Module D

Credit Management
Unit 26

Overview of Credit Management

PRINCIPLES OF CREDIT

 1. safety of funds
 2. purpose
 3. profitability
 4. liquidity
 5. security
 6. risk spread
TYPES OF BORROWERS

1. An individual
2. Sole proprietary firm
3. Partnership firm and joint ventures
4. Hindu undivided family
5. Companies
6. Statutory corporations
7. Trusts and co-operative Societies
Priority Sector

 (For complete details, RBI Master circular dated 1st July, 2009,, available on
their website www.rbi.org.in may be referred.)
 RBI, as regulator of banks in India, decides about the sectors which are
included in the priority sector, as also, the minimum percentage of total
credit of a bank which should go to this sector. Priority sector lending by
commercial banks is monitored by
 Reserve Bank of India through periodical 'Returns' received from them.
Performance of banks is also reviewed in the various forums set up under the
Lead Bank Scheme (at State, District and Block levels).
Priority Sector

 The main sectors, included in the priority sector are as follows:

 Agriculture
 Micro, Small and Medium Enterprises (MSMEs)
 Export Credit
 Education
 Housing
 Social Infrastructure
 Renewable Energy
 Others
 Weaker Sections
Targets for Priority Sector Lending
Categories Domestic commercial Foreign banks with less than 20 Regional Rural Banks Small Finance Banks
banks (excl. RRBs & SFBs) branches
& foreign banks with 20
branches and above

Total 40 per cent of ANBC as 40 per cent of ANBC as 75 per cent of ANBC as computed in 75 per cent of ANBC as
Priority computed in para 6 below computed in para 6 below or para 6 below or CEOBE whichever is computed in para 6 below
Sector or CEOBE whichever is CEOBE whichever is higher; out higher; However, lending to Medium or CEOBE whichever is
higher of which up to 32% can be in the Enterprises, Social Infrastructure and higher.
form of lending to Exports and Renewable Energy shall be reckoned
not less than 8% can be to any for priority sector achievement only up
other priority sector to 15 per cent of ANBC.

Agricultur 18 per cent of ANBC or Not applicable 18 per cent ANBC or CEOBE, whichever 18 per cent of ANBC or
e CEOBE, whichever is is higher; out of which a target of 10 CEOBE, whichever is higher;
higher; out of which percent# is prescribed for SMFs out of which a target of 10
a target of 10 percent# is percent# is prescribed for
prescribed for Small and SMFs
Marginal Farmers (SMFs)

Micro 7.5 per cent of ANBC or Not applicable 7.5 per cent of ANBC or CEOBE, 7.5 per cent of ANBC or
Enterprise CEOBE, whichever is higher whichever is higher CEOBE, whichever is higher
s

Advances 12 percent# of ANBC or Not applicable 15 per cent of ANBC or CEOBE, 12 percent# of ANBC or
to Weaker CEOBE, whichever is higher whichever is higher CEOBE, whichever is higher
Sections
 The targets for lending to SMFs and for Weaker Sections shall be revised
upwards from FY 2021-22 onwards as follows:
Financial Year Small and Marginal Farmers target * Weaker Sections
target ^
2020-21 8% 10%
2021-22 9% 11%
2022-23 9.5% 11.5%
2023-24 10% 12%
MSMED Act 2006
IRAC NORMS

 Stages in the Life of an Account

 Standard
 Sub-standard
 Doubtful (DB-1, DB-2, DB-3)
 Loss
IRAC NORMS PROVISIONING
Standard assets

 The provisioning requirements for all types of standard assets stands as below.
Banks should make general provision for standard assets at the following rates
for the funded outstanding on global loan portfolio basis:
 a) Farm Credit to agricultural activities, individual housing loans and Small
and Micro Enterprises (SMEs) sectors at 0.25 per cent;
 b) advances to Commercial Real Estate (CRE)1 Sector at 1.00 per cent;
 c) advances to Commercial Real Estate – Residential Housing Sector (CRE -
RH)2 at 0.75 per cent
 d) housing loans extended at teaser rates as indicated in Paragraphs 5.9.9;
 e) restructured advances – as stipulated in the prudential norms for
restructuring of advances.
Standard assets

 f) Advances restructured and classified as standard in terms of the Master

Direction – Reserve Bank of India (Relief Measures by Banks in Areas affected
by Natural Calamities) Directions 2018 – SCBs, as updated from time to time,
at 5%.
 g) All other loans and advances not included in (a) – (f) above at 0.40 per
cent.
Substandard assets

 A general provision of 15 percent on total outstanding should be made

without making any allowance for ECGC guarantee cover and securities
available.
 The ‘unsecured exposures’ which are identified as ‘substandard’ would
attract additional provision of 10 per cent, i.e., a total of 25 per cent on the
outstanding balance. However, in view of certain safeguards such as escrow
accounts available in respect of infrastructure lending, infrastructure loan
accounts which are classified as sub-standard will attract a provisioning of 20
per cent instead of the aforesaid prescription of 25 per cent. To avail of this
benefit of lower provisioning, the banks should have in place an appropriate
mechanism to escrow the cash flows and also have a clear and legal first
claim on these cash flows.
Doubtful Asset

 The provisioning requirement for unsecured ‘doubtful’ assets is 100 per cent.
Unsecured exposure is defined as an exposure where the realisable value of
the security, as assessed by the bank/approved valuers/Reserve Bank’s
inspecting officers, is not more than 10 percent, ab-initio, of the outstanding
exposure. ‘Exposure’ shall include all funded and non-funded exposures
(including underwriting and similar commitments). ‘Security’ will mean
tangible security properly charged to the bank and will not include intangible
securities like guarantees (including State government guarantees), comfort
letters etc.
Fair Practices Code

RBI has issued guidelines on fair practices code for lending.

 1) application for loans and their processing
 (2) loan appraisal and terms and conditions
 (3) disbursements of loans
 (4) post disbursement supervision
 (5) general guidelines relating to discrimination based on sex, caste and
religion.
harassment in recovery, transfer/takeover of accounts, etc.
THANK YOU
UNIT 27

ANALYSIS OF FINANCIAL STATEMENT

THINGS TO LOOK FOR ANALYSIS

 The Net Worth of the Application

 Repayment Captivity
 Viability
 Availability of Unencumbered Securities
WHICH ARE THE FINANCIAL STATEMENTS

 Balance sheet
 Profit & Loss account
USERS OF FINANCIAL STATEMENTS

 1. Other creditors and lenders

 2. Investors
 3. Government agencies
 4. Rating agencies
 5. Customers
 6. Employees
 7. General public
 8. Analysts
BASIC CONCEPTS USED IN PREPARATION OF
FINANCIAL STATEMENTS

 1. Entity Concept
 2. Money Measurement Concept
 3. Stable Monetary Unit Concept
 4. Going Concern Concept
 5. Cost Concept
 6. Conservatism Concept
 7. Dual Aspect Concept
 8. Accounting Period Concept
 9. Accrual Concept
 10. Realization Concept
 11. Matching Concept
LEGAL POSITION REGARDING FINANCIAL
STATEMENTS
 Format
The format of balance sheet can be either Vertical or Horizontal
Horizontal Form

Liabilities Assets
The items shown in the first column The items shown in the second column
against Liabilities are: against Assets are:
 Share Capital  Fixed assets
 Reserves and surplus  Investments
 Secured loans  Current assets
 Unsecured loans  Loans and advances
 Current liabilities  Miscellaneous expenditure
 Provisions
Vertical Form

(A) Sources of funds

 1. Shareholders’ funds
 (a) Share capital
 (b) Reserves and surplus
 2. Loan funds
 (a) Secured loans
 (b) Unsecured loans
(B) Application of funds
 1. Fixed assets
 2. Investments
 3. Current assets, loans and advances
 Less: Current liabilities and provisions Net current assets
 4. Miscellaneous expenditures
TECHNIQUES USED IN ANALYSIS OF FINANCIAL
STATEMENTS

 Funds Flow Analysis

 Trend Analysis
 Ratio Analysis
Trend Analysis

 (a) The items for which trend is required to be seen, are arranged in
horizontal form and percentage increase or decrease from the previous year's
figures is indicated below it. Generally, this is used to see the trends of sales,
operating profit, PBT, PAT etc. from P and L account. Similarly, the balance
sheets, arranged in horizontal order, give the trends of increase or decrease
of various items.
 (b) Common size statements are prepared to express the relationship of
various items to one item in percentage terms. For example, consumption of
raw materials is expressed as a percentage of sales for different years and
comparison of these figures gives indication of trend of operating efficiency.
Ratio Analysis:

 Liquidity Ratios
 Solvency Ratio
 Leverage Ratio
 Profitability Ratio
 Turnover Ratio
THANK YOU
UNIT 28

WORKING CAPITAL FINANCE

 Definitions of (a)working capital , (b) Operating cycle :

 (a) Working capital means the sum of the funds invested at various current
assets used in the operating cycle, by the industrial and trading
establishments.

 (b) Operating cycle means the length of time required to convert ‘Non-Cash
current assets’, (like raw material (RM), work in process (WIP), finished goods
(FG), and receivables) into cash.
First Method of Lending

 As per Tandon's-I method (also called as 'first method') of lending the

borrower has to arrange 25% of Working Capital Gap (WCG) as margin
 As per Tandon’s-I method (also called as ‘first method’) of lending the
borrower has to arrange 25% of Working Capital Gap (WCG) as margin.

 The first method can be explained from the following illustration.

 Let us take an example of a company which has Total Current Assets (TCA) of
Rs.100.00 and Other Current Liabilities (OCL) i.e. (without working capital
facilities from the bank) is Rs.20.00.
 Now we will compute the Maximum Permissible Bank Finance (MPBF) under
method-I.
FIRST METHOD OF LENDING

 TCA=100 and OCL=20,

 WCG is (TCA-OCL))=100-20=80 ——————————-Let us call it as (A)

 25% of WCG = 80×25÷100= 20————————- Let us call it as (B)

 (i.e. Minimum Net Working Capital)

 In this case, Maximum Permissible Bank Finance (MPBF) = (A)-(B) = 80-20 = 60

 Therefore, MPBF from Bank under the first method is Rs.60 if Total Current Asset is
Rs.100
 Current Ratio in first method: Since Total Current Liabilities (including Bank
finance) would be Rs.80 against Total Current Assets of Rs.100, the minimum
Current Ratio under method–I would be 100:80 i.e minimum Current Ratio is
1.25:1.
 Tandon’s-II method (also called as ‘second method’): In this method of lending
the borrower has to arrange 25% of Total Current Assets (TCA) as margin.
llustration :Tandons Secon method of lending

 Let us again take an example of TCA of a company is Rs.100.00 and OCL is Rs.20.00
.We shall now calculate the MPBF under 2nd method.

 WCG =CA-CL=100-20 = 80 ————————————————- Let us call it as (x)

 25% of TCA=100×25÷100 = 25 ——————————————–Let us call it as (y)

 The MBPF under second method is (x)-(y) = 80-25=55

 MPBF, from Bank under the second method ,is Rs.55 when Total Current Asset is
Rs.100 and working capital gap is 80.
Current Ratio in second method

 Current Ratio in second method: Since Total Current Liabilities would be

(20+55)=75 against Total Current Assets of Rs.100, the minimum Current Ratio
under method–II would be 1.33:1
 The Chore committee (headed by Shri.K.B.Chore), appointed by RBI in April
1979 recommended that all borrowers except sick units having working
capital of Rs.50 lacs and over from the banking system must be placed under
method-II which gives current ratio of 1.33:1. Although the lower cut-off limit
for method II is changed from time to time as per RBI guidance, the
benchmark current ratio of 1.33:1 under this method remains unchanged.
Relaxation to this condition is available to export oriented units; products
manufactured by MSME units wherein banks may apply the first method.
Turnover method (Nayak Committee norms)

 Turnover method (Nayak Committee norms)

 Under turnover method, the aggregate fund-based working capital limits are
computed on the basis of Minimum of 20% of their projected annual turnover.
The borrower has to bring the margin of 5% of the annual turnover of such
borrowers as margin money.
Example

 EXAMPLE
 If projected sales turn-over is =
Rs.100, 000.00
 Then, working capital gap is 25% of turnover = Rs.
25000.00

 Minimum permissible Bank Finance should be 20% of turnover = Rs.

20,000.00

 Margin money from the borrower should be 5% of Rs.100000.00 = Rs.

5000.00
 Cash Budget method

 The pattern of financing the peak cash deficit(s) is followed for industries
dealing in seasonal products like sugar and tea, construction activities, film
industries, order based activities etc. In the above type of industries, the
requirement of finance may be peak during some calendar months whereas
the realizations of sale proceeds take place at a length of time. Therefore,
under Cash budget method, the bank finance is sanctioned based on
projected monthly cash flows estimated by the borrower and approved by the
bank. The current ratio for this kind of facility is normally 1.33: 1 (1.25:1 for
MSE) as a benchmark. Some Banks consider lower ratio on the case-to-case
basis depending upon components and quality of current assets and current
liabilities.
working capital to information
technology and software industry
 For the businesses in the IT and software industry enjoying working capital
limits of Rs 10 crore and above from the banking system, the regular
guidelines regarding working capital financing would be applicable. Banks can
stipulate a reasonable amount as promoters’ contribution towards margin.
Some of the highlights of the guidelines
include the following:
 Banks can consider sanction of working capital limits based on the track record of the promoters group
affiliation, composition of the management team and their work experience as well as the infrastructure.

 In the case a business has working capital limits of up to Rs 2 crore, working capital assessment can be
made at 20 percent of the projected turnover. In other cases, the banks can consider assessment of MPBF on
the basis of the monthly cash budget system. For the businesses in the IT and software industry enjoying
working capital limits of Rs 10 crore and above from the banking system, the regular guidelines regarding
working capital financing would be applicable.
 Banks can stipulate a reasonable amount as promoters’ contribution towards margin.
 Banks can obtain collateral security wherever available. First / second charge on current assets, if
available, can also be obtained.
 The rate of interest for loan to the IT and software industry must be similar to the general category of
borrowers. Further, concessional rate of interest can be provided for software exporters as pre-
shipment/post-shipment credit.
 Banks can evolve tailor-made follow up system for such loans and even obtain quarterly statements of cash
flows to monitor the operations. In case the sanction was not made on the basis of the cash budgets, they
can devise a reporting system, as they deem fit.
Trade Receivables Discounting System
(TReDS) 3.12.2014 guide lines given by RBI

 TReDS is an electronic platform for facilitating the financing / discounting of

trade receivables of Micro, Small and Medium Enterprises (MSMEs) through
multiple financiers. These receivables can be due from corporates and other
buyers, including Government Departments and Public Sector Undertakings
(PSUs).

 TReDS is a payment system authorised under the PSS Act. It is a platform for
uploading, accepting, discounting, trading and settling invoices / bills of
MSMEs and facilitating both receivables as well as payables factoring (reverse
factoring). MSME sellers, corporate and other buyers, including Government
Departments and PSUs, and financiers (banks, NBFC-Factors and other
financial institutions, as permitted) are direct participants in the TReDS and
all transactions processed under this system are '"without recourse" to MSMEs.
NON FUND BASED LIMITS

 Letter of Credit

 Guarantees
Co-Acceptance of Bills

 Co-acceptance of bills means “an undertaking from the third party (Bank) to
make payment to the drawer of the bill (seller/exporter) on due date even if
the buyer/importer fails to make the payment on that date”.

 Thus, in the Co-acceptance of the bills, the bank which stands as co-accepter
acts as a guarantor similar to LC opening and undertakes to make timely
payment to the seller/exporter even if the buyer/importer fails to make
payment on due date.
L/C

 Appraisal of LC Limit
 An L C is used for purchase of goods either through imports or local purchase.
 For assessing the L C requirement of an enterprise, we have to know the
following;
 (1) Average Amount of Each L C: This is dependent on the monthly
consumption of goods and the economic order quantity. Economic order
quantity (E O Q) is estimated
 by examining the sources of supply, means of transport, discount etc. In case
of imports, the E O Q is often larger in comparison to indigenous purchases.
 (2) Frequency of L C Opening: Once E O Q is estimated, the number of I-Cs to
be opened in a year can be calculated by dividing annual consumption by E O
Q.
 Frequency of opening L Cs will be 12 divided by the number of I-Cs to be
opened in a year.
 (3) How many L Cs will be outstanding at a particular time: The time taken
for one L C
 to remain in force depends upon the lead time (time taken from the date of
opening L C
 to shipment of goods), the transit time and the usance available to purchaser
from the
 date of receipt of goods. If the frequency of opening L C is less than this,
bank will have
 more than one L C outstanding at any point of time.
 Example: If lead time is 10 days, transit is 20 days and
EXAMPLE

 Example: If lead time is 10 days, transit is 20 days and usance period is six
months, the total time for which an L C will remain outstanding is seven
months. If consumption of goods is Rs 6 crore per year and EOQ is Rs one
crore, the frequency of opening L C isevery 2 months.

 It means that at any point of time, there will be four L Cs outstanding

(7divided by 2 and rounded off to next figure). As the amount of each L C is Rs
one crore, the total L C limit will be Rs 4 crore.
Commercial Paper

 Commercial Paper (C P), an unsecured money market instrument issued in

theform of a promissory note, was introduced in India in 1990 with a view to
enabling highly rated corporate borrowers to diversify their sources of short-
term borrowings.
 The costof borrowing through C P is normally lower compared to other sources
of short term
 finance and therefore, it serves as a useful tool in working capital
management of the corporate.
Factoring

 This is a method of financing the receivables of a business enterprise.

 The financier is called 'Factor' and can be a financial institution.
 Banks are not permitted to do this business themselves but they can promote
subsidiaries to do this. Under factoring, the factor not only purchases the
book debts/receivables of the client, but may also control the credit given to
the buyers and administer the sales ledger.
 The purchase of book debts/receivables can be with recourse or without
recourse to the client. If it is without recourse, the client is not liable to pay
to the factor in case of failure of the buyer to pay.
FORFAITING

 This is similar to factoring but is used only in case of exports and where the
sale is supported by bills of exchange/promissory notes. The financier
discounts the bills and collects the amount of the bill from the buyer on due
dates.

 Forfaiting is always without recourse to the client. Therefore, the exporter

does not carry the risk of default by the buyer.
THANK YOU
UNIT – 29

Term Loans
PROJECT APPRAISAL

 Project appraisal can be broadly taken in the following steps:

 (1) Appraisal of Managerial Aspects
 (2) Technical Appraisal
 (3) Economic Appraisal
Term Loans

 DEFERRED PAYMENT GUARANTEES ( D P Gs)

 When the purchaser of a fixed asset does not pay to the supplier immediately,
 but pays according to an agreed repayment schedule, and the bank
guarantees this repayment, the guarantee is called D P G. This is a Non-fund
based method for financing purchase of fixed assets. However, if the
purchaser defaults in payment of any amount, the bank has to pay the same
to the supplier and the exposure becomes fund based till the amount is
recovered from the client. The risks involved in a D P G are same as those in a
term loan and therefore, the appraisal for a D P G is same as that for a term
loan.
Appraisal of Managerial Aspects: The appraisal of managerial aspects involves
seeking the answer to the following questions:

(a) What are the credentials of the promoters'?

(b) What is the financial stake of promoters in the project? Can they bring
additional funds in case of contingencies arising out of delay in project
implementation and changes in market conditions?

(c) What is the form of business organization? Who are the key persons to be
appointed to run the business?
Technical Appraisal:

 The technical feasibility of a project involves the following

 aspects:
 (a) location
 (b) products to be manufactured, production process
 (c) availability of infrastructure (d) provider of technology
 (e) details of proposed construction (f) contractor for project execution
 (g) waste-disposal and pollution control
 (h) availability of raw materials
 (i) marketing arrangements
Appraisal of Managerial Aspects:

 The appraisal of managerial aspects involves seeking the answer to the

following questions:
 (a) What are the credentials of the promoters'?
 (b) What is the financial stake of promoters in the project? Can they bring
additional funds in case of contingencies arising out of delay in project
implementation and changes in market conditions?
 (c) What is the form of business organization? Who are the key persons to be
appointed to run the business?
Economic Appraisal:

 The economic or financial feasibility of a project involves the

 following aspects:
 (a) Return on Investment: The usual methods used are the NPV, IRR, payback
period, cost benefit ratio, accounting rate of return etc.
 (b) Break-even Analysis: A project with a high break-even point is considered
more risky compared to the one with lower break-even point.
 (c) Sensitivity Analysis: As market conditions are uncertain, a small change in
the prices of raw materials or finished goods may have a drastic impact on
the viability of a project.
 Sensitivity analysis examines such impac
 (c) Sensitivity Analysis: As market conditions are uncertain, a small change in
the prices of raw materials or finished goods may have a drastic impact on
the viability of a project.
 Sensitivity analysis examines such impact.
Types of Financing by Banks

 (a) Take-out Financing: Banks may enter into take-out financing arrangement
with I D F
 C & other financial institutions or avail of liquidity support from I D F C &
other F Is.
 Inter-institutional: Guarantees Banks are permitted to issue guarantees
favouring other lending institutions in respect of infrastructure projects,
provided the bank issuing the guarantee takes a funded share in the project
at least to the extent of 5 per cent of the project cost and undertakes normal
credit appraisal, monitoring and follow-up of the project.
Take-out Financing /Liquidity Support

 essentially a mechanism designed to enable banks to avoid asset-liability

maturity mismatches that may arise out of extending long tenor loans to
infrastructure projects.
 Under the arrangements, banks financing the infrastructure projects will have
an arrangement with I D F C or any other financial institution for transferring
to the latter the out standings in their books on a pre-determined basis.
 I D F C and S B I have devised different take-out financing structures to suit
the requirements of various Banks, addressing issues such as liquidity, asset-
liability mismatches, limited availability of project appraisal skills, etc. They
have also developed a Model Agreement that can be considered for use as a
document for specific projects in conjunction with other project
Liquidity support from I D F C:

 As an alternative to take-out financing structure, I D F C and S B I have

devised a product, providing liquidity support to banks.
 Under the scheme, I D F C would commit, at the point of sanction, to
refinance the entire outstanding loan (principal+ unrecovered interest) or
part of the loan, to the bank after an agreed period, say, five years. The
credit risk on the project will be taken by the bank concerned and not by I D
F C. The bank would repay the amount to I D F C with interest as per the
terms agreed upon.
THANK YOU
UNIT 30

CREDIT DELIVERY
UNIT 30 CREDIT DELIVERY

 DOCUMENTATION
 Documents are to be signed by the borrowers and guarantors so that the bank
 can establish their liability in a court of law. In addition, the borrower has to
sign the documents which create charge over the primary security, i.e. the
security created out of the bank finance. For charge over collateral security,
the owner of that security should sign the relevant documents.
CHARGE OVERE SECURITIES

 The charge could be any of the following:

 (1) Mortgage
 (2) Hypothecation Pledge
 (3) Lien
 (4) Assignment
DISBURSAL OF LOANS

 Working Capital Loans

 Calculation of DP

 TERM LOAN DISBURSAL

CONSORTIUM AND MULTIPLE BANKING

 In consortium lending system, two or more lenders join together to finance a

single borrower. The lending banks formally join together, by way of an inter-
se agreement to meet the credit needs of a borrower.

 Multiple banking is an arrangement where a borrower takes loan amount from

several banks. In this case no bank knows that his borrower has taken loan
from other banks too. There is no contractual relationship between various
banks like that in consortium banking and each bank holds its individual
security and own credit rates.
SYNDICATION OF LOANS

 A syndicated loan is a facility of finance being offered by a pool of lenders.

These pools of lenders are called syndicates who agree as a group to provide
significant loans for single borrowers. The large borrower can be a
corporation, a joint venture for a particular project, or a sovereign
government.
The term 'Syndication

 ' is normally used for sharing a long-term loan to a borrower by two or more
banks. This is a way of sharing the risk, associated with lending to that
borrower, by the banks and is generally used for large loans. The borrower,
intending to avail the desired amount of loan, gives a mandate to one bank
(called Lead bank) to arrange for sanctions for the total amount, on its
behalf. The lead bank approaches various banks with the details These banks
appraise the proposal as per their policies and risk appetite and take the
decision. The lead bank does the liaison work and common terms and
conditions of sanction may be agreed in a meeting of participating banks,
arranged by the lead bank. Normally, the lead bank charges
 'Syndication fee' from the borrower.
THANK YOU
UNIT 31

CREDIT CONTROL AND MONITORING

AVAILABLE TOOLS FOR CREDIT
MONITORING / L R M
 (1) Conduct of the Accounts with the Bank:
 (2) Periodic Information Submitted as per the Terms of the Advance
 (3) Audit of Stocks and Receivables Conducted by the Bank
 (4) Financial Statements of the Business, Auditors’ Report:
 (5) Periodic Visits and Inspection
 (6) Interaction: Interaction with select creditors and debtors.
 (7) Periodic Scrutiny: Periodic scrutiny of borrowers' books of accounts and the accounts
maintained with other banks(8) Market Reports about the, Borrower and the Business
Segment: These
 reports are available from the industry associations and rating agencies.
 (9) Appointing Bank’s Nominee on Company’s Board: In exceptional cases, or
 in case of large limits, bank may opt to appoint nominee director on the board to keep a
 tab on the important decisions.
 (10) Credit Audit: (The details given here are based on R B I's 'Guidance note
on
 credit risk management') Credit audit is an examination of various credit
functions of the bank. It is normally conducted by internal staff having
adequate credit experience.
 Credit Audit examines compliance with extant sanction and post-sanction
processes and procedures laid down by the bank from time to time. Each bank
formulates its own policies, procedures, and organizational set up for credit
audit. In some banks, credit audit plays an important role in monitoring of
large value accounts also.
(A) Objectives of Credit Audit

 R B I's suggestions in this respect, contained in their 'Guidance note on credit

 risk management', are as under:
 (1) Improvement in the quality of credit portfolio
 (2) Review sanction process and compliance status of large loans
 (3) Feedback on regulatory compliance
 (4) Independent review of Credit Risk Assessment
 (5) Pick-up early warning signals and suggest remedial measures
 (6) Recommend corrective action to improve credit quality, credit
administration
 and credit skills of staff, etc.
 Functions of Credit Audit Department
 (1) To process Credit Audit Reports
 (2) To analyze Credit Audit findings and advise the departments/ functionaries
 concerned
 (3) To follow up with controlling authorities
 (4) To apprise the Top Management
 (5) To process the responses received and arrange for closure of the relative
 Credit Audit Reports
 (6) To maintain database of advances subjected to Credit Audit
(D) Scope and Coverage

 1) Portfolio Review
 (2) Loan Review
 (3) Action Points for Review
 (4) Frequency of Review
 (5) Procedure to be followed for Credit Audit
Legal Audit of title documents in respect
of large value loan accounts
 On a review, RBI has decided that the banks should also subject the title deed
and other documents in respect of all credit exposure of Rs. 5 crores and
above to periodic legal audit and re verification of title deeds with relevant
authorities as part of regular audit exercise till the loan fully stands repaid.
THANK YOU
UNIT 32 –

Risk Management and Credit

Rating
MEANING OF CREDIT RISK

 Opeational Risks:
 Market Risks
 Credit Risks
FACTORS AFFECTING CREDIT RISK

 External Factors
 Internal Factors
External Factors:

 These factors affect the business of a customer and reduce his capability to
honor the terms of financial transaction with the bank. The main external
factors affecting the overall quality of the credit portfolio of a bank are
exchange rate and interest rate fluctuations, Government policies,
protectionist policies of other countries, political risks, etc. These factors
look similar to what is mentioned under market risks above. But, whereas the
market risks directly affect a bank, the factors mentioned here affect the
businesses of the customers thus impairing the quality of the credit portfolio.
Internal Factors

 These mainly relate to overexposure (concentration) of credit to a particular

segment or geographical region, excessive lending to cyclical industries,
ignoring purpose of loan, faulty loan and repayment structuring, deficiencies
in the loan policy of the bank, low quality of credit appraisal and monitoring,
and lack of an efficient recovery machinery.
STEPS TAKEN TO MITIGATE CREDIT RISKS

 At Macro Level
 At Micro Level
CREDIT RATINGS

 1) To decide about accepting, rejecting or accepting with modifications/

special covenants
 (2) To determine the pricing, i.e. the rate of interest to be charged
 (3) To help in the macro evaluation of the total credit portfolio by classifying
it on the ratings allotted to individual accounts. This is used for assessing the
provisioning requirements, as also a decision making tool, by the management
of the bank, for reviewing the loan policy of the bank.
USE OF CREDIT DERIVATIVES FOR RISK
MANAGEMENT
 Credit Default Swaps (C D Ss):
 Credit Linked Notes (C L N):
Credit Default Swaps (C D Ss):

 This is a bilateral contract in which the risk seller (lending bank) pays a
premium to the buyer for protection against credit default or any other
specified credit event. Normally, C D S is a standardized instrument of I S D A
(International Swaps and Derivatives Association).The credit events defined
by ISDA are, bankruptcy, failure to pay, restructuring, obligation acceleration,
obligation repudiation or moratorium etc. As per R B I guidelines, plain vanilla
C D Ss only are allowed.
Credit Linked Notes (C L N):

 In this, the risk seller gets risk protection by paying regular premium to the
risk buyer, which is normally a S P V which issued notes linked to the
underlying credit. These notes are purchased by the general investors and the
money received from them is used by the SPV to buy high quality securities.
The general investors get fixed or variable return on the note during its life.
On maturity of the underlying credit, the securities purchased by SPV are sold
and money returned to the investors. But, in case of default in the underlying
credit, these securities are used to pay to the risk seller.
Central Repository of information on
Large Credit
 Banks are required to report credit information including classification of an
account as SMA to CRILC on all their borrowers having aggregate fund based
and non-fund based exposure of Rs.5 Crore and above
Thank you
UNIT 33

Rehabilitation and Recovery

Non Performing Assets (N P As)

 As per R B I directives, banks in India have to classify their assets into

Performing or Standard assets or Non performing assets (N P As). N P As are
further classified into (a) Sub-standard, (b) doubtful and (c) loss assets. The
classification is based on the period of default as also the availability of
security. The amount of provision required to be made on the asset portfolio
of a bank depends on its classification into the four categories of standard,
sub standard, doubtful and loss.
WILLFUL DEFAULTERS

 1) The unit has defaulted in meeting its payment or repayment obligations to the
lender even when it has the capacity to honour the said obligations.
 (2) The unit has defaulted in meeting its payment or repayment obligations to the
lender and has not utilized the finance, borrowed for the specific purposes for
which the finance was availed of but has diverted the funds for other purposes.
 (3) The unit has defaulted in meeting its payment or repayment obligations to the
lender and has siphoned off the funds so that the funds have not been utilized for
the specific purpose for which finance was availed of, nor are the funds available
with the unit in the form of other assets.
 (4) The unit has defaulted in meeting its payment or repayment obligations to the
lender and has also disposed off or removed the movable fixed assets or
immovable property given by him or it for the purpose of securing a term loan
without the knowledge of the bank or lender.
Non Cooperative Borrower

 A non-cooperative borrower is one who does not engage constructively with

his lender by defaulting in timely repayment of dues while having ability to
pay, thwarting lenders’ efforts for recovery of their dues by not providing
necessary information sought, denying access to assets financed / collateral
securities, obstructing sale of securities, etc

 In effect, a non-cooperative borrower is a defaulter who deliberately stone

walls legitimate efforts of the lenders to recover their dues.
OPTIONS AVAILABLE TO BANKS FOR STRESSED
ASSETS

 (1) Exit from the account

 (2) Rescheduling or Restructuring
 (3) Rehabilitation
 (4) Compromise
 (5) Legal action
 (6) Write off
Legal Action

 1) Government Machinery
 2) Civil Courts
 3) Lok Adalats
 4) Debt Recovery Tribunals (DRTs)
 5) SARFAESI Act, 2002
 6) The Enforcement of Security Interest and Recovery Debts Laws
(Amendment) Act, 2004 has amended the SARFAESI Act,
 7) Write off
CORPORATE DEBT RESTRUCTURING (C D R)
MECHANISM

 (1) The borrowers enjoy credit facilities from more than one bank or F l under
multiple banking or syndication or consortium system of lending.
 (2) The total outstanding (fund-based and non-fund based) exposure is Rupees
10 crores or above.
 C D R system in the country will have a three tier structure
 (a) C D R Standing Forum and its Core Group.
 (b) C D R Empowered Group.
 (c) C D R Cell.
C D R Standing Forum

 The C D R Standing Forum would be the representative general body of all

financial institutions and banks participating in C D R system. All financial
institutions and banks should participate in the system in their own interest.
C D R Standing Forum will be a self-empowered body, which will lay down
policies and guidelines, and monitor the progress of corporate debt
restructuring.
CDR Empowered Group

 The individual cases of corporate debt restructuring shall be decided by the

CDR Empowered Group, consisting of E D level representatives of Industrial
Development Bank of India Ltd., ICICI Bank Ltd. and State Bank of India as
standing members, in addition to E D level representatives of financial
institutions and banks who have an exposure to the concerned company.
While the standing members will facilitate the conduct of the Group's
meetings, voting will be in proportion to the exposure of the creditors only.
 The CDR Empowered Group would be mandated to look into each case of debt
restructuring, examine the viability and rehabilitation potential of the
Company and approve the restructuring package within a specified time
frame of 90 days, or, at best within 180 days of reference to the Empowered
Group.
CDR Cell

 All references for corporate debt restructuring by creditors or borrowers will

be made to the CDR Cell. It shall be the responsibility of the lead
institution/major stakeholder to the corporate, to work out a preliminary
restructuring plan in consultation with other stakeholders and submit to the
CDR Cell within one month.
The Category 1 CDR system

 The Category 1 CDR system will be applicable only to accounts classified as

'standard' and 'substandard the books of at least 90 per cent of creditors (by
value)
 The accounts where recovery suits have been filed by the creditors against
the company, may be eligible for consideration under the CDR system
provided, the initiative to resolve the case under the CDR system is taken by
at least 75 per cent of the creditors (by value) and 60 per cent of creditors
(by number).
 BIFR cases are not eligible for restructuring under the CDR system.
 However, large value B I F R cases may be eligible for restructuring under the
CDR system if specifically recommended by the CDR Core Group.
Category 2 CDR System

 Introduced for cases where the accounts have been classified as 'doubtful' in
the books of creditors, and if a minimum of 75 per cent of creditors (by value)
and 60 per cent creditors (by number) satisfy themselves of the viability of
the account and consent for such restructuring,
SMA Category

 Special Mentioned Account

 Lenders shall recognize incipient stress in loan accounts, immediately on
default, by classifying such assets as special mention accounts (SMA) as per
the following categories:
Scheme for sustainable restructuring of
stressed assets

 Scheme for Sustainable Structuring of Stressed Assets also known as S4A

Scheme was launched on 13th June 2016 by the Reserve Bank of India as an
initiative to address and resolve the debt issues of the corporate sector along
with strengthening the ability of the lender to deal with stressed assets

 As per the S4A scheme, the debt of a company is bifurcated into two parts
namely sustainable and unsustainable debt based on the cash flows of the
company’s project. The sustainable debt of a company should not be less than
50% of the existing debt and the unsustainable debt can be converted into
optionally convertible debentures.
S4A Scheme- Key Features

 Under the S4A scheme, an account is considered eligible for restructuring if

the total loans in the account by all the institutional lenders exceeds Rs. 500
crore which includes the rupee loans as well as the foreign currency loans.
 An independent agency is hired by the lending bank for evaluating sustainable
debt.
Sale of Financial Asset

A financial asset may be sold to the SC/RC by any bank/ FI where the asset is:
 i) A NPA, including a non-performing bond/ debenture, and
 ii) A Standard Asset where :
 (a) the asset is under consortium/ multiple banking arrangements,
 (b) at least 75% by value of the asset is classified as non-performing asset in
the books of other banks/FIs, and
 (c) at least 75% (by value) of the banks / FIs who are under the consortium /
multiple banking arrangements agree to the sale of the asset to SC/RC.
Thank You