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INCREASED IMPORTANCE OF CREDIT APPRAISAL PROCESS IN TODAY'S BANKING LANDSCAPE
with Mrs. Ranjana Kumar
The recent economic crisis has seen a spate of defaults on loans across banks and one of the key 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, 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. It is better that the bank which handles the financing of the term loan also takes care of the working capital. It is better that the bank which handles the term loan financing also takes care of the working capital. In the past, organizations like IDBI and IFCI which were basically term lending institutions at that point of time, got into a lot of problems of high non-performing assets (NPAs) because they gave only term loans. They never kept the working capital accounts with them. That was being done by the various commercial banks and they were the ones who had the operation's income from them. Most importantly, when we now give these types of loans, we take charge of the plant and machinery and the mortgage of the land. The bank can also consider taking some collateral security but this is just a comfort factor, not the main source of recovery for the bank. The main source of repayment to the bank is from the operations of the company. Over a period of time, there has been an increased emphasis in monitoring the account. For instance, we take monthly information now where earlier it used to be quarterly. Everything is computerized so it's easy for the borrowers to give the required information to us - their actual sales against what their projections were, what they have done etc. Know your borrower like the back of your palm. One thing I would stress a lot is regular contact with the customer. Traditionally we say, know your borrower like the back of your palm. Judge the promoters also - their policies, their scheme of things, for example, if they have participated in a fair abroad, the number of enquiries they generated; the number of those enquiries that have fructified as orders and the number that have just remained as enquiries etc. Then, their business clientele - are they spread out or are they just banking on 2-3 clients, how are they manning their receivables etc. tejas@iimb: In your past role as the MD of Indian Bank, one of the problems you handled was the high NPAs on the balance sheet. Did you find a causal relationship of this problem to the credit appraisal process? If yes, what measures did you take to improve the process? RK: Yes, one of the important reasons for the high NPAs was faulty credit appraisal. There was no in-depth appraisal at all and in a large number of accounts, people were being judged based on the fact that they were well known or that their company was well known. Banking is not like that. An in-depth analysis is required. In Indian bank, subsequent to the restructuring, we demarcated accounts. We decided to have corporate branches or credit intensive branches such that large credit would be given only through those branches.
. For example. Bankers say that there has to be a y-o-y growth and the government also expects it. But the most important thing would be the objectivity and the acceptability of the rating agency. internal audit was also strengthened. tejas@iimb: Given that the current ratings are not freely accessible to borrowers. What is your reading of the situation? RK:Absolutely right. we should aim to be in touch with customers all the time and get market information from them directly. they may grow by a maximum of 16%. It cannot be a wild goose chase and it shouldn't be that kind of pressure. Some may be able to achieve this. Even if you have the best account. some time must be given for consolidation and an 18% growth is very high. does this data asymmetry pose a threat to consumers by potentially allowing financial institutions to charge higher rates than warranted? RK: Very right. Therefore. The fact is the economy has to grow so people have to be given loans so credit has to expand. Again these officers. tejas@iimb: With the emergence of multiple credit rating agencies in India. officers with thorough knowledge and experience would be posted in those branches. when it goes to the banker. you would need to know about everything.he has to act well in time while the account is still a standard asset. It would be done only through certain specialized branches which would have proper policies in place on how the appraisal would be done. and their internal policies. I think it's been suggested now that the borrowers must know on what basis they are rated. Also.e. I'm not saying that has to be completely relied on. take the gems and jewellery business which is basically a family business. For example. but judiciously use what you can and use it to your benefit. Suppose an SME wants to get itself rated. do you see a problem in terms of data integrity and increased transaction costs? RK: Of course. Of course. it shows that rating as a plus point. Suppose a banker wants to reduce exposure in a unit . in today's circumstances. What a prudent banker should do is find out which father is separating from his son. Further. how resilient your borrower is. 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. which father is going to go with his son-in-law etc. So borrowers would like to know how they are being judged. everything won't go well all the time. That was very important.Every branch would not be doing it. But it has to be done with proper analysis and reasoning based on data. That means their expertise. 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. 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. So you have to find out whether the promoter has the wherewithal to come out of a difficult situation i. that's how those rating agencies sustain themselves. which will come only if you meet them regularly. which results in a more comprehensive process. The question is the expectation. some may not be able to grow by even 16%. In this kind of interest rate regime. It would involve a cost of course. that this year. the people who head their departments. Assume an annual growth of 18%. 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. were trained in an institute of the SBI which is known for its credit appraisal. That means you understand the customer. Now this may not be possible y-o-y. there would always be some kind of subjectivity at times. Perhaps another issue that could come up is the various yardsticks that the rating agency uses to come up with the ratings do they keep that a secret or not. not just the balance sheet. at all levels. the bankers have said in the recent meeting of the IBA. where interest rates have been deregulated (though banks are by and large following the same interest rates) there are differences. For any credit institution. there will be a cost to that but we don't know whether the cost will be paid by the borrower or the bank. Then the quality of advance will definitely suffer. Credit Rating Agencies tejas@iimb: Foreign credit appraisal firms incorporate non banking information into their credit rating process. which brother is separating from his brother.
It's a great thing to happen to the country frankly. Which banker would not want to go for them? These SHGs are not necessarily agriculture. Rajasthan. If the critical period goes away and then you give the loan. Work doesn't end in the sanctioning of the account. equip them. was because their recoveries were 98-100%. That is a sustainable model. how can a balance be maintained between stricter credit appraisal to reduce risk. that's where it starts. Credit rating agencies perhaps could use this as a tool for their own ratings. So help him in this way .Work doesn't end in the sanctioning of the account. And one of the reasons why banks went gaga over these people. all in a very big way. more responsible and his self-esteem goes up. tejas@iimb: Initially in the US. the quality standards and they should get trained/ equipped. the right quality of seeds. obviously it will be misused in other things. especially low-income segments. Information on those people through this scheme will definitely help. Going forward. it is also the state government. from a government regulation standpoint. then there is no reason for the standard of living not to increase for the farmer. I think the real benefit would also be that if everybody gets this number. 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. upgrade their skills and most important. Take agriculture which is a state subject. Gujarat etc. So it is a joint responsibility. of course. apart from the fact that social lending was mandatory also in a way. So SHGs should also be conscious of the market. that's where it starts. So the success of microfinance will come provided you train the staff. don't have a middle man between them and the buyer. Only if the borrower has some stake in the loan. And they must take very strong action against those flooding the market with spurious things. There is. It could be products or other activities such as making things in the rural areas. The bank can only give a loan. then there would be no situation where somebody gets a benefit which is actually to be given to somebody else. 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. should be made available well in time before the crop. The important thing is the income generating capacity of the person to pay. 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. It is for the state to see that the farmer is provided with the right fertilizers. And if this is taken care of. incentives were given in order to make housing affordable to everyone. it has come to states like Madhya Pradesh. will there be a reason for him to repay it. It is not just the bankers who are responsible. 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. Then he becomes more accountable. But I think a lot has to do with financial inclusion.don't just give him free credit. These things do happen sometimes in rural areas. Conclusion . in some cases at least they did not insist on any stake of the borrower in a loan. Even more important than the quality of advance is the monitoring process. Future of Credit Appraisal tejas@iimb: How will the Unique ID scheme. It shouldn't be a flash in the pan. and ensuring affordability and credit access to lower income groups? RK: In the US. especially in the rural and semi-urban areas. Then only there will be a reason for him to repay back. There has to be some stake of the borrower in any loan. The benefit of this is that they meet the consumer and they are able to understand the needs of the consumer. if I understand right. You are not going to sell the property to get your goods. and the right pesticides. But this scheme will definitely help. fertilizers etc. It started in a big way in South India with Andhra being one of the first and Karnataka and Tamil Nadu. particularly in small ticket personal loans. a lesser risk in doing it through SHGs. make them conscious of the market. But in the last decade. tejas@iimb: The past few years have seen many players exiting the UPL (Unsecured Personal Loan) space. Today people are becoming much more quality conscious. But the seeds.
Ranjana Kumar is a prominent Indian banker. Going forward. initiatives like the Unique ID scheme and proliferation of SHGs. Post her retirement as Chairperson of the National Bank for Agriculture and Rural Development (NABARD). 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. 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. Known as the 'Turnaround Queen of India'.Post the recent crisis. Further. she is currently the Vigilance Commissioner in the Central Vigilance Commission. . Profile Mrs. leading to financial inclusion are expected to play a critical role in credit appraisal and risk management.
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