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COMMERCIAL BANKING FUNDS, REGULATORY PROCESS & PRIORITY SECTOR LENDING

A PRESENTATION BY CA. R.C.AGARWAL


MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

POST NINETIES

New Economic policy 1991


MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

Privatisation of Financial Institutions

IFCI to IFCI Ltd., IDBI to IDBI Ltd. & to IDBI bank ICICI to ICICI bank Number of private banks set up Govt. holding in banks diluted by more than 40%

MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

Reorganisation of Institutional Structure


Setting up of universal banks One stop banking PSB Boards to have share holder representatives

MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

Development in commercial banking

Demand for refinance has shrunk from banks Focus on Non fund based finance Capital adequacy, asset classification & provisioning norms and accounting standards made applicable to DFIs and FIs

MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

Development in commercial banking

Financial services such as

Merchant banking, Project counseling, Portfolio management, Credit syndication, New issue management, Mergers and acquisitions, Corporate advisory services, Debenture trusteeship, Sponsorship of mutual funds etc.

MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

Commercial Banks

Economic environment Statutory Liquidity Ratio (SLR) 38.5% , Cash Reserve Ratio (CRR) 15% + 10% (incremental ratio) of net demand & time liabilities (NDTL)
CRR now is 6% SLR is 24% Item / Week Ended 2007
Sep. 7

2008 2009
Aug. 1 Sept. 5

2011
July 26

Cash Reserve Ratio

7.00 8.75

9.00

Lower intt. on SLR and CRR Directed credit programmes to Priority sector Narsimham committee-I
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Growth of banking industry

Details 1951 19.7.69 1997 2011 Aug 26 No. of SCBs+Non-SCBs (Exc.RRB) 92 85 101 171 RRB 196 86 Branches (SCBs/Non-SCBs) 4,151 8,261 63,700 80,000 Deposits 919 5,540 5,07,533 55,09,100 Advances 727 3,813 2,82,702 40,44,862 Advance to priority Sec. 1 lakh 16 lakhs
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Growth of banking industry

1951

1969

No of A/c credit No. of A/cs deposit % of CD deposits % of HSS deposits % of fixed deposit

51 16 33

1995 2007 11,00,000 2,79,00,000 18,00,000 30,00,00,000 25 17 25 22 50 61

MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

Growth of banking industry

Type of banks 1969 Nationalised banks 14 SBI & Associates. 8 RRB

1997 19 8 196

2011 19 6 82

MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

Commercial Banks

Directed credit Scope of priority sector expended by including finance to SIDC, SFC, refinance to RRB and for Foreign and new private sector banks investment in SIDBI bonds Heavy increase in branches, unprecedented growth in deposits and advances mainly priority sector Impressive progress in achieving social objectives Heavy fall in productivity and profitability High cost/exp. due to branch expansion in RU/SU

MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

Commercial Banks

Interest rate structure


Only intt. rate of HSS remained regulated From 1997 Bank Rate (BR) linked to refinance from RBI, penal intt. by RBI for shortfall in reserve PLR system introduced Base rate system introducede Concessional ROI withdrawn from priority sector excluding Export & Agri. Concessional ROI to export finance with interest subside from GOI

MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

Commercial Banks

Capital adequacy norms 9% (capital to risk weighted asset ratio) Income recognition, Asset classification and Provisioning norms

Introduced from 1992 Now NPA after 3 months


Standard sub standard Doubtful loss assets

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Commercial Banks

Transparency of financial statements


Formats changed- to disclose breakup of provisions and percentage of net NPA to net advances etc.

Tax treatment to provisions


Only write off are tax deductible. 5% of income and 10% of average aggregate advances of rural branches permitted as deductible general provision

MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

Commercial Banks

Board of Industrial Finance and Reconstruction (BIFR) This has not been very successful experiment Debt recovery tribunals-1993 8 recovery tribunals ONE appellate tribunal in Mumbai Helped in the recovery of bad advances Securitization Act It has given extensive powers to banks to take possession of assets and auction the same to recover the dues Sale of NPA accounts in lots
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Commercial Banks

Regional rural banks Sponsored by PSBs- 196 banks now to RRBs 82 Branch licensing procedure - liberalized 1994 Foreign banks Allowed to open branches on reciprocal arrangement Permitted to invest upto 20%, within overall 40% investment, in private sector banks They are exempt from target credit in agri. finance
MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

Commercial Banks

New private sector banks


Since nineties new licenses started A few banks e.g. Times bank, Global trust bank, Punjab bank, Centurion bank of Punjab already closed / merged

Public issues of PSBs


Most of the PSBs have come to capital market minus Punjab & Sindh Bank United Bank of India has been permitted to come with IPO

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Commercial Banks

Supervisory authority RBI


Board of Financial supervision (RBI) has been setup

Appointment of CMD/EDs and Board members


Appointment Committee has been setup with RBI Governor as chairman

Recruitment & creation of posts


Public sector banks covered in autonomy criteria

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Commercial Banks

Narsimham Committee II - 1998


Appointed as a follow-up of 1992 recommendations and to examine II generation reforms in terms of action to be taken to strengthen the banking system streamlining procedures, upgrading technology and HRD structural changes in the system

Mutual Funds
Bank subsidiaries sponsored Many banks have started marketing the products

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Management of bank funds


Reserves

prescribed by RBI SLR

& CRR Advances Investments Cash and Bank balances


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CAPITAL

Tier I capital is (a) paid up capital, statutory reserves and other free reserves (b) capital reserve minus equity in subsidiaries, intangible assets and losses Tier II capital includes cumulative perpetual preferential shares, revaluation reserve, general provisions, hybrid debt capital instruments Tier III Capital i.e. permanent perpetual preference shares
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CAPITAL

Maintain unimpaired min. capital equallent to the prescribed rate in the aggregate of risk weighted assets and other exposer (CRAR) Capital adequacy includes-capital funds, risk adjusted and off balance sheet items and capital adequacy for subsidiaries Risk adjusted assets=Risk weighted aggregated fund based and non funded assets
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Exposer norms

Follow prescribed exposer limits for credit in relation to individual, group, industry, sector Exposer norms for investment in various securities are determined by the RBI and the Boards of banks Advance against shares/debentures Against physical and demat shares Upto 10 lakhs and 20 lakhs respectively Against IPO at concessional rate upto 10 lakhs to individuals
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REGULATORY BODIES
GOVERNMENT OF INDIA MINISTRY OF FINANCE RESERVE BANK OF INDIA (RBI) 1948

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RESERVE BANK OF INDIA 1948

MAJOR FUNCTIONS Monitors, regulates, controls banking and financial system Maintains monetary stability, Promote development of markets and systems Ensure credit allocation according to national priorities Regulates volume of money and credit Bankers bank Manages SLR/CRR Determines liquidity control measures Acts as lender of last resort

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ROLE OF RBI

Note issuing authority


Sole right to issue currency notes/coins other than one rupee notes/coins and coins of smaller denominations One rupee notes/coins and coins of smaller denomination are issued by the Central Government circulation is done by RBI Currency issued by RBI is legal tender all over India. Presently the RBI issues coins of Paise 50, Rs. 1, 2, 5 & 10 and notes of Rs. 10, 20, 50, 100, 500, 1000

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ROLE OF RBI

Note issuing authority-cont


Production of currency, distribution, exchange, withdrawal & destruction of notes, improvement in security features & technology up-gradation of currency notes Through Regional issue offices and Currency chests of RBI / Banks / Govt, treasury Issues currency against 100% security/backing of coins/bullion, foreign securities, rupee coins, Govt. of India securities etc.

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ROLE OF RBI

Government banker

Banker to the central / state Govt. Undertakes all banking services on their behalf & transfer of funds & management of public debt No interest on Govt. deposits is payable and no charges are recoverable for normal banking business of the Govt. Manages special funds e.g. calamity fund etc., issues and manages relief bonds, Govt. employees pension disbursal and functions as Govt. treasury Govt. pays commission for issue and management of public debt i.e. raising resources from market

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ROLE OF RBI

Government banker-cont

Ways & Means Advances (WAMAs), to the Govt., for 3 months maturity to bridge temporary gaps between receipts & payments at the graduated scale of intt. rate based on duration Normal/clean advances without collateral Secured advances against Govt. securities Discretionary special advances Overdraft facility to state Govt. in addition to WAMA for 7 days @ BR and 8th day onwards @ BR+3%

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ROLE OF RBI

Supervising authority
Regulates / supervises banking operations through RBI Act and Banking Regulation Act Issues branch/extension counters/off-site ATM licenses Prescribe min. paid-up capital, reserves, transfer to reserve fund, cash reserves and other liquid assets for banks

MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

ROLE OF RBI

Supervising authority-cont
Inspects the working of banks Conducts ad-hock investigation Controls appointments of CMD/CEO of private sector banks Approves / forces amalgamation / reconstruction / liquidation of banks Supervises through Board of Financial Supervision

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ROLE OF RBI

Exchange control authority

Develops/regulates foreign exchange Markets within framework of Foreign Exchange Management Act (FEMA) Custodian of countrys foreign exchanger reserves-Approx. $320 bl. Decides investment & utilization of these reserves Foreign exch. dealing through Authorised dealers (AD) Supervises/controls ADs, exporters/importers for currency trade Controls foreign exchange forward markets to provide cover for exchange risk to importers/exporters

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ROLE OF RBIRegulator of money & credit


Formulates credit policy for adequate flow of bank credit Maintains currency price stability Influences the cost of money and credit Important tools of credit policy are: OMOs, BR, Refinance, CRR, SLR, LAF & Repo Rates

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ROLE OF RBIRegulator of money & credit

Open Market Operations (OMOs) - sale & purchase of securities of Central Govt. and treasury bills (T.bills). To control the amount of credit & money supply To make bank rate policy more effective To maintain stability in Govt. security & T. bill market To support Govt. borrowing Programme The OMOs are conducted only in Central Govt. securities RBI uses only switching operation (no purchases against cash) i.e. sale of long term against short term securities

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ROLE OF RBIRegulator of money & credit

Bank rate (BR) 6% Rate used by RBI to buy/rediscount bills of exchange/other eligible CP Banks relate their lending rate with BR increase/decrease From 1997 advances by RBI, refinance, penalties for shortfall in reserves are linked with BR Refinance To relieve liquidity shortage To direct credit to selective sectors Export and General refinance in use

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ROLE OF RBIRegulator of money & credit

Cash Reserve Ratio (CRR) 4.5% Intt. equal to BR for reserves above 3% Ensure safety and liquidity of bank deposits Penalty, ineligibility to refinance and also graduated fall in intt. rate of CRR on shortfalls Statutory Liquidity Ratio (SLR) 23% To restrict the expansion of bank credit To increase bank investment in Govt. securities To ensure solvency of banks It is the ratio of cash in hand (excl. CRR), bl. in CD A/cs with banks & RBI, gold and unencumbered Govt., local bodies & Govt. guaranteed securities to total demand & time liabilities Default results in restrictions/high cost on refinance
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ROLE OF RBIRegulator of money & credit

Liquidity Adjustment Facility (LAF)- 2000 Operates through Repo and Reverse repo transactions to create the liquidity and to absorb liquidity on daily basis The maturity period of Repos is 1 to 14 days and min. bid size is 5 crore Repo rate is normally 3-4 days rate, call rate is overnight rate thereby call rate remains normally higher than repo rate

Discretionary liquidity (DL) and call rate impact each other

MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

ROLE OF RBIRegulator of money & credit

Liquidity Adjustment Facility (LAF)- 2000-cont. Discretionary liquidity DL means liquidity created with banks & Primary dealers (PD) as a part of policy i.e. (i) net repos and OMOs of RBI (ii) RBI credit to banks (iii) RBI credit to PDs netted for cumulative change for reserve requirement LAF technique is based on the view that RBI balance sheet can have autonomous and discretionary components LAF impact short term intt. rates
MANAGEMENT OF COMMERCIAL BANKS BY CA. R.C. AGARWAL

ROLE OF RBIRegulator of money & credit

Liquidity Adjustment Facility (LAF)- 2000-cont..

Autonomous liquidity (AL) is the flows from regular banking functions e.g. currency authority and banker to the Govt. and banks

It is total of (i) incremental accommodation in Ways and Means Advance (WAMAs), (ii) net primary subscription to T. bills, dated securities (iii) rupee coins net of Govt. deposits with RBI and (iv) RBI primary market subscription Does not include flows out of policy intervention in market

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Money Market

Primary dealers (PD), money market mutual funds (MMMF) came up, deregulation of intt. rates, enlargement of participants have emerged Call / notice market Commercial bills market Treasury bills market- (T bills) Commercial paper market (CP) Certificate of deposits market (CD) Repo market Foreign exchange market
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Priority sector lending means

Sectors of economy which are to be given priority In 1968 meeting of National Credit Council, GOI decided that commercial banks to increase finance in the sectors of Agriculture Small scale industries Description of priority sector got formalized in 1972 Net Bank Credit (NBC) This is reported every fortnight to RBI and is used for calculating % for Priority Sector lending
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Priority Sector includes broadly

Agriculture Small scale industries including setting up of industrial estates Small road and water transport operators owning upto 10 vehicles Consumption loans under consumption credit scheme for weaker section Loans to software industry upto max. 1 crore from banking industry Small business with original cost of equipment used for business max. upto 20 lakhs Retail trade with max. finance to retail traders upto 10 lakhs
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Priority Sector includes broadly

State sponsored organizations for SC / ST Educational loans to individuals Loans to specified industries in food and agro processing sector having investment in plant and machinery upto 5 crore Investment by banks in venture capital funds registered with SEBI Micro credit provided directly or through intermediaries e.g. Loans to self help groups Loans to NGO for lending to self help groups
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Priority Sector includes broadly

Professional and self employed persons with borrowings unto 10 lakhs including Max. 2 lakhs for working capital Purchase of one motor vehicle within these limits For doctors setting up practice in rural area the limits are 15 and 3 lakhs respectively

Housing loans (both direct and indirect) Loans upto 15 lakhs in all areas Loans upto 1 lakh for repairs in Rural/semi-urban areas Loans upto 2 lakh for repairs in urban areas
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PRIORITY SECTOR FINANCE

Definition, targets and sub targets for priority sectors are being determined by RBI every year and can be modified from time to time RBI decides procedures of handling the loan applications, recording of applications, time schedule for disposal, collaterals, penalties for delayed payment and rehabilitation of sick SSI units etc.
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Small Scale Industries


Industrial units engaged in manufacturing, processing or preserving of goods as also ancillary units and whose investment in plant and machinery is of maximum 1 crore or as may be specified from time to time For items like hosiery, drugs, stationery items etc. the limit is 5 crore

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Tiny Enterprises

Unit having investment in plant and machinery upto 25 lakhs

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Micro credit

Provision of thrift, credit and other financial services and products of very small amount to poor in rural / semi urban / urban areas to raise their income levels

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Self help groups means


Registered or unregistered group of micro entrepreneurs Group of 10-20 members formed with an intention to save small amount regularly to help each other in times of need Only one person from a family can be member of SHG

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Target for Domestic and Foreign banks

Category Domestic banks Foreign banks Total PS advances 40% of NBC 32% of NBC Total Agri. Adv. 18% of NBC No target SSI Adv. No target 10% of NBC Export credit Not treated PS 12% of NBC Adv. to weaker sec10% of NBC No target DRI Adv. 1% of Previous No target years total advances
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Direct agriculture finance

Advance directly to farmers for agriculture Crop loan Upto 5 lakh against pledge/hypothecation of agri. Produce for max. 12 months Direct agri. Finance should be 13.5% of NBC Medium and long term loans for Purchase of machinery Land development Construction of farm bldg. etc. Loans to plantations, fishery, poultry, bio-gas plant For purchase of land by small farmers etc.
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Indirect agriculture finance includes

Credit for distribution of fertilizers, pesticides, seeds etc. Loans upto 40 lakhs for distribution of cattle feed, poultry feed etc. Deposits held by banks in NABARD Rural infrastructure development fund (RIDF) Subscription to specified bonds of Rural Electrification Corp. and NABARD etc. Loans for other specified activities from time to time
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Indirect finance to SSI

As specified from time to time

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PRIORITY SECTOR FINANCE

Type of investment treated as priority sector finance Specified bonds of SIDBI, NABARD, NHB, HUDCO and institutions Facilities like Lines of credit, Bill discounting etc. to SIDBI, SFC and other specified organizations In case of shortfall of target by a bank Domestic commercial banks are allocated, after announcement in budget every year, contribution to Rural Infrastructure Development Fund (RIDF) of NABARD at the rate and for the period as declared every year Foreign banks can deposit an amount equal to deficit in SIDBI bonds of 1 year @ 8%
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Weaker sections within priority sector


Small and marginal farmers with max. 5 acres of land, landless labourers, tenant farmers Artisans, village and cottage industry with a max. Credit limit of 50000 SC and ST Beneficiaries under DRI scheme Self help groups etc

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Non-fund based

Non fund based facilities are 100% substitute of fund based facilities Contingent liability can become current liability if invoked These all are 100% risk weighted assets Therefore, proper appraisal is necessary D.P. (Document against payment) L/C (Letter of credit) D.A. (Document against acceptance) L/C (Letter of credit) Guarantees Performance Financial Advance payment Deferred payment (DPG)
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Main objectives of Non-fund facilities


To overcome shortage of funds To increase profitability To increase liquidity To have easy monitoring To facilitate international trade To achieve optimum utilization of funds

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At the time of sanctioning guarantee facility keep in mind


Financial worth of party Capability of party to fulfill obligations Capability of firm to fulfill contract terms Past experience with the firm Purpose for which facility is required Securities offered

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Precautions for financial guarantee

Lien on the goods received Proper treatment be given for assessing working capital facilities Ensure advance cash/goods received are used for production Ensure there are no onerous clauses Penalty for cost over run of project V/s profitability of project Capability of firm to complete the work as per terms
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Precautions for DPG


Study of supply contract for supply schedule, payment terms, advance payments etc. Liability of bank should progressively reduce with the payments Firms capability to reimburse the amount paid by bank on due dates Bank has to charge interest from due date to actual date of payment by the customer Over due installments should not be recovered by debit to C/C unless sufficient DP is available
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Normal purpose to issue guarantees

Performance guarantee

Supply contract Bid bond Security deposit/Earnest money bond Performance Advance payment Turnkey projects Bid bond Performance Advance payment Retention money guarantee Guarantee for raising funds in foreign countries

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Normal purpose to issue guarantees

Financial guarantee In lieu of excise duty payment For disputed custom duty For payment of sales tax For payment of Income tax For payment of goods purchased on credit Other guarantees In favour of supplier of goods for undertaking job work In lieu of payment of excise duty on goods exported In lieu of custom duty on imported goods which are to be ultimately exported Export performance
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RBI guidelines for guarantees


Minimum cash margin of 50% for guarantees covering custom/import duties of selective credit control items No guarantee to be issued for inter company deposits/loans irrespective of source Guarantee not to be issued in favour of NBFC / Institutions for repayment of deposit placed by them with corporate companies 100% margin to be insisted for guarantying payments of government dues as govt. can not run on guarantees

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RBI guidelines for guarantees

In case of following guarantees normally 100% cash margin to be taken Guarantee issued to the court Sales tax/Income tax guarantee Guarantees for clearance of foreign cars Guarantees to steamer companies / Railways for delivery of goods in absence of bills of landing / railway receipt
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COMMERCIAL BANK MANAGEMENT-CREDIT APPRAISAL & MONITORING


A PRESENTATION BY CA. R.C.AGARWAL

Purpose of Credit Appraisal

It is major area of decision making for credit proposals To know about the party To ensure fair assessment of borrowers needs for credit Appraisal is done pre-sanction and post sanction level It is scientific financial analysis of partys overall operations To identify exact purpose for which credit facilities are required To decide the eligibility of credit

Purpose of Monitoring

To ensure proper end-use of funds To nullify the chances of diversion of funds To have periodic review of progress and prospects of the partys position To maintain control over the partys operations To ensure implementation of banks terms and conditions To pick-up signals on the health and status of partys position To take remedial measures To take care of recovery, revival or rehabilitation

Important aspects of bank lending

Lending is an individual decision for lender/borrower Main principles of lending Priority / non-priority area Safety / Security Liquidity Purpose Profitability National objective Spread / diversification of risk Post sanction supervision and control

Important aspects of bank lending

Types of borrowers Corporate / Non-corporate Partnership / Proprietorship Individual Manufacturing Traders Small scale industry (SSI) Small medium enterprise (SME) Priority Sector Seasonal Industry like Tea, Cotton Sugar etc.

Preliminary important matters

3 P
Party Project Profitability

3 C
Character of party Capacity of party Capital invested by party

Preliminary important matters

To satisfy about

Policy Business policy of party about business Bank/Government/RBI Priority/Non priority Marketability of product Availability of raw material and infrastructure Achievability of projections Turnover projections Profit projections

Preliminary important matters

Nature of Account
Prestigious group Export oriented Deposit oriented Backward area Ancillary business Agro products or other priority sector area Small scale industry

Important points for appraisal from Party

Standing of party Business experience Directors / Partners worth and market standing Capacity of management team Position of industrial relations Labour turnover New account/ renewal / modification Category of advance i.e. priority non-priority etc. Type of business Details of branches of firm

Important points for appraisal from Party

Age of plant and machinery Future plan for 3 to 5 years Plans for modernization / expansion and source of finance Why change of bank is desired in existing project/business Industrial group covered under MRTP Act 1969 Location of factory and branch from where facility to be availed Major shareholders Comments on credit report Banking with the bank since when

Important points for appraisal from Party

Capital structure and means of capital Borrowing powers Search report about charge creation, titles of assets etc. Details of facilities required Facilities enjoyed with other Banks/Institutions Financial ratios Statutory liabilities / Contingent liabilities Litigations Facilities enjoyed by Guarantors/Associate firms Justification for working capital requirement

Important points for appraisal from Party

Restrictive covenants About dividend About management About assets About expansion of business About unsecured loans and advances Assessment of fund based and non-fund based facilities requirements Experience with banks-covering nature and conduct of bank accounts Tax assessment Promoters contribution

Important points for appraisal from Party

Comparison of
Last projections with actuals Reasons for variations Growth of the company with similar company in market

Relationship with turnover to


Summations Average balance Utilisation of funds / limits

Important aspects in credit application

Terms of agreement for sale and payment to be received Of assets purchased Of goods sold/purchased Credit period permitted or received Diversion of funds To sister concerns Investments in Capital / Commodity markets Investments in real estate In other activities / projects of different line/same line For long term purposes or vice versa

Term Loans

Important information to be provided

Techno-economic report Details of land and buildings and plant and machinery Technical competence and Manufacturing process Delivery schedule of plant and machinery and consumables Means of finance Security offered Margin Working capital arrangements Time schedule for implementation of Project

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Term Loans

Important information to be provided cont...


Cash flow / Debt coverage ratio / Amount of limit / Repayment schedule Pre-sanction inspection Applications pending with other Financial institutions/banks Refinance Finance availed from other banks

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Care

Current assets Cash and deposits under lien for bank guarantees and L/Cs Receivables Inventories Current liabilities Deposits of out side parties Unsecured deposits Term loan installments payable within 1 year IT provisions D.A. L/C facility Stocks of DA L/C
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Care

Other long term liabilities


Debentures issued for working capital Private placements made for working capital Venture capital received for working capital Term loans taken for working capital Multiple finance on same goods Total commitments of guarantees Plans of future expansion Non fund based facilities

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Important matters

Last 2 reviews to see projections were nearer to actuals Capacity utilization will party be able to produce as projected in available capacity Quarterly information system To fix limits Whether company is working within projected levels Levels of inventory, receivables and consumable stores and spares norms for industry and past trends
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APPRAISAL

Statement of accounts Depreciation Whether consistent policy is followed i.e. straight line method or reducing balance method If rates applied are less, whether permission of Company Law Board has been taken Depreciation affects profitability and not cash accruals Interest To assess that the amount is in relation with Bank and Financial Institutions borrowings Excess or less can be due to undisclosed inter corporate borrowings / lending in between Six monthly closings
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APPRAISAL

Statement of accounts cont. Whether Projected turnover is achievable? Keep in mind Modernization / Expansion / Increase in orders Export receivables Reduce from CA before arriving at working capital eligibility These receivable to financed fully without margin Deposits from market Maturing / due in a year, to be taken as current liability-not necessary to pay but due and even renewed To see that current liabilities are not projected less To see that current assets are not projected more
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Danger signals

Account is running grossly out of order or always running near the drawing power Payments are being made for purpose other than normal business Abnormal cash transactions Heavy return of bills (more than 10%) Payment of all bills on due date by drawees Heavy sales without any reflection in partys account with bank Party spending abnormally heavy amounts on luxury expenses, especially for personal use

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Danger signals

Very few transactions in partys account Reduction in normal visits of party to bank branch Party behaves abnormally like abnormal courtesy, abnormal noncooperation Abnormal thing noticed during inspection of account Transfer of amounts outside the business of firm Transactions through shroffs or money lenders When there is undue delay or avoidance in submission of Balance sheet and other papers for review of account Default in payment of statutory dues
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Evolution of working capital finance

In the past 4 decades RBI has appointed various committees for formulating norms for working out working capital eligibilities

Daheja Committee-1968
Its

view was bank lending is unrelated to borrowers actual need or activities as it was extended based on financial worth of borrower, collateral security and guarantee offered Hence guidelines were issued for industrial borrowers

Tandon committee-1975
3

methods suggested for maximum permissible bank finance working Progressive increase in contribution i.e. margin To bifurcate bank finance in loan and fluctuating cash credit component Norms for holding inventory and receivables

Tandon committee-1975

I method of lending Total current assets (CA) (-) Current liabilities excluding bank borrowings (CL) = working capital gap (WCG) Less 25% of WCG or Net working capital (NW i.e. CA-CL) which ever is higher = MPBF Minimum current ratio 1.17:1

Tandon committee-1975

II method of lending

Total current assets (CA) (-) Current liabilities excluding bank borrowings (CL) = Working capital gap (WCG) Less 25% of total current assets or Net working capital (NW i.e. CA-CL) whichever is higher = MPBF Minimum current ratio 1.33 : 1

Chore committee-1978
To

use II method of Tandon committee for limits of 10 lakh and above Firm to submit monthly select operational data Banks to fix operational limits on the basis of QIS

Nayak and in house committee - 1993 Turnover method


Working capital requirement is to be computed minimum 25% of projected turnover 80% of requirement to be given by banks and 20% by borrowers Turnover method Assessment Projected annual turnover (PAT) i.e. gross sales inclusive of excise duty should be realistic Reasonableness of PAT be satisfied from annual statement of accounts Assess as per turnover method and as per traditional system

In house committee-October 1993

Turnover method Assessment-cont If traditional method calculation is more than the limits to be permitted by turnover method than limit to be permitted whichever is higher but DP to be on the basis of value of stocks less margin and unpaid stocks Level of trade credit should be in tune with past practice. If it is more than projected trade credit allow at past level if justification is convincing

Freedom to determine MPBF

As per RBI credit policy of April 1997, RBI withdrew the prescriptions to calculate working capital limits as per Tandon committee Banks to have their own system to assess working capital credit needs within prudential guidelines and exposer norms prescribes by RBI Units engaged in export need not provide margin for financing current assets represented by export receivables Credit limits of units in Sugar industry to be determined on basis of Current ratio of 1:1

Freedom to determine MPBF

Sick/Weak units to be exempt from application of II method of lending


Additional credit needs of exporters coming out of firm orders of confirmed L/C, which were not taken in account for fixing regular limits, to be provided in full even if sanction of such additional limits exceeds MPBF Borrowing units marketing/trading 100% product manufactured by village, tiny and SSI units will be subjected to I method of MPBF provided such firm settles dues of suppliers within 30 days from date of supply

Actions need prior approval of lending institution

Additional acquisition of fixed assets Expansion and modernization plans Borrowings from outside sources Investment in subsidiaries Dividend out of years earnings Issuing guarantees on behalf of sister concern Pre-payment of loans before due date to financial institutions Disposal of assets

Willful defaulters

The unit has defaulted in meeting its payment/repayment obligations to lender even when it has capacity to honour the said obligation OR Unit has defaulted in meeting its payment/repayment obligations to lender and has not utilized finance from lender for purpose for which finance was granted but has diverted the funds for other purposes OR Unit has defaulted in meeting its payment/repayment obligations to lender and has siphoned off the funds so that the funds have not been utilized for the specific purpose for which the finance was granted, nor the funds are available with the unit in form of other assets

Diversion of funds

Use of short term working capital funds for long term purpose Using funds for purposes/activities or creation of assets other than those for which finance was sanctioned Transferring funds to subsidiaries/group companies or other corporates Routing funds through any bank other than lender bank or members of consortium without prior permission of lender Investment in other companies by way of acquiring equities/debt instruments without approval of lenders

Diversion of funds

Shortfall in deployment of funds visa-a-visa the amounts disbursed/drawn and the difference not being accounted for Siphoning of funds is construed to have occurred if any funds financed are utilized for purpose unrelated to operations of the borrower, to the detriment of the financial health of the entity or of the lender. The decision of lender in this respect should be base on circumstances of the case.