Future of Credit Appraisal Problems in Unsecured Loans Credit Rating Agencies Importance of credit appraisal process

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INCREASED IMPORTANCE OF CREDIT APPRAISAL PROCESS IN TODAY'S BANKING LANDSCAPE
with Mrs. Ranjana Kumar

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The recent economic crisis has seen a spate of defaults on loans across banks and one of the key onsEconomicsStrategyHuman reasons behind this seems to be inadequate credit appraisal processes. Through this interview with Mrs. Ranjana Kumar, Vigilance Commissioner and former Chairperson and Managing Director, FEATUR Indian Bank, we have tried to examine some of the key issues in credit appraisal in the context of recent events to gauge the place it holds or should hold in today's banking landscape.

Importance of credit appraisal process
tejas@iimb: What risk assessment mechanisms are typically used to assess borrowers - with the increased focus post the global financial crisis, what changes have been made to strengthen the process? RK: As far as the credit appraisal in India is considered, we ask for the balance sheet when we get a new account. If it is an existing concern, we'd go through the balance sheet and the profit and loss statement for the past three years, analyze it, have the project report of the company to see how it has been doing and then, on the basis of the project report, we would assess what the requirement is - whether it is a term loan required to purchase plant and machinery etc. or it is just working capital required for running the concern.

Mr. Sanjay

Did you find a causal relationship of this problem to the credit appraisal process? If yes. Again these officers. one of the important reasons for the high NPAs was faulty credit appraisal. It is better that the bank which handles the term loan financing also takes care of the working capital. tejas@iimb: In your past role as the MD of Indian Bank. the number of enquiries they generated. Banking is not like that. know your borrower like the back of your palm. Traditionally we say. In the past. we take monthly information now where earlier it used to be quarterly. what measures did you take to improve the process? RK: Yes.their policies. In Indian bank.their actual sales against what their projections were. one of the problems you handled was the high NPAs on the balance sheet. officers with thorough knowledge and experience would be posted in those branches.are they spread out or are they just banking on 2-3 clients. how are they manning their receivables etc. Further. The main source of repayment to the bank is from the operations of the company. for example. An in-depth analysis is required. we demarcated accounts. Then. subsequent to the restructuring. got into a lot of problems of high nonperforming assets (NPAs) because they gave only term loans. at all levels. It would be done only through certain specialized branches which would have proper policies in place on how the appraisal would be done. One thing I would stress a lot is regular contact with the customer. we take charge of the plant and machinery and the mortgage of the land. their business clientele . people were being judged based on the fact that they were well known or that their company was well known. Over a period of time. organizations like IDBI and IFCI which were basically term lending institutions at that point of time. Also. For instance. Know your borrower like the back of your palm. what they have done etc. were trained in an institute of the SBI which is known for its credit appraisal. That was being done by the various commercial banks and they were the ones who had the operation's income from them. Everything is computerized so it's easy for the borrowers to give the required information to us . There was no in-depth appraisal at all and in a large number of accounts. Most importantly.It is better that the bank which handles the financing of the term loan also takes care of the working capital. not the main source of recovery for the bank. They never kept the working capital accounts with them. That was very important. when we now give these types of loans. internal audit was also strengthened. Sourav Muk on Knowled S Credit Rating Agencies tejas@iimb: Foreign credit appraisal firms incorporate non banking information . if they have participated in a fair abroad. Every branch would not be doing it. the number of those enquiries that have fructified as orders and the number that have just remained as enquiries etc. Judge the promoters also . their scheme of things. there has been an increased emphasis in monitoring the account. We decided to have corporate branches or credit intensive branches such that large credit would be given only through those branches. The bank can also consider taking some collateral security but this is just a comfort factor.

Of course. which father is going to go with his sonin-law etc. when it goes to the banker. Even if you have the best account. which will come only if you meet them regularly. not just the balance sheet. which results in a more comprehensive process. For example. in today's circumstances. there would always be some kind of subjectivity at times. does this data asymmetry pose a threat to consumers by potentially allowing financial institutions to charge higher rates than warranted? RK: Very right. But the most important thing would be the objectivity and the acceptability of the rating agency. some time must be given for consolidation and an 18% growth is very high.do they keep that a secret or not. which brother is separating from his brother. It would involve a cost of course. that's how those rating agencies sustain themselves. Problems in Unsecured Loans tejas@iimb: A common blame that has been laid in the loans business (specifically unsecured loans) is the chase for new customers which results in relaxation of creditworthiness criteria. their experience. tejas@iimb: With the emergence of multiple credit rating agencies in India. For this. If you meet those people regularly you will be able to sense that something may come up and take a decision well in time to limit your exposure. So borrowers would like to know how they are being judged. the people who head their departments.he has to act well in time while the account is still a standard asset. that this year. Assume an annual growth of 18%. In this kind of interest rate regime. how resilient your borrower is. That means you understand the customer. So you have to find out whether the promoter has the wherewithal to come out of a difficult situation i. Now this may not be possible y-o-y. What is your reading of the situation? RK:Absolutely right. they may grow by a maximum of . do you see a problem in terms of data integrity and increased transaction costs? RK: Of course.into their credit rating process. Do you see this as a necessity in India and is it feasible to implement? RK: It's like having complete knowledge of your customer. everything won't go well all the time. Bankers say that there has to be a y-o-y growth and the government also expects it. What a prudent banker should do is find out which father is separating from his son. where interest rates have been deregulated (though banks are by and large following the same interest rates) there are differences. you would need to know about everything. I think it's been suggested now that the borrowers must know on what basis they are rated. and their internal policies. but judiciously use what you can and use it to your benefit. For example. tejas@iimb: Given that the current ratings are not freely accessible to borrowers. I'm not saying that has to be completely relied on. take the gems and jewellery business which is basically a family business. I think in all fairness the borrower should know how he's being rated and the bankers should have a very open policy on that. Suppose a banker wants to reduce exposure in a unit . For any credit institution. Therefore. Perhaps another issue that could come up is the various yardsticks that the rating agency uses to come up with the ratings . there will be a cost to that but we don't know whether the cost will be paid by the borrower or the bank. the bankers have said in the recent meeting of the IBA. That means their expertise. we should aim to be in touch with customers all the time and get market information from them directly. Suppose an SME wants to get itself rated.e. it shows that rating as a plus point.

That is a sustainable model. Gujarat etc. It's a great thing to happen to the country frankly. It started in a big way in South India with Andhra being one of the first and Karnataka and Tamil Nadu.16%. Rajasthan. Future of Credit Appraisal tejas@iimb: How will the Unique ID scheme. if successfully implemented impact the credit appraisal process and the role of credit rating agencies in India? RK: A lot of progress has been made in the implementation of this scheme. There is. A second grade appraisal followed by first grade monitoring can still help the account to be healthy whereas a first grade appraisal followed by second grade monitoring will definitely end up as a problem. particularly in small ticket personal loans. It cannot be a wild goose chase and it shouldn't be that kind of pressure. Today people are becoming much more quality conscious. tejas@iimb: The past few years have seen many players exiting the UPL (Unsecured Personal Loan) space. The question is the expectation. it has come to states like Madhya Pradesh. Which banker would not want to go for them? These SHGs are not necessarily agriculture. It could be products or other activities such as making things in the rural areas. But it has to be done with proper analysis and reasoning based on data. especially in the rural and semi-urban areas. Would a microfinance model through SHGs be a viable form of risk reduction given the difficulty of assessing the creditworthiness of this segment? RK: Microfinance has been here for almost 15-20 years. The benefit of this is that they meet the consumer and they are able to understand the needs of the consumer. So SHGs should also be conscious of the market. of course. Information on those people through this scheme will definitely help. that's where it starts. Work doesn't end in the sanctioning of the account. That's why for the last couple of years we are talking about financial inclusion where we want every person in the rural and semi-urban areas to have a bank account. But this scheme will definitely help. upgrade their skills and most important. Then the quality of advance will definitely suffer. But I think a lot has to do with financial inclusion. that's where it starts. apart from the fact that social lending was mandatory also in a way. The fact is the economy has to grow so people have to be given loans so credit has to expand. make them conscious of the market. Some may be able to achieve this. a lesser risk in doing it through SHGs. It shouldn't be a flash in the pan. Credit rating agencies perhaps could use this as a tool for their own ratings. These things do happen sometimes in rural areas. some may not be able to grow by even 16%. all in a very big way. But in the last decade. And one of the reasons why banks went gaga over these people. then there would be no situation where somebody gets a benefit which is actually to be given to somebody else. don't have a middle man between them and the buyer. . Even more important than the quality of advance is the monitoring process. equip them. So the success of microfinance will come provided you train the staff. the quality standards and they should get trained/ equipped. Work doesn't end in the sanctioning of the account. was because their recoveries were 98-100%. I think the real benefit would also be that if everybody gets this number.

Take agriculture which is a state subject. Known as the 'Turnaround Queen of India'. So help him in this way . and ensuring affordability and credit access to lower income groups? RK: In the US. leading to financial inclusion are expected to play a critical role in credit appraisal and risk management. All materials copyright of the Indian Institute of Management. It is not just the bankers who are responsible.tejas@iimb: Initially in the US. the right quality of seeds. how can a balance be maintained between stricter credit appraisal to reduce risk. Only if the borrower has some stake in the loan. especially low-income segments. If the critical period goes away and then you give the loan. The bank can only give a loan. Ranjana Kumar is a prominent Indian banker. Going forward. incentives were given in order to make housing affordable to everyone. fertilizers etc. more responsible and his self-esteem goes up. will there be a reason for him to repay it. Bangalore © 2008 Feedback . from a government regulation standpoint. Going forward. It is for the state to see that the farmer is provided with the right fertilizers. she is currently the Vigilance Commissioner in the Central Vigilance Commission. You are not going to sell the property to get your goods. The important thing is the income generating capacity of the person to pay. should be made available well in time before the crop. About Us . and the right pesticides. And if this is taken care of. There has to be some stake of the borrower in any loan. in some cases at least they did not insist on any stake of the borrower in a loan. Then only there will be a reason for him to repay back. And they must take very strong action against those flooding the market with spurious things. Profile Mrs. if I understand right. initiatives like the Unique ID scheme and proliferation of SHGs. But the seeds. Further. IIMB Website . there is a growing realization that there is a need to go beyond just credit appraisal to proper monitoring of the account post the sanctioning of the loan. Conclusion Post the recent crisis.don't just give him free credit. then there is no reason for the standard of living not to increase for the farmer. So it is a joint responsibility. there has been an increased focus on credit appraisal with an emphasis on acquiring a thorough understanding of all aspects of the customer and his business. it is also the state government. obviously it will be misused in other things. Then he becomes more accountable. she was responsible for the turnaround of Indian Bank in her role as Chairman and Managing Director. Post her retirement as Chairperson of the National Bank for Agriculture and Rural Development (NABARD).

if I understand right. It is for the state to see that the farmer is provided with the right fertilizers. It is not just the bankers who are responsible. will there be a reason for him to repay it. then there is no reason for the standard of living not to increase for the farmer. Only if the borrower has some stake in the loan. So help him in this way . Conclusion Post the recent crisis. especially low-income segments. the right quality of seeds. incentives were given in order to make housing affordable to everyone. initiatives like the Unique ID scheme and proliferation of SHGs. should be made available well in time before the crop.tejas@iimb: Initially in the US. The important thing is the income generating capacity of the person to pay. in some cases at least they did not insist on any stake of the borrower in a loan. Further. And if this is taken care of. If the critical period goes away and then you give the loan. fertilizers etc. Going forward. Profile Mrs. Then he becomes more accountable. it is also the state government. from a government regulation standpoint. Ranjana Kumar is a prominent Indian banker. There has to be some stake of the borrower in any loan. Post her retirement as Chairperson of the National Bank for Agriculture and Rural Development (NABARD). there has been an increased focus on credit appraisal with an emphasis on acquiring a thorough understanding of all aspects of the customer and his business. she was responsible for the turnaround of Indian Bank in her role as Chairman and Managing Director. obviously it will be misused in other things. . leading to financial inclusion are expected to play a critical role in credit appraisal and risk management. Known as the 'Turnaround Queen of India'. and the right pesticides. and ensuring affordability and credit access to lower income groups? RK: In the US. more responsible and his self-esteem goes up. You are not going to sell the property to get your goods. how can a balance be maintained between stricter credit appraisal to reduce risk. there is a growing realization that there is a need to go beyond just credit appraisal to proper monitoring of the account post the sanctioning of the loan. Take agriculture which is a state subject. Going forward. And they must take very strong action against those flooding the market with spurious things. she is currently the Vigilance Commissioner in the Central Vigilance Commission.don't just give him free credit. Then only there will be a reason for him to repay back. So it is a joint responsibility. The bank can only give a loan. But the seeds.

IIMB Website . Bangalore © 2008 Feedback . About Us .All materials copyright of the Indian Institute of Management.

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