avoiding to meet

Bank staff / avoiding to discuss problems in managing the business.

23.Stock audit
27

23.1 Stock audit is an important credit monitoring tool for effective supervision of
credit portfolio. Stock and Debtors being the primary security in Cash Credit facility,
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banks obtain stock statement and conduct stock inspection at periodic intervals.
However, bankers may not have knowledge about all kinds of goods financed, all
types of accounting practices and also may not be able to carry out a detailed
verification of stocks when they are huge in number. Hence, banks engage external
agents to conduct stock audit. Stock audit is in addition to the stock inspection
conducted by branches on periodical basis and will be conducted by external
auditors, generally Chartered Accountants and Cost Accountants.

23.2Stock Audit, unlike stock inspection by branches, is not confined to physical

verification of stocks alone. The scope of stock audit extends much beyond, as
discussed in the following paragraphs. It is generally conducted for accounts beyond
a threshold limit as defined in Credit Policy. Stock audit helps in prevention and early
detection of frauds, as also signs of incipient sickness.

23.3As per our Bank’s credit policy, external auditors who are in the Bank’s
approved panel shall conduct stock audit for all borrowal accounts enjoying fund
based working capital limits as per following guidelines:

a) For working capital limits (funded) of Rs.5 crores. and above, once in a year
b) For working capital limits (funded) of Rs.3 crores and above but below Rs.5
Crores, once in two years

23.4Stock audit may also be ordered at shorter intervals, wherever required.

23.5Stock audit is waived for all WC limits sanctioned under SOD (RE),
Varthagamitra scheme, etc., where stock and book debts are obtained as collateral
security with primary security being land/building.

23.6 Advantages of stock audit:

a) Verification of the stocks and books of accounts by an impartial third party -
outsider.
b) A professional check on the methods of accounting by a qualified C.A.
c) The calculation of DP by verifying the various components of stock by the auditor
will add a stamp of authenticity to the entire process of stock verification.
d) A full-fledged & thorough check of the stocks, scrutiny of books, examination of
accounting methods, mechanism of valuation and identification of obsolete or
slow moving stocks will be done to evaluate the conduct of the business.

24. Credit Audit

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24.1 Credit Audit is implemented in most of the banks mainly as a pre-disbursement

exercise while in some banks it is conducted as a post disbursement exercise.
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Former is known as Pre-release audit and the latter as Credit Audit or Credit Process
Audit.

24.2 The pre-disbursement credit audit covers all the processes followed in sanction
(akin to credit appraisal sanction review), details of securities available, compliance
of sanction terms and conditions, documentation etc., so as to verify the
conformance to the laid down regulations procedures, without questioning the
discretion exercised by the sanctioning authority.

24.3 Credit audit involves the examination of following steps:

a) Post sanction compliance of terms & conditions

b) Verification of documentation
c) Perfection of securities
d) Creation of charge

24.4 It is in fact an audit put in place to identify, analyze and appraise

discrepancies/shortcomings/defects, if any for timely action and rectification. The
main object of credit audit is to keep the Bank’s assets healthy.

24.5 In our Bank, the Credit Audit is known as Post Disbursement Verification Audit
(PDVA). External auditors who are in the Bank approved panel are conducting PDVA
for the following facilities:

a) All fresh sanction of fund based aggregate limits of Rs.5.00 Crores and above.
b) All enhancements of fund based aggregate limits of Rs.5.00 Crores and above.
c) For take over accounts with aggregate exposure of Rs.5.00 Crores and above,
immediately after disbursement.
d) In case of consortium and multiple banking advances, we may fall in line with the
decision of the consortium member banks in this regard.
24.6 In case of existing borrowers, when the aggregate of the existing & proposed
fund based working capital limits exceeds Rs.5 Crores, PDVA is to be conducted.
Branches/ D.Os shall take up with CMG, Central Office for conducting PDVA.
___________________________________________________________________________

Compiled for VRDDHI CTS by Prof. P.S.Srikrishnan., Senior Faculty, SIBSTC, Bangalore.
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