COMMERCIAL BANK

MANAGEMENT

Granting Credit
Concept: What and why is credit management?
• Major function of bank.
• Generates interest, commission an exchange income to bank
• Main aid to income and profit of the bank
• Most challenging tasks as risk must be properly analyzed.
• Poor credit management is one of the major causes of failure of banks
• Credit risk and high dependency on it while measuring overall banking
risk
• Bank adheres principles of liquidity, safety and profitability while
formulating loan policies.
• Bank also diversifies its loan portfolio across various sectors for
reduction of risk coming from a single sector. (Diversification)
• It includes credit marketing, credit processing, portfolio management,
risk analysis, credit monitoring and recovery management etc.
 Types of Credit
• Fund based Credit Facility vs Non Fund based Credit Facility
(Use of fund)
• Fixed Term Loan Vs Working Capital Loan (Nature)
• Short Term Loan/Long Term Loan (Term)
• Secured Loan/Unsecured Loan (Security)
• Corporate Loan (Wholesale Loan) /Consumer Loan (Retail
Loan) (Customer or borrower)
• Other Loans: Demand Loan, Trust Receipt Loan, Purchase or
Discount of Bills, Bridge Gap Loan, Margin Type Loan
 Credit: Types on various basis
• On the bases of use of fund:
– Fund based Loan
• Borrowers are disbursed with bank’s physical cash or fund after approval
of the credit facility.
• Bank Charges interest on such loans and interest rate in fixed as addition
of agreed premium on base rate of the bank.
– Non fund based Loan
• Bank does not disburse any loan for such facilities but commits the
creditor of the borrower to pay if borrowers fails to pay the creditor on
any future date within the validity of the facility. Eg LC and BG.
• Bank charge certain commission for the arrangement instead of interest.
• Incase of default from the borrower, such amount if have to paid by the
bank, is termed as either devolved LC or invoked guarantee which are
termed as bad loans and attract prompt recovery action including high
interest rate applicable to the balance.
 Credit: Types on various basis….
• On the basis of nature
– Fixed Term Loan
• The loan is disbursed for a specified period of more than one year. The
repayment of the loan is scheduled at the time of disbursement itself
with equated instalments or fixed unequal instalments of interest and
principal both or principal part only while interest is to be paid
separately at the predefined periodicity.
• Early payment of any principal part of the loan attracts prepayment
charge.
– Revolving loan (Working Capital Loan)
• As the name suggests, such loan are extended for a period of one year
and is subject to repayment or renewable at the expiry. Renew of such
loans are subject to good conduct of account, timely interest payment
and successful running of the business o which it has been extended.
• The borrower has flexibility to use the loan limit in full or none at their
discretion an the borrower has been allowed transactions in the loan
account itself.
• Such loan is also called line of credit
 Credit: Types on various basis…..
• On the basis of term
– Short Term Loan
• Such loans are extended for a period of one year or less. They have to
be repaid or renewed at the time of expiry.
• They can be both revolving and non revolving.
– Long Term loan
• Such loan is disbursed for a specified period of more than one year.
The repayment of the loan is scheduled at the time of disbursement
itself with equated instalments or fixed unequal instalments of interest
and principal both or principal part only while interest is to be paid
separately at the predefined periodicity.
• Early payment of any principal part of the loan attracts prepayment
charge.
 Credit: Types on various basis…..
• On the basis of security
– Secured Loan
• Loans backed by any movable/immovable asset as security. In this
case the borrower need to provide pledge/hypothecation/mortgage
charge in the security offered for the limit.

– Unsecured loan
• For such loan no security Oher than the borrower’s personal guarantee
has been pledged/hypothecated/mortgaged to the bank. For example,
professional loan and credit card .
 Credit: Types on various basis…..
• On the basis of borrower
– Wholesale/Commercial
• Loans or credit facilities extended to corporate houses, big firms,
company and corporations are called commercial or wholesale credit.
Such facilities are basically extended by analyzing financials of the
borrowers.
• Banks provide both fixed term loan and revolving loan limits as per
their requirement but the loan amount is relatively at a higher side.
• Although, such customers get loan in cheaper rate but they provide
chunk business and side by side other non fund based business can
also be obtained from such customers.
– Retail/Consumer
• These are the small loans extended to the individual customers for
fulfilling their various requirements like building house, buying car,
doing treatment, buying electronics etc.
• Such loans are generally of term loan nature but overdraft facility up
to Rs.50 lac is also allowed per person which is subject to further
repayment or renewal at its expiry.
 Credit: Types on various basis…..
• Others
– Demand Loan
• Loans extended to meet short term fund requirement of the borrower.
Such limits are used for short term seasonal requirement of additional
working capital loan. Such loan may be of one time and may be
revolving in nature.
– Trust Receipt Loan
• Such loan is extended to settle letter of credit and can be provided up
to the specified period as per NRB for sight LC and usance LC. Even
NRB has put some restrictions (50% to 100%) to provide loan for
importing various items due to the adverse balance of payment and
foreign currency reserve of our country.
– Bridge Gap Loan
• Loan provided for a period up to the period of disbursement of original
limit. Such loan comes into existence when bank plans to finance a big
project and the aggregate proposal is under the pipeline. Such bridge
gap loans are settled by the proceeds of the original loan.
 Credit: Types on various basis…..
• Others
– Margin Loan
• Loans extended against the pledge of shares of A class intuitions
listed in NEPSE.
• 70% of the effective value of shares has been allowed as loan. The
effective value is the minimum of current rate or 150 days average
rate of the share. If due to movement in market, the ratio is
tempered, the bank calls for margin deposit or additional pledging of
shares to accommodate such fall in value within the guideline.
– Bill Purchase and Discounting
• Various payment instruments like cheques, drafts, documents under
LC, bill of exchange etc) are purchased by bank as per the approved
limit on certain commission and sends for realization.
• If the realization takes more than contracted time or rejected, such
amount is payable by the customer with interest to the bank.
 Process of Credit Management
• Credit marketing
• Credit Appraisal
• Credit Approval
• Credit Documentation
• Credit Disbursement
• Credit Monitoring
• Credit Recovery, Restructuring and Rescheduling
 Credit Marketing
– Cut throat competition between banks
– Relations, capacity, rates and services
– Strategies
– Make attractive schemes and promotional advertisements
– Visit new customers and markets with keeping on continuous follow
ups
– Quality services to existing clients to be ensured for auto stimulated
word of mouth advertisement by them.
– Offer competitive rate and waiver in commission rate for value
customers
– Ensure easy lending procedures (in terms of hassles and time)
– Target suitable market for suitable schemes
– Focus on customer service for their retention
 Credit Appraisal
• Why is appraising needed?
• Varies from structured to vague in terms of size and nature
of the proposed credit
• Key elements of Credit appraisal

– Macro Level Analysis (Environment)

– Micro level Analysis

• Industry wise Analysis
• Unit wise Analysis
Appraising Credit Proposals……
• Macro Level Analysis
– Economic Environment
– Demographic Environment
– Socio-cultural Environment
– Technological Environment
– Political Environment
– Labor Markets
– Legal Environment
 Appraising Credit Proposals……
• Micro Level Analysis
– Industry Analysis
• Risk grading as per various factors for particular industry
• Study of performance of current units, profitability, technology used , availability of
market share, competitive position etc

– Firm Specific Analysis

• Non-Financial Analysis
• Financial Analysis
Appraising Credit Proposals……
• Non Financial Analysis
– Character
– Capacity
– Collateral
– Conditions
– Capital
– Compliance
Appraising Credit Proposals……
• Financial Analysis
– Liquidity Ratios
• Current Ratio
• Acid Test Ratio

– Profitability Ratios
• Profit Margin
• Return on Capital Employed
• Return on Assets
• Return on Shareholder’s Equity

– Solvency Ratios
• Debt Equity Ratio

– Efficiency/Activity Ratios
• Asset Utilization Ratio
• Stock Turnover Ratio
• Debtor’s Period
 Security
• Primary Security

• Collateral Security

• Personal Guarantee
Properties of Good Collateral
• Durability
• Identification
• Marketability
• Stability of value
• Free from legal issues
Collateral Security used in Banking
• Land and or building
• Inventory
• Account Receivable
• Plant and Machinery
• Project itself
• Other personal properties
• Personal Guarantees
• Charge on assets etc
 Valuation
– Valuation done by bank approved valuator selected from open bid
participation. They are not staffs of bank but are independent experts
who suggests values of collaterals to bank for making lending
decisions.
– Land and buildings, plant and machinery are valuated
– Plant and machineries are valued by cost of purchase less
depreciation.
– Buildings or structures are valued at cost of construction less
depreciation.
– Land is valued with the weighted rate derived from 70% of the market
rate and 30% of Government rate to find out the FMV. Necessary set
back deduction of area while calculating the FMV shall be take care
provisions for rivers, hi tension lines and right of way etc.
– After deducting certain %, the distress value of the security is
recommended.
 Credit Approval
– How to approve credit facilities?

• Delegation of authority in terms of sanctioning loan

proposals.
• Appraisal is routed through proper channel with
comments to the approving authority.
• Approving authority goes through the proposal with the
recommendations of the officials of various stages and
finally gives approval to the credit proposal.
 Credit Documentation

• Proper documentation ensures legal claim on collateral property.

• Some documents are executed at the bank premise itself while some has
to be registered with Government Offices like Land Revenue Office and
Secured Transaction Registration Office (STRO)
• Mortgage deed of collateral should be registered with land revenue office
while hypothecation of stocks should be registered with STRO via system
entry.
Documentation: List of Required documents
– Loan application
– Renewed/updated Business Registration, recent tax/vat clearance
– Approved appraisal and approval memo
– Loan sanction letter or offer letter (Duly accepted)
– Evidence of income or financial statements
– Loan deed
– Pari-passu agreement in case of consortium financing
– Promissory notes
– Mortgage deed and rokka letter
– Consent deed for third party collateral
– Personal guarantees (First party or third party)
– Group Guarantee/Corporate Guarantee if any
– Hypothecation deed for stocks and receivable
– (Charge to be created in STRO)
– Power of attorney
– Original Lalpurja/Copy of blue book
– Valid insurance polices
 Credit Disbursement

• After ensuring the completion of documentation procedure,

checklist along with a note is prepared and sent to the
appropriate authority for disbursement approval.

• Once the approval is received, loan is disbursed as per the

concerned scheme by giving manager’s cheque to the beneficiary
party, by crediting loan amount to operating account or by
opening loan account and allowing cheque leafs to the party etc.
Credit Monitoring and Supervision

• Used for approved purpose or not.

• Borrower is complying all the terms and conditions of
sanction or not
• Helps to detect future risk by identifying the warning
signals
• Level of stocks, books of receivables, cash flow etc to be
closely studied.
 Recovery Management
– Essential part of credit management.

– All credit may not remain good till the end.

– Dealing with problematic loan accounts.

– Bank has to set up efficient and effective loan

recovery mechanism.
– Cost of carrying problematic loans are high.
Recovery Management: Procedure
– Regular monitoring
– Communication to borrower for performance of accounts
– Ensuring legal accuracy of loan documents
– Assessing the present value of collateral
– Dialogue with the borrower for possible solutions /Restructuring of
loans
– Convey the reputation loss of legal actions if initiated
– Legal actions to be initiated by issuing loan pay back letter for
7/15/35 days and notice publication in National newspaper
– Compromise proposal
– Auction process to be initiated
– Blacklisting with CIC
– Filing case at DRT
 Credit Administration
• Ensures soundness of credit portfolio
• Ensures proper maintenance and administration of credit
files.
• Records keeping, correct opening of loan accounts for
ensuring correcting reporting and safe keeping of security
documents
• Ensures compliance with applicable laws and internal
policies
• Purely back office function supporting and controls
extension of credit
• Segregation of approval and administration processes
should be made.
 Credit Administration…..
Following information is needed to be updated in credit files.
• Application
• Evidence of approval
• Latest financial reports
• Record and date of all credit reviews
• Record of all guarantees and securities
• Record of terms and conditions
• Internal ratings
• Insurance expiries
• Evidence of security validation function ensuring legal validity,
existence, valuation, registration of charge and safekeeping.
 Credit Administration…..
Basically credit administration function includes the following
after sanction functions
• Documentation
• Disbursement
• Monitoring
• Loan Repayment
• Maintenance of credit files
• Collateral and security documents (safe keeping of
originals and their charges registered with the respective
Government offices)
Loan Classification and Loan Loss Provisioning
• Entire loans are classified in below classes based on expiry of the deadline of repayment
of principal/interest of loans.
– Pass
• Overdue up to 1 month
• 1% provision on loan amount needed
• During the covid period, NRB has increased the provision to 1.30% which is not lifted yet.
– Watch List
• Overdue up to 3 months
• 5% provision on loan amount needed
– Sub-standard
• Overdue up to 6 months
• 25% provision on loan amount needed
– Doubtful
• Overdue up to a year
• 50% provision on loan amount is needed
– Loss
• Overdue above one year
• 100% provision on loan amount is needed
Performing and Nonperforming Loan
• Performing loans are the loans where principal/interest
overdue has not crossed 3 months.
• Pass and watch list loans are basically performing loans
while the other are nonperforming.
• Management of NPL is essential for
– increasing profitability of the bank.
– sound loan management
– good financial standing among the competitors

• Nonperforming assets include nonbanking asset,

pending interest suspense account with the unutilized
assets. Proper disposal of them ensures added profits
in the ongoing year.
 Managing Credit Risks

Credit Risk is basically the risk of default by a credit

customer. If the loan has been extended after fulfilling all
prudential banking practice, risk of being default is also
minimum.

Bank ensures to mitigate credit risk by formulating effective

loan policy and implementing it completely. It is like a
constitution within a bank for credit management and should
be delivered to all officials for full compliance. It not only
ensures the compliance guidelines of the regulators but also
promulgates uniform credit practice to be followed in a bank
by own stringent practices as well. Board formulates the Loan
Policy and reviews it at the required time frame.
 Managing Credit Risks
Methods used to reduce credit risks.

 Avoiding risky sectors

 Sufficient Collateral

 Diversifying the portfolio

 Error free Documentation

 Guarantees

 Maintenance of loan limit

 Monitoring of loan account

 Transfer risk (Insurance of credit/CDS (Credit default

swap))
 Managing Credit Risks
Basic points covered by Loan Policy;
• Area to lend and not to lend in view of facilities, collateral,
geographical sectors etc

• Detailed Credit process to be fulfilled

• Credit approving authorities at various levels

• Clear guidelines for each type of credit facilities

• Concentration of loans borrower wise or sector wise

• Authority for allowing discount on probable loss and write offs

• Credit Pricing

• Internal Risk rating system

• Guidelines to manage problematic loans

• Guidelines for monitoring and reporting system

 Principles of Lending
1. Principle of safety or security
 To lend with less probability of default

 Lend with follow up with good credit mechanism with sound appraisal
practice and good credit policy

 To lend, financial and commercial viability, track record and management

qualities (honesty, knowledge, reputation, willingness to pay)

 Priority should be given for obtaining cashable property as collateral

2. Principle of liquidity

 Bank must have best mechanism to manage assets and liabilities

 The sources and uses of funds should be managed in such a way

that the maturity of assets and liabilities match each other.

 Bank should not be in the position of out of fund due to liquidity

problem

 Bank can’t deny extending already approved credit line otherwise

financed project can be compromised.
 Principles of Lending
3. Principle of Risk Diversification
 Do not put all eggs in a single basket.

 With no of customers, sectors, sub sectors , loan types, collateral type etc,
bank must diversify its credit portfolio to minimize credit risk.

 Some guidelines of NRB also addresses the same for banking.

4. Principle of Profitability
 Every financed loan must generate profit for bank.

 Profit is necessary for commercial bank for bank’s sustainability and

growth.

5. Principle of Purpose
 If loan is misused, the chances of its returning becomes less.

 Bank must ensure that the loan is used for the purpose for which it is
granted.