credit appraisal sept 2012

8/13/2019 Credit Appraisal Sept 2012

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Chapter-1

INTRODUCTIONIn the present situation, banking in India has attained fair amount of maturity in

terms of supply, product range and reach-even though reach in rural India still remains achallenge for the private sector and foreign banks. In terms of quality of assets andcapital adequacy, Indian banks are considered to have clean, strong and transparentbalance sheets relative to other banks in comparable economies in its region. SinceIndian economy is witnessing strong growth the demand for banking services, especiallyretail banking, mortgages and investment services are expected to be strong. One mayalso expect M&A ’s, takeovers, and asset sales.

Currently, India has 83 scheduled commercial banks (SCBs) - 25 public sector

banks (that is with the Government of India holding a stake), 22 private banks (these donot have government stake; they may be publicly listed and traded on stock exchanges)and 36 foreign banks. They have a combined network of over 63,000 branches and37,000 ATMs. According to a report by ICRA Limited, a rating agency, the public sectorbanks hold over 75 percent of total assets of the banking industry, with the private andforeign banks holding 18.2% and 6.5% respectively.

Bank Definition:Under Indian Law:

According to Banking Regulation Act, 1949(Vide Section 5b, c) as follows:A) “Accepting for the purpose of lending or investment of deposits of money from thepublic, repayable on demand or otherwise & withdrawal by cheque draft & order orotherwise (Sec. 5b)

B) A banking c ompany is “a company which transacts the business of banking in India”(Sec. 5c)

Banks are institutions that accept various types of deposits & use those funds forgranting loans. The business of banking is that of an intermediary between thesaving & investment units of the economy. It collects the surplus funds of millions ofindividual savers who are widely scattered & channelizes them to the investors.

Business of Banking



Role of Banks in an Economy:Banks play an important & active role in the economic development of a

country. If the banking system is a country is effective, efficient & disciplined it bringsabout rapid growth in the various sectors of the economy. The following is thesignificance of banks in the economic development of a country:

1. Banks promote capital formation:Commercial banks accept deposits from individuals & businesses, these

deposits are then made available to the businesses which make use of them forproductive purposes in the country. The banks are therefore not only the storehouses of the country’s wealth, but also provide financial resources necessary foreconomic development.

2. Investment in new enterprise:Businessman normally hesitates to invest their money in risky enterprises.

The commercial banks generally provide short & medium term loans toentrepreneurs to invest in new enterprise & adopt new methods of production.The provision of timely credit increases the productive capacity of the economy.

3. Promotion of trade & Industry:With the growth of commercial banking there is vast expansion in trade &

industry. The use of bank draft, check, bill of exchange, credit cards & letters ofcredit etc has revolutionized both national & international trade.

4. Development of Agriculture

The commercial banks particularly in developing countries are nowproviding credit for development of agriculture & small scale industries in ruralareas. The provision of credit to agriculture sector has greatly helped in raisingagriculture productivity & income of the farmers.

5. Implementation of Monetary policy:



The central bank of the country controls & regulates volume creditthrough the active cooperation of the banking system in the country. Ithelps in bringing price stability & promotes economic growth within theshortest possible period of time.

6. Monetization of the economy:The commercial banks by opening branches in the rural & backward areasare reducing the exchange of goods through barter. The use of money hasgreatly increased the volume of production of goods. The non monetizedsector (barter economy) is now being converted into monetized sectorwith the help of commercial banks.

Chapter-2OBJECTIVES OF THE STUDY

The main objective of the research is to understand the concept of credit (Loan)appraisal.

What is the process of credit appraisal?

How can it function and control? What are the important things in credit appraisal? How banks do credit ratings? How banks fix the interest rates for different sectors?

Under this project I have also studied overview of banking industry. I have includedoverview of banking sector as well as types of bank.



Chapter-3Scope of the Study

To provide necessary information to prospective customers providing loans To help customers in the form filling procedure. To inform customers about the different products offered by the bank.

Chapter-4

Limitations of the study:

As the credit rating is one of the crucial areas for any bank, some of thetechnicalities are not revealed which may have cause destruction to theinformation and our exploration of the problem.

As some of the information is not revealed, whatever suggestions generated, arebased on certain assumptions.

Credit appraisal system includes various types of detail studies for different areasof analysis, but due to time constraint, our analysis was of limited areas only.



Chapter-5

State Bank of India

The State Bank of India, the country’s oldest Bank and a premier in terms ofbalance sheet size, number of branches, market capitalization and profits is today goingthrough a momentous phase of Change and Transformation – the two hundred year oldPublic sector behemoth is today stirring out of its Public Sector legacy and moving withan ability to give the Private and Foreign Banks a run for their money.The bank is entering into many new businesses with strategic tie ups – Pension Funds,General Insurance, Custodial Services, Private Equity, Mobile Banking, Point of SaleMerchant Acquisition, Advisory Services, structured products etc – each one of theseinitiatives having a huge potential for growth.

The Bank is forging ahead with cutting edge technology and innovative new bankingmodels, to expand its Rural Banking base, looking at the vast untapped potential in thehinterland and proposes to cover 100,000 villages in the next two years.

It is also focusing at the top end of the market, on whole sale banking capabilities toprovide India’s growing mid/large Corporate with a complete array of products andservices. It is consolidating its global treasury operations and entering into structuredproducts and derivative instruments. Today, the Bank is the largest provider of

infrastructure debt and the largest arranger of external commercial borrowings in thecountry. It is the only Indian bank to feature in the Fortune 500 list.

The Bank is changing outdated front and back end processes to modern customerfriendly processes to help improve the total customer experience. With about 11448 ofits own branches and another 6500+ branches of its Associate Banks already networked,today it offers the largest banking network to the Indian customer. Banking behemothState Bank of India is planning to set up 15,000 ATMs in the country by March 2010investing more than Rs 1,000 crores.

RP Sinha, deputy managing director (information technology) of the bank, said: "Weplan to have 25,000 ATMs in the country by March 2010. We will add 15,000 ATMs tothe existing ones by end of this fiscal." The bank has almost 10,300 ATMs in the countryat present.

http://upload.wikimedia.org/wikipedia/en/c/cc/SBI-logo.svg



According to a senior SBI official, the spot for an ATM counter is taken on lease. Itrequires Rs 5.2-5.5 lakh to set up the infrastructure and almost Rs 3.5 lakh for an ATMmachine. "All put together, the cost is around Rs 9 lakh per counter," he said. Going bythe estimate, SBI would require a whopping Rs 1,350 crores for setting up 15,000 ATMs.

The Bank is also in the process of providing complete payment solution to its clientelewith its ATMs, and other electronic channels such as Internet banking, debit cards,mobile banking, etc.

With four national level Apex Training Colleges and 54 learning Centers spread all overthe country the Bank is continuously engaged in skill enhancement of its employees.Some of the training programs are attended by bankers from banks in other countries.

The bank is also looking at opportunities to grow in size in India as well as

internationally. It presently has 82 foreign offices in 32 countries across the globe. It hasalso 8 Subsidiaries in India – SBI Capital Markets Ltd, SBI Mutual Funds, SBI factor andcommercial services Ltd, SBI DFHI Ltd, SBI Cards and Payment Services Ltd, SBI LifeInsurance Company Ltd, SBI Fund Management Pvt. Ltd, SBI Canada - forming aformidable group in the Indian Banking scenario. It is in the process of raising capital forits growth and also consolidating its various holdings.

KEY AREAS OF OPERATION:The business operations of SBI can be broadly classified into the key income generatingareas such as National Banking, International Banking, Corporate Banking, & Treasuryoperations. The functioning of some of the key divisions is enumerated below:

a) Corporate banking

The corporate banking segment of the bank has total business of around Rs1, 193 bn.SBI has created various Strategic Business Units (SBU) in order to streamline its

operations.

These SBUs are as follows:

1) Corporate Accounts

2) Leasing



3) Project Finance

4) Mid Corporate Group

5) Stressed Assets Management

b) National banking

The national banking group has 14 administrative circles encompassing a vast networkof 9,177 branches, 4 sub-offices, 12 exchange bureaus, 104 satellite offices and 679extension counters, to reach out to customers, even in the remotest corners of thecountry. Out of the total branches, 809 are specialized branches. This group consists offour business group which are enumerated below:

1) Personal Banking SBU

2) Small & Medium Enterprises

3) Agricultural Banking 4) Government Banking

c) International banking

SBI has a network of 73 overseas offices in 30 countries in all time zones andcorrespondent relationship with 520 international banks in 123 countries. The bank iskeen to implement core banking solution to its international branches also. During FY06,

25 foreign offices were successfully switched over to Pinnacle software. SBI has installedATMs at Male, Muscat and Colombo Offices. In recent years, SBI acquired 76%shareholding in Guiro Commercial Bank Limited in Kenya and PT Indamines Bank Ltd. inIndonesia. The bank incorporated a company SBI Botswana Ltd. at Gaborone.

d) Treasury

The bank manages an integrated treasury covering both domestic and foreign exchangemarkets. In recent years, the treasury operation of the bank has become more activeamidst rising interest rate scenario, robust credit growth and liquidity constraints. Thebank diversified its operations more actively into alternative assets classes with a viewto diversify the portfolio and build alternative revenue streams in order to offset thelosses in fixed income portfolio. Reorganization of the treasury processes at domesticand global levels is also being undertaken to leverage on the operational synergybetween business units and network. The reorganization seeks to enhance the



efficiencies in use of manpower resources and increase maneuverability of banksoperations in the markets both domestic as well as international.

e) Associates & Subsidiaries

The State Bank Group with a network of 14,061 branches including 4,755 branches of itsseven Associate Banks dominates the banking industry in India. In addition to banking,the Group, through its various subsidiaries, provides a whole range of financial serviceswhich includes Life Insurance, Merchant Banking, Mutual Funds, Credit Card, Factoring,Security trading and primary dealership in the Money Market.

1) Associates Banks:

SBI has six associate banks namely

• State Bank of Indore

• State Bank of Travancore

• State Bank of Bikaner and Jaipur

• State Bank of Mysore

• State Bank of Patiala

• State Bank of Hyderabad

2) Non-Banking Subsidiaries/Joint Ventures

i) SBI Capital Markets Ltd,ii) SBI Mutual Funds,iii) SBI factor and commercial services Ltd,

iv) SBI DFHI Ltd,v) SBI Cards and Payment Services Ltd,vi) SBI Life Insurance Company Ltd,vii) SBI Fund Management Pvt. Ltd, SBI



Chapter-6

OVERVIEW OF CREDIT APPRAISALCredit appraisal means an investigation/assessment done by the bank prior

before providing any loans & advances/project finance & also checks the commercial,financial & technical viability of the project proposed its funding pattern & furtherchecks the primary & collateral security cover available for recovery of such funds.

Brief overview of credit:

Credit Appraisal is a process to ascertain the risks associated with the extension of thecredit facility. It is generally carried by the financial institutions which are involved inproviding financial funding to its customers. Credit risk is a risk related to nonrepayment of the credit obtained by the customer of a bank. Thus it is necessary toappraise the credibility of the customer in order to mitigate the credit risk. Properevaluation of the customer is performed this measures the financial condition and theability of the customer to repay back the loan in future. Generally the credits facilitiesare extended against the security know as collateral. But even though the loans arebacked by the collateral, banks are normally interested in the actual loan amount to be

repaid along with the interest. Thus, the customer's cash flows are ascertained toensure the timely payment of principal and the interest.

It is the process of appraising the credit worthiness of a loan applicant. Factors like age,income, number of dependents, nature of employment, continuity of employment,repayment capacity, previous loans, credit cards, etc. are taken into account while



appraising the credit worthiness of a person. Every bank or lending institution has itsown panel of officials for this purpose.

However the 3 ‘C’ of credit are crucial & relevant to all borrowers/ lending which mustbe kept in mind at all times.

Character Capacity Collateral

If any one of these is missing in the equation then the lending officer must question the

viability of credit.

There is no guarantee to ensure a loan does not run into problems; however if propercredit evaluation techniques and monitoring are implemented then naturally the loanloss probability / problems will be minimized, which should be the objective of everylending officer.

Credit is the provision of resources (such as granting a loan) by one party to anotherparty where that second party does not reimburse the first party immediately, thereby

generating a debt, and instead arranges either to repay or return those resources (ormaterial(s) of equal value) at a later date. The first party is called a creditor, also knownas a lender, while the second party is called a debtor, also known as a borrower.

Credit allows you to buy goods or commodities now, and pay for them later. We usecredit to buy things with an agreement to repay the loans over a period of time. Themost common way to avail credit is by the use of credit cards. Other credit plans includepersonal loans, home loans, vehicle loans, student loans, small business loans, trade.

A credit is a legal contract where one party receives resource or wealth from anotherparty and promises to repay him on a future date along with interest. In simple terms, acredit is an agreement of postponed payments of goods bought or loan. With theissuance of a credit, a debt is formed.

Basic types of credit



There are four basic types of credit. By understanding how each works, you will be ableto get the most for your money and avoid paying unnecessary charges.

Service credit is monthly payments for utilities such as telephone, gas, electricity, andwater. You often have to pay a deposit, and you may pay a late charge if your paymentis not on time.

Loans let you borrow cash. Loans can be for small or large amounts and for a few daysor several years. Money can be repaid in one lump sum or in several regular paymentsuntil the amount you borrowed and the finance charges are paid in full. Loans can besecured or unsecured.

Installment credit may be described as buying on time, financing through the store orthe easy payment plan. The borrower takes the goods home in exchange for a promiseto pay later. Cars, major appliances, and furniture are often purchased this way. Youusually sign a contract, make a down payment, and agree to pay the balance with aspecified number of equal payments called installments. The finance charges areincluded in the payments. The item you purchase may be used as security for the loan.

Credit cards are issued by individual retail stores, banks, or businesses. Using a creditcard can be the equivalent of an interest-free loan--if you pay for the use of it in full atthe end of each month.

Brief overview of loans:Loans can be of two types fund base & non-fund base:

Fund Base includes:

Working Capital Term Loan

Non-Fund Base includes:



Letter of Credit Bank Guarantee Bill Discounting

Fund Base: -

Working Capital:

GeneralThe objective of running any industry is earning profits. An industry will requirefunds to acquire “ Fixed assets” like land, building, plant, machinery, equipments,vehicles, tools etc., & also to run the business i.e. its day to day operations.

Funds required for day to-day working will be to finance production & sales. Forproduction, funds are needed for purchase of raw materials/ stores/ fuel, foremployment of labor, for power charges etc., for storing finishing goods till theyare sold out & for financing the sales by way of sundry debtors/ receivables.Capital or funds required for an industry can therefore be bifurcated as fixedcapital & working capital. Working capital in this context is the excess of currentassets over current liabilities. The excess of current assets over current liabilitiesis treated as net working capital or liquid surplus & represents that portion of the

working capital, which has been provided from the long-term source.

Definition:

Working capital is defined as the funds required carrying the required levels ofcurrent assets to enable the unit to carry on its operations at the expected levelsuninterruptedly.

Thus Working Capital required is dependent on(a) The volume of activity (viz. level of operations i.e. Production & sales)(b) The activity carried on viz. mfg process, product, production program, the

materials & marketing mix.

Methods & Application



SEGMENT LIMITS METHOD

Small Scale Industries Upto Rs 5 cr Traditional Method & NayakCommittee method

Above Rs 5 cr Projected Balance Sheet Method

Small Business Finance All loans Traditional / Turnover Method

Commercial & IndustrialTrade & Services

Upto Rs 1 cr Traditional Method for Trade &Projected Turnover Method

Above Rs 1 cr& upto Rs 5 cr

Projected Balance Sheet Method &Projected Turnover Method

Above Rs 5 cr Projected Balance Sheet MethodC & I Industrial Units Below

Rs 25 lacsTraditional Method

Rs 25 lacs &Over but uptoRs 5 cr

Projected Balance Sheet Method &Projected Turnover Method

Above Rs 5 cr Projected Balance Sheet Method

Operating cycle method

Any manufacturing activity is characterized by a cycle of operations consistingof purchase of purchase of raw materials for cash, converting these intofinished goods & realizing cash by sale of these finished goods.

Diagrammatically, the OPERATING CYCLEis represented as under

The time that lapses between cash outlay & cash realization by sale of finishedgoods & realization of sundry debtors is known as the length of the operatingcycle.

That is, the operating cycle consists of:



Time taken to acquire raw materials & average period for which they are in store. Conversion process time Average period for which finished goods are in store & Average collection period of receivables (Sundry Debtors)

Operating cycle is also called the cash-to-cash cycle & indicates how cash is convertedinto raw materials, stocks in process, finished goods, bills (receivables) & finally back to

cash. Working capital is the total cash that is circulating in this cycle. Therefore, workingcapital can be turned over or redeployed after completing the cycle.

The length of the operating cycle = a+b+c+d (as in 4.4)

cash

Rawmaterials

Work-in-progress

Finishedgoods

debtors



If a = 60 days

b = 10 daysc = 20 daysd = 30 days

The operating cycle is 120 days (nearly 4 months). This means there are 365/120 = 3cycles of operations in a year.

Sales = Rs. 1, 00,000 per annumOperating expenses = Rs. 72,000 per annum

But the working capital requirement, as you know, is not Rs. 72,000.

In these cases, there are 3 operating cycles in a year. That means each rupee ofworking deployed in the unit is turned over 3 times in a year. (This is also known asworking capital turnover ratio).

Therefore WCR = Operating Expenses = Rs. 72,000/- = Rs. 24,000/-No. of cycles per annum 3

WCR is therefore not Rs. 72,000/- but only Rs. 24,000/-

Assessment of Working Capital Requirement & Permissible Bank Finance usingOperating Cycle Concept

Let us consider a case of a unit where:

Sales = Rs. 20,000 pm (A)Raw Materials = Rs. 14,000 pmWages = Rs. 2,000 pm

Other manufacturing



Expenses = Rs. 3,000 pmTotal expenses = Rs. 19,000 p.m. (B)Profit = Rs. 1,000 P.m. (C)

The operating cycle is

Raw Materials = 15 daysStock in Process = 2 daysFinished Goods = 3 daysSundry Debtors = 15 daysThe total length of Operating cycle = 35 days (D)

WCR = B * D = 19,000 * 35 = Rs. 22,167/- (approx.)30 30

Where B = Operating Expenses; &D = Length of Operating cycle

The length of the operating cycle is different from industry to industry and from onefirm to another within the same industry. For instance, the operating cycle of apharmaceutical unit would be quite different from one engaged in the manufacture ofmachine tools. The operating cycle concept enables us to assess the working capitalneed of each enterprise keeping in view the peculiarities of the industry it is engaged inand its scale of operations. Operating cycle is an important management tool indecision-making.

Traditional Method of Assessment of Working Capital Requirement

The operating cycle concept serves to identify the areas requiring improvement for thepurpose of control and performance review. But, as bankers, we require a more detailedanalysis to assess the various components of working capital requirement viz., financefor stocks, bills etc. Bankers provide working capital finance for holding an acceptablelevel of current assets, viz. raw materials, stocks-in-process, finished goods and sundrydebtors for achieving a predetermined level of production and sales. Quantification of



these funds required to be blocked in each of these items of current assets at any timewill, therefore provide a measure of the working capital requirement (WCR) of anindustry.

It can thus be summarized as follows:

Projected Annual Turnover Method for SSI units (Nayak Committee)For SSI units which enjoy fund based working capital limits up to Rs.5 cr, the minimumworking capital limit should be fixed on the basis of projected annual turnover. 25% ofthe output or annual turnover value should be computed as the quantum of workingcapital required by such unit .The unit should be required to bring in 5% of their annualturnover as margin money and the Bank shall provide 20% of the turnover as workingcapital finance. Nayak committee Guidelines correspond to working capital limits as perthe Operating Cycle method where the average production / processing cycle is taken to

be 3 months (i.e. working capital would be turned over 4 times in a year).

Projected Annual Turnover Method for C & I industrial units (limits upto Rs 5 cr)

Bank has decided to extend Nayak Committee approach for assessment of limits to C&Iindustrial units requiring credit limits upto Rs.5 cr. That is, credit requirement up to Rs.5



require fund based working capital finance of Rs. 25 lacs and above. In the case of SSIborrowers, who require working capital credit limit up to Rs.5 cr, the limit shall becomputed on the basis of Nayak Committee formula as well as that based on productionand operating cycle of the unit and the higher of the two may be sanctioned. Fundbased working capital credit limits beyond Rs 5 cr for SSI units shall be computed in thesame way as for C&I units. For business enterprises in Trade and Services Sector, wherethe projected turnover method is not applicable, PBS method shall be followed.

In the Projected Balance Sheet (PBS) method, the borrower’s total business operations,financial position, management capabilities etc. are analyzed in detail to assess theworking capital finance required and to evaluate the overall risk of the exposure. Thefollowing financial analysis is also to be carried out:

Analysis of the borrower’s Profit and Loss account, Balance Sheet, Funds Flowetc. for the past periods is done to examine the profitability, financial position,financial management, etc. in the business.

Detailed scrutiny and validation of the projected income and expense in thebusiness, and projected changes in the financial position (sources and uses offunds) are carried out to examine if these are acceptable from the angle ofliquidity, overall gearing, efficiency of operations etc.

There will not be a prescription like mandatory minimum current ratio or maximumlevel of a current asset (inventory and receivables holding level norms) under PBSmethod. Under the PBS method, assessment of WC requirement will be carried out inrespect of each borrower with proper examination of all parameters relevant to theborrower and their acceptability.

TERM LOAN:

1. A term loan is granted for a fixed term of not less than 3 years intended normallyfor financing fixed assets acquired with a repayment schedule normally notexceeding 8 years.

2. A term loan is a loan granted for the purpose of capital assets, such as purchaseof land, construction of, buildings, purchase of machinery, modernization,



renovation or rationalization of plant, & repayable from out of the future earningof the enterprise, in installments, as per a prearranged schedule.From the above definition, the following differences between a term loan & theworking capital credit afford by the Bank are apparent:

The purpose of the term loan is for acquisition of capital assets. The term loan is an advance not repayable on demand but only in

installments ranging over a period of years. The repayment of term loan is not out of sale proceeds of the goods &

commodities per se, whether given as security or not. The repaymentshould come out of the future cash accruals from the activity of the unit.

The security is not the readily saleable goods & commodities but the fixedassets of the units.

3. It may thus be observed that the scope & operation of the term loans are entirelydifferent from those of the conventional working capital advances. The Bank’scommitment is for a long period & the risk involved is greater. An element of riskis inherent in any type of loan because of the uncertainty of the repayment.Longer the duration of the credit, greater is the attendant uncertainty ofrepayment & consequently the risk involved also becomes greater.

4. However, it may be observed that term loans are not so lacking in liquidity asthey appear to be. These loans are subject to a definite repayment programmeunlike short term loans for working capital (especially the cash credits) which arebeing renewed year after year. Term loans would be repaid in a regular way fromthe anticipated income of the industry/ trade.

5. These distinctive characteristics of term loans distinguish them from the shortterm credit granted by the banks & it becomes necessary therefore, to adopt adifferent approach in examining the applications of borrowers for such credit &for appraising such proposals.

6. The repayment of a term loan depends on the future income of the borrowingunit. Hence, the primary task of the bank before granting term loans is to assure

itself that the anticipated income from the unit would provide the necessaryamount for the repayment of the loan. This will involve a detailed scrutiny of thescheme, its financial aspects, economic aspects, technical aspects, a projection offuture trends of outputs & sales & estimates of cost, returns, flow of funds &profits.



Appraisal of Term Loans

Appraisal of term loan for, say, an industrial unit is a process comprising severalsteps. There are four broad aspects of appraisal, namely

Technical Feasibility - To determine the suitability of the technology selected &the adequacy of the technical investigation & design;

Economic Feasibility - To ascertain the extent of profitability of the project & itssufficiency in relation to the repayment obligations pertaining to term assistance;

Financial Feasibility - To determine the accuracy of cost estimates, suitability ofthe envisaged pattern of financing & general soundness of the capital structure;

& Managerial Competency – To ascertain that competent men are behind theproject to ensure its successful implementation & efficient management aftercommencement of commercial productio n.

Technical Feasibility:

The examination of this item consists of an assessment of the various requirement ofthe actual production process. It is in short a study of the availability, costs, quality &accessibility of all the goods & services needed.

a) The location of the project is highly relevant to its technical feasibility & hencespecial attention will have to be paid to this feature. Projects whose technicalrequirements could have been taken care of in one location sometimes failbecause they are established in another place where conditions are lessfavorable. One project was located near a river to facilitate easy

transportation by barge but lower water level in certain seasons madeessential transportation almost impossible. Too many projects have becomeuneconomical because sufficient care has not been taken in the location ofthe project, e.g. a woolen scouring & spinning mill needed large quantities ofgood water but was located in a place which lacked ordinary supply of water& the limited water supply available also required efficient softening



treatment. The accessibility to the various resources has meaning only withreference to location. Inadequate transport facilities or lack of sufficientpower or water for instance, can adversely affect an otherwise soundindustrial project.

b) Size of the plant – One of the most important considerations affecting thefeasibility of a new industrial enterprise is the right size of the plant. The sizeof the plant will be such that it will give an economic product, which will becompetitive when compared to the alternative product available in themarket. A smaller plant than the optimum size may result in increasedproduction costs & may not be able to sell its products at competitive prices.

c) Type of technology – An important feature of the feasibility relates to thetype of technology to be adopted for a project. A new technology will have tobe fully examined & tired before it is adopted. It is equally important to avoid

adopting equipment or processes which are absolute or likely to becomeoutdated soon. The pri nciple underlying the technological selection is that “adeveloping country cannot afford to be the first to adopt the new nor yet thelast to cast the old aside”.

d) Labor – The labor requirements of a project need to be assessed with specialcare. Though labor in terms of unemployed persons is abundant in thecountry, there is shortage of trained personnel. The quality of labor required& the training facilities made available to the unit will have to be taken into

accounte) Technical Report – A technical repo rt using the Bank’s Consultancy Cell,

external consultants, etc., should be obtained with specific comments on thefeasibility of scheme, its profitability, whether machinery proposed to beacquired by the unit under the scheme will be sufficient for all stages ofproduction, the extent of competition prevailing, marketability of theproducts etc., wherever necessary.

Economic FeasibilityAn economic feasibility appraisal has reference to the earning capacity of theproject. Since earnings depend on the volume of sales, it is necessary to determinehow much output or the additional production from an established unit the marketis likely to absorb at given prices.



a) A thorough market analysis is one of the most essential parts of projectinvestigation. This involves getting answers to three questions.

How big is the market? How much it is likely to grow? How much of it can the project capture?

The first step in this direction is to consider the current situation, taking accountof the total output of the product concerned & the existing demand for it with aview to establishing whether there is unsatisfied demand for the product. Careshould be taken to see that there is no idle capacity in the existing industries.

b) Future – possible future changes in the volume & patterns of supply &demand will have to be estimated in order to assess the long term prospectsof the industry. Forecasting of demand is a complicated matter but one of the

vital importance. It is complicated because a variety of factors affect thedemand for product e.g. technological advances could bring substitutes intomarket while changes in tastes & consumer preference might cause sizableshifts in demand.

c) Intermediate product – The demand for “Intermediate product” will dependupon the demand & supply of the ultimate product (e.g. jute bags, paper forprinting, parts for machines, and tyres for automobiles). The market analysisin this case should cover the market for the ultimate product.

Financial Feasibility The basis data required for the financial feasibility appraisal can be broadly groupedunder the following heads

i) Cost of the project including working capitalii) Cost of production & estimates of profitabilityiii) Cash flow estimates & sources of finance.

The cash flow estimates will help to decide the disbursal of the term loan. The estimateof profitability & the breakeven point will enable the banker to draw up the repaymentprogramme, start-up time etc. The profitability estimates will also give the estimate ofthe Debt Service Coverage which is the most important single factor in all the termcredit analysis.



A study of the projected balance sheet of the concern is essential as it is necessary forthe appraisal of a term loan to ensure that the implementation of the proposed scheme.

Break-even point:

In a manufacturing unit, if at a particular level of production, the total manufacturingcost equals the sales revenue, this point of no profit/ no loss is known as the break-evenpoint. Break-even point is expressed as a percentage of full capacity. A good project willhave reasonably low break-even point which not be encountered in the projections offuture profitability of the unit.

Debt/ Service Coverage:

The debt service coverage ratio serves as a guide to determining the period ofrepayment of a loan. This is calculated by dividing cash accruals in a year by amount ofannual obligations towards term debt. The cash accruals for this purpose shouldcomprise net profit after taxes with interest, depreciation provision & other non cashexpenses added back to it.

Debt Service = Cash accrualsCoverage Ratio Maturing annual obligations

This ratio is valuable, in that it serves as a measure of the repayment capacity of theproject/ unit & is, therefore, appropriately included in the cash flow statements. The

ratio may vary from industry to industry but one has to view it with circumspectionwhen it is lower than the benchmark of 1.75. The repayment programme should be sostipulated that the ratio is comfortable.

Managerial CompetenceIn a dynamic environment, the capacity of an enterprise to forge ahead of itscompetitors depends to a large extent, on the relative strength of its management.Hence, an appraisal of management is the touchstone of term credit analysis.

If there is a change in the administration & managerial set up, the success of the projectmay be put to test. The integrity & credit worthiness of the personnel in charge of themanagement of the industry as well as their experience in management of industrialconcerns should be examined. In high cost schemes, an idea of the unit’s key personnelmay also be necessary.



Non-Fund Base:

Letter of Credit: Introduction

The expectation of the seller of any goods or services is that he should get the paymentimmediately on delivery of the same. This may not materialize if the seller & the buyerare at different places (either within the same country or in different countries). Theseller desires to have an assurance for payment by the purchaser. At the same time thepurchaser desires that the amount should be paid only when the goods are actuallyreceived. Here arises the need of Letter of Credit (LCs). The objective of LC is to providea means of payment to the seller & the delivery of goods & services to the buyer at thesame time.

Definition

A Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at therequest & on the instructions of the customer (the applicant) or on its own behalf,

i. is to make a payment to or to the order of a third party (the beneficiary), or is toaccept & pay bills of exchange (drafts drawn by the beneficiary); or

ii. authorizes another bank to effect such payment, or to accept & pay such bills ofexchanges (drafts); or

iii. Authorizes another bank to negotiate against stipulated document(s), providedthat the terms & conditions of the credit are complied with.

Basic Principle:

The basic principle behind an LC is to facilitate orderly movement of trade; it istherefore necessary that the evidence of movement of goods is present. Hencedocumentary LCs is those which contain documents of title to goods as part of the LCdocuments. Clean bills which do not have document of title to goods are not normally

established by banks. Bankers and all concerned deal only in documents & not in goods.If documents are in order issuing bank will pay irrespective of whether the goods are ofexpected quality or not. Banks are also not responsible for the genuineness of thedocuments & quantity/quality of goods. If importer is your borrower, the bank has toadvice him to convert all his requirements in the form of documents to ensure quantity& quality of goods.



Parties to the LC

1) Applicant – The buyer who applies for opening LC 2) Beneficiary – The seller who supplies goods 3) Issuing Bank – The Bank which opens the LC

4) Advising Bank – The Bank which advises the LC after confirming authenticity 5) Negotiating Bank – The Bank which negotiates the documents 6) Confirming Bank – The Bank which adds its confirmation to the LC 7) Reimbursing Bank – The Bank which reimburses the LC amount to negotiating

bank 8) Second beneficiary – The additional beneficiary in case of transferable LCs

Confirming bank may not be there in a transaction unless the beneficiary demandconfirmation by his own bankers & such a request is made part of LC terms. A bank willconfirm an LC for his beneficiary if opening bank requests this as part of LC terms.Reimbursing bank is used in an LC transaction by an opening bank when the bank doesnot have a direct correspondent/branch through whom the negotiating bank can bereimbursed. Here, the opening bank will direct the reimbursing bank to reimburse thenegotiating bank with the payment made to the beneficiary. In the case of transferableLC, the LC may be transferred to the second beneficiary & if provided in the LC it can betransferred even more than once.

Bank Guarantee:A contract of guarantee is defined as ‘a contract to perform the promise or d ischargethe liability of the third person in case of the default’. The parties to the contract ofguarantees are:

a) Applicant: The principal debtor – person at whose request the guarantee isexecuted

b) Beneficiary: Person to whom the guarantee is given & who can enforce it in case

of default.c) Guarantee: The person who undertakes to discharge the obligations of theapplicant in case of his default.

Thus, guarantee is a collateral contract, consequential to a main contract betweenthe applicant & the beneficiary.



has the necessary experience, capacity, expertise, & means to perform the obligationsunder the contract & any default is not likely to occur.

Branches should not issue guarantees for a period more than 18 months without priorreference to the controlling authority. Extant instructions stipulate an Administrative

Clearance for issue of BGs for a period in excess of 18 months. However, in cases whererequests are received for extension of the period of BGs as long as the fresh period ofextension is within 18 months. No bank guarantee should normally have a maturity ofmore than 10 years. Bank guarantee beyond maturity of 10 years may be consideredagainst 100% cash margin with prior approval of the controlling authority.

More than ordinary care is required to be executed while issuing guarantees on behalfof customers who enjoy credit facilities with other banks. Unsecured guarantees, wherefurnished by exception, should be for a short period & for relatively small amounts. Alldeferred payment guarantee should ordinarily be secured.

Appraisal of Bank Guarantee Limit

Proposals for guarantees shall be appraised with the same diligence as in the case offund-base limits. Branches may obtain adequate cover by way of margin & security so asto prevent default on payments when guarantees are invoked. Whenever an applicationfor the issue of bank guarantee is received, branches should examine & satisfythemselves about the following aspects:

a) The need of the bank guarantee & whether it is related to the applicant’s normaltrade/business.

b) Whether the requirement is one time or on the regular basisc) The nature of bank guarantee i.e., financial or performanced) Applicant’s fin ancial strength/ capacity to meet the liability/ obligation under the

bank guarantee in case of invocation.e) Past record of the applicant in respect of bank guarantees issued earlier; e.g.,

instances of invocation of bank guarantees, the reasons thereof, th e customer’s

response to the invocation, etc.f) Present o/s on account of bank guarantees already issuedg) Marginh) Collateral security offered



Format of Bank Guarantees

Bank guarantees should normally be issued on the format standardized by Indian BanksAssociation (IBA). When it is required to be issued on a format different from the IBAformat, as may be demanded by some of the beneficiary Government departments, it

should be ensured that the bank guarantee is

a) for a definite period,b) for a definite objective enforceable on the happening of a definite event,c) for a specific amountd) in respect of bona fide trade/ commercial transactions,e) contains the Bank’s standard limitation clause f) not stipulating any onerous clause, &g) not containing any clause for automatic renewal of the bank guarantee on its

expiry



Chapter-7

SBI NORMS FOR CREDIT APPRAISAL

Credit appraisal means an investigation/assessment done by the bank prior beforeproviding any loans & advances/project finance & also checks the commercial, financial& technical viability of the project proposed its funding pattern & further checks theprimary & collateral security cover available for recovery of such funds.

Loan policy – an Introduction State Bank of India’s (SBI) Loan Policy is aimed at accomplishing i ts mission of

retaining the bank’s position as a Premier Financial Services Group, with Worldclass standards & significant global business, committed to excellence incustomer, shareholder & employee satisfaction & to play a leading role in theexpanding & diversifying financial services sector, while continuing emphasis onits Development Banking role.

The Loan Policy of the any bank has successfully withstood the test of time andwith inbuilt flexibilities, has been able to meet the challenges in the market place.The policy exits & operates at both formal & informal levels. The formal policy iswell documented in the form of circular instructions, periodic guidelines &

codified instructions, apart from the Book of Instructions, where proceduralaspects are highlighted.

The policy, at the holistic level, is an embodiment of the Bank’s approach tosanctioning, managing & monitoring credit risk & aims at making the systems &controls effective.

The Loan Policy also aims at striking a balance between underwriting assets of

high quality, and customer oriented selling . The objective is to maintain Bank’sundisputed leadership in the Indian Banking scene.

The Policy aims at continued growth of assets while endeavoring to ensure thatthese remain performing & standard. To this end, as a matter of policy the Bankdoes not take over any Non-Performing Asset (NPA) from other banks.



The Central Board of the Bank is the apex authority in formulating all matters of

policy in the bank. The Board has permitted setting up of the Credit Policy &Procedures Committee (CPPC) at the Corporate Centre of the Bank of which theTop Management are members, to deal with issues relating to credit policy &procedures on a Bank-wide basis. The CPPC sets broad policies for managingcredit risk including industrial rehabilitation, sets parameters for credit portfolioin terms of exposure limits, reviews credit appraisal systems, approves policiesfor compromises, write offs, etc. & general management of NPAs besides dealingwith the issues relating to Delegation of Powers.

Based on the present indications, following exposure levels are prescribed:

Individuals as borrowers Maximum aggregate credit facilities ofRs. 20 crores( Fund based & non-fund based )

Non-corporate( e.g. Partnerships, HUF, Associations )

Maximum aggregate credit facilities of Rs. 80crores ( Fund based & non-fund based )

Corporate Maximum aggregate credit facilities asper prudential norms of RBI on exposures

Term Loans (loans with residual maturity of over 3 years) should not in theaggregate exceed 35% of the total advances of SBI.

The Bank shall endeavor to restrict fund based exposure to a particular industryto 15% of the Bank’s total fund based exposure.

The Bank shall restrict the term loan exposure to infrastructure projects to 10%of Bank’s total advances.

The Bank shall endeavor to restrict exposure to sensitive sectors (i.e. to capital

market, real estate, and sensitive commodities listed by RBI) to 10% of Bank’stotal advances.

The Bank’s aggregate exposure to the capital markets shall not exceed 5% of thetotal outstanding advances (including commercial paper) as on March 31 of theprevious year.



Credit Appraisal Standards Qualitative:

At the outset, the proposition is examined from the angle of viability & also from theBank’s prudential levels of exposure to the borrower, Group & Industry. Thereafter, a

view is taken about our past experience with the promoters, if there is a track record togo by. Where it is a new connection for the bank but the entrepreneurs are already inbusiness, opinion reports from existing bankers & published data if available arecarefully pursued. In case of a maiden venture, in addition to the drill mentionedheretofore, an element of subjectively has to be perforce introduced as scant historicaldata weight age to be placed on impressions gained out of the serious dialogues withthe promoter & his business contacts.

Quantitative:(a) Working capital:

The basis quantitative parameters underpinning the Bank’s credit appraisal are asfollows:-

Sector/ Parameters Mfg Others

Liquidity

Current Ratio (min.)

1.33 1.20(For FBWC limitsabove Rs. 5 cr.)

1.00(For FBWC limits uptoRs. 5 cr.))

Financial Soundness

TOL /TNW (max.)

3.00 5.00

DSCR

Net (min.)

Gross (min.)

2:1

1.75:1

2:1

1.75:1

Gearing

D/E (max.) 2:1 2:1

Promoters’ contribution (min.) 30% ofequity

20% of equity



Profits:

While net profit is ultimate yardstick, cash accruals, i.e., profit before depreciation &taxation conveys the more comparable picture in view of changes in rate of depreciation

& taxation, which have taken place in the intervening years. However, for the sake ofproper assessment, the non-operating income is excluded, as these are usually one timeor extraordinary income. Companies incurring net losses consistently over 2 or moreyears will be given special attention, their accounts closely monitored, and if necessary,exit options explored.

Credit Rating:Wherever the company has been rated by a Credit Rating Agency for any instrumentsuch as CP / FD this will be taken into account while arriving at the final decision.

However as the credit rating involves additional expenditure, we would not normallyinsist on this and only use this tool if such an agency had already looked into thecompany finances.

Term Loan(i) In case of term loan & deferred payment guarantees, the project report is

obtained from the customer,(ii) This may be compiled either in-house or by a firm of consultants/ merchant

bankers. The technical feasibility & economic viability is vetted by the bank &wherever it is felt necessary, the Credit Officer would seek the benefit of asecond opinion either from the Bank’s Technical Consultancy cell or from theconsultants of the Bank/ SBI Capital Markets Ltd.

(iii) Promoter’s contribution of at least 20% in the total equity is what we normallyexpect. But promoters’ contribution may vary largely in mega projects. Thereforethere cannot be a definite benchmark. The sanctioning authority will have thenecessary discretion to permit deviations.

(iv) The other basic parameter would be the net debt service coverage ratio i.e.

exclusive of interest payable, which should normally not go below 2. On a grossbasis DSCR should not be below 1.75. These ratios are indicative & thesanctioning authority may permit deviations selectively.

(v) As regards margin on security, this will depend on Debt: Equity gearing for theproject, which should preferably be near about 1.5: 1 & should not in any case beabove 2:1, i.e., Debt should not be more than 2 times the Equity contribution.



The sanctioning authority in exceptional cases may permit deviations from thenorm very selectively.

(vi) Other parameters governing working capital facilities would also govern TermCredit facilities to the extent applicable.

Lending to Non-Banking Financial Companies (NBFCs)

Financing of infrastructure projects

Lease Finance

Letter of Credit, Guarantees & bills discounting

Fair Practices for lenders

Documentation standards

1: The systems and procedures for documentation have been laid down keeping in view

the ultimate objective of documentation which is to serve as primary evidence in anydispute between the Bank and the borrower and for enforcing the Bank's right torecover the loan amount together with interest thereon (through a court of law as a

final resort), in the event of all other recourses proving to be of no avail. In order thatthis objective is achieved, our documentation process attempts to ensure that:

The owing of the debt to the Bank by the borrower is clearly established by thedocuments.

The charge created on the borrower's assets as security for the debt ismaintained and enforceable

The Bank's right to enforce the recovery of the debt through court of law is notallowed to become time-barred under the Law of Limitation.

2: Documentation is not confined to mere obtention of security documents at theoutset. It is a continuous and ongoing process covering the entire duration of anadvance comprising the following stages:

(i) Pre-execution formalities:



safeguarding the documents are made fully conversant with them. This is furtherstrengthened through on-the-job training at the branches as well as at the Bank'straining colleges / centers, where the officials are briefed on the documentationprocedures so that the Bank's interest is protected in this crucial area.4. In respect of consortium advances, the documents are generally executed inconsultation with the other member banks in accordance with the guidelines laid downby RBI /IBA in the matter. Similarly, where advances are extended jointly with thefinancial institutions, documents are specially drafted in consultation with the solicitors/ in-house legal experts to ensure pari passu charge and / or second charge, whicheveris applicable, of the movable / immovable assets of the borrower to protect the Bank'sinterests.

1. While it is the Bank's endeavor to standardize documents for all types of facilities, in

cases where documents have to be specially drafted, the Local Head Offices areempowered to vet and approve such documents for facilities which are sanctionedat their level. For facilities requiring sanction of COCC / ECCB, such specially drafteddocuments are cleared by the Corporate Centre.

3. Requirement of documents for process of loan

1. Application for requirement of loan

2. Copy of Memorandum & Article of Association 3. Copy of incorporation of business

4. Copy of commencement of business

5. Copy of resolution regarding the requirement of credit facilities

6. Brief history of company, its customers & supplies, previous track records, ordersin hand. Also provide some information about the directors of the company

7. Financial statements of last 3 years including the provisional financial statementfor the year 2010-11

8. Copy of PAN/TAN number of company



Library research

Websites

Expected contribution of the study:

This study will help in understanding the credit appraisal system at SBI & to understand

how to reduce various risk parameters, which are broadly categorized into financial risk,

business risk, industrial risk & management risk associated in providing any loans or

advances or project finance.

Beneficiaries:

Researcher:

This report will help researcher in improving knowledge about the credit appraisal

system and to have practical exposure of the credit appraisal scenario in SBI.

Management student:

The project will help the management student to know the patterns of credit appraisalin SBI bank.

SBI Bank:

The project will help bank in reducing the credit risk parameters and to improve its

efficiencies. It will also help to reduce risk associated in providing any loans & advances

or project finance in future and to overcome the loopholes.



Short write-up on the researcher and reason for taking up the project:

The researcher are MBA 2 nd year students, studying in N.R.INSTITUTE OF BUSINESS

MANAGEMENT(GLS),AHMEDABAD.

The reason for taking up the project is to know and understand the credit appraisal system in

banking sector.

Credit appraisal is the major focus of banking industries these days,

so the project will help in understanding and analyzing the situation

prevailing currently.

credit appraisal sept 2012

Documents