credit policies of banks

8/20/2019 Credit Policies of Banks

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Introduction:

Credit Policy

The word, "policy", can be a broad and frightening term. While most companies havetheir own policies, procedures, and guidelines, it is unlikely that any two firms willdefine them in a similar manner. Furthermore, while many individuals appreciate theneed for a workable set of regulations, "policy" carries some negative connotationsof bureaucracy and inflexibility. The word is derived from the same root as politicsand police, and the sentence, "It's not our policy," can infuriate customers.

Though most consumers expect to pay cash or use a credit card when making a

purchase, commercial customers typically want to be billed for any products and

services they buy. You need to decide how much credit you're willing to extend them

and under what circumstances. There's no one-size-fits-all credit policy--your policywill be based on your particular business and cash-flow circumstances, industry

standards, current economic conditions, and the degree of risk involved.

As you create your policy, consider the link between credit and sales. Easy credit

terms can be an excellent way to boost sales, but they can also increase losses if

customers default. A typical credit policy will address the following points:

Credit limits. You'll establish dollar figures for the amount of credit you're

willing to extend and define the parameters or circumstances.

Credit terms. If you agree to bill a customer, you need to decide when the

payment will be due. Your terms may also include early-payment discounts

and late-payment penalties.

Deposits. You may require customers to pay a portion of the amount due in

advance.

Credit cards and personal checks. Your bank is a good resource for credit

card merchant status and for setting policies regarding the acceptance ofpersonal checks.

Customer information. This section should outline what you want to know

about a customer before making a credit decision. Typical points include

years in business, length of time at present location, financial data, credit

rating with other vendors and credit reporting agencies, information about the

individual principals of the company, and how much they expect to purchase

from you.


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Documentation. This includes credit applications, sales agreements,

contracts, purchase orders, bills of lading, delivery receipts, invoices,

correspondence, and so on.

An often-overlooked element in setting a credit policy is the design of invoices

and statements. The invoice is the document that describes what the

customer is being billed for; the statement is the follow-up document that

indicates the status of the account.

One collection and creditor rights expert says that invoices and statements

that are clear, easy to read, and allow the customer to quickly identify what is

being billed are likely to be paid faster.

Here are several points to include on the invoice:

An invoice number

An invoice date A customer number or other identifying code

A complete and clear description of the product or service and item numbers,

if appropriate. Avoid abbreviations your customer may not understand.

The customer's purchase order, job order or other reference information that

will make identifying the invoice easier

The total dollar amount due, clearly indicated

Payment terms and due date (and specify any early-payment incentives or

late-payment penalties).

OBJECTIVES OF A CREDIT POLICY

Five (5) objectives of a credit policy are listed as follows:

To ensure consistency in the processes and procedures used to manage all

credit aspects of an organization.

To ensure that the expectations of the management of an organization and

the credit department are aligned and met consistently.

To ensure that all customers are treated fairly when making credit decisions.

To provide for succession management and training if credit personnel leave

the business.

To evaluate credit decision making and adjust as circumstances warrant.


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SETTING CREDIT POLICIES

Choosing the right balance in setting credit policies is a fine art. On the one hand, itis important for your business to work with retailers to build sales — but on the otherhand, if you are too free with credit, you may lose more on your sales than you willmake — and that soon leads to financial disaster. So then, how do you juggle thedesire for higher sales with the need for rational credit decisions to strike the rightbalance?

To answer this question, one of the most important things to look at is the size oforder. Obviously your credit standards should be more rigid on a large order than ona small order. In most instances, if you're selling to small retailers and your openingorder requirements are not substantial, your typical first order will be in the $100-$300 range.

If you're using typical mark-ups to get to that wholesale amount, your out-of-pocketcosts to produce the order will be in the $50-150 range. That being the case, yoursale is no larger than what someone may typically spend on a retail-shopping trip.Sales of this nature are typically cash — including credit cards and checks. Thedollar amount simply doesn't justify spending the time and money to do a full-blowncredit investigation — so the terms are simple.

On your first sale to a retailer of this dollar amount, it is totally legitimate to requestthat it ship COD. In some sectors, such as the handmade craft sector, this is thenorm. Their system is very simple and workable at both ends. The first order is

COD and subsequent orders are shipped Net 30 days, which means the retailerpays by check 30 days after the order is shipped.

An invoice typically accompanies the package (as it should also with the CODshipment), and the retailer processes it for payment according to terms. The logic isthat the supplier is guaranteed full payment on the first order — and the fact that theorder was paid for indicates the store has the money to purchase additionalinventory.

In the rare event that the retailer defaults on payment of the second shipment — assuming it's of comparable size to the first — the supplier only loses profit, since the

first COD payment would cover the cost of the second shipment.

You stand a pretty good chance that the third order will be paid for because you nowhave two instances of good credit with the retailer. Theoretically, the most you canlose on this credit system is your profit. Your costs are covered.

If a retailer balks at the COD terms, explain that you are a small start-up companyand you do not have the staff available to do credit checks. Asssure the retailer thatyou will notify them of the COD amount the day the order ships so they can preparea check in advance and that subsequent orders will go open account.


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Note: Do notify a customer of the COD amount whenever you make a shipment.Many times the people working in the store are not authorized to write checks andthe shipment will have to be refused and reshipped the next day — which is a hasslefor everyone involved.

Be wary of a retailer that gets too huffy at the COD terms on an initial small order. All too often that is a danger sign that the retailer is not credit worthy.

If you ship an order COD, make sure you ship it "complete". As reasonable as CODon a first order may be, it is unreasonable to expect a retailer to accept two or threeCOD shipments simply to get the entire order. There is an add-on shipping fee forCODs. If you ship in three increments, you are forcing the retailer to pay that CODcharge three times!

If you must make an initial partial shipment, either cancel out the balance of theorder or ship it out "open account" — after getting the retailer's approval. Many

times the retailer would prefer not to get the straggling merchandise, preferring toadd it onto their re-order instead.

Even when you start a relationship on a COD basis, it is a good idea to provide acredit application to the retailer for their submission. It gives you a good vehicle toensure you have the proper information for your records of the name, address, andownership of your customer. And it gives you a good way to store tax identificationnumbers just in case you're sales-tax audited and need to prove you were sellingitems for resale and not consumption.

Keep the form as simple as possible and ask for no more than one bank and threevendor references. Make it look professional — but not invasive. If you have timeyou may want to follow-up with credit information requests to the vendors and banklisted — but since your first order is COD, you don't need to hold up any shipmentsawaiting their response.

However you decide to handle credit, remember that the retailers areyourcustomers. Treat them in a friendly albeit professional manner.


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IMPORTANCE OF CREDIT POLICIES

Credit policies help govern the lending or credit activities of an organization. Thisrelates to goods or services extended to customers on a credit basis. There aredifferent types of credit polices which can affect the efficiency and cash flow of anorganization.

Identification

o Credit policies represent the guidelines and rules established by top management togovern or oversee the organization's credit department and it performance. This caninclude credit or loan qualification requirements, loan amounts, types of customers,collateral requirements and applicable interest rates.

Types

o Credit policies can be based on the business industry. Automotive, home, academic,retail, wholesale and credit card lending all may have different credit policies. Tightcredit policies refer to conservative or restrictive guidelines in the extension of credit.Loose policies allow for more freedom or flexibility. A given business, for example,may focus more on debt collection instead of credit investigations and analysis.

Significance

o The significance of credit policies can be realized in the operational efficiency ofcredit departments. This is due to a reduction of ambiguity over how to proceed in

their functions. Written guidelines allow for clarity and help to provide instruction.Credit policies can also help improve a company's cash flow, depending on thepolicy type. Tight credit polices can reduce instances of loan default and speed upaccounts receivable turnover, thus increasing cash flow.

WHY DO BANKS CREATE CREDIT?

Simply put, to collect interest.People put their money into banks to generate interest and keep it safe.(could youimagine the crime rate if everyone kept their life savings in cash at their ownhouse?).

Banks then loan that money out to other people or companies on the condition thatthey'll pay back the money plus, say 10% more (called interest)--within an agreedupon deadline. This person or company then makes good on their payment (plusinterest) and the bank gives some of the interest--say 1-2%--to the people that keeptheir money at the bank.


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The more money that people keep at the bank, the more money the bank can lendout, thereby generating more money for them in the form of interest.Credit cards, then, are a simplified process of lending the approved cardholder a pre-set amount of money (on which they have to pay interest) without the hassle ofdressing up, going to a bank, and convincing them that you will be successful in

paying them back. With credit cards, the longer it takes to pay them back, the moreyou end up spending in interest, which is literally free money for the banks.If everytime I give you $10 you give me $12 back, why WOULDN'T I create credit?

SIX ESSENTIAL ELEMENTS OF AN EFFECTIVE CREDIT

POLICY:

Receivables represent the largest single liquid asset of most companies.On a good day, efficiently turning these accounts into cash flow is a tough job. In the current bus iness climate – with reduced sales potential and thethreat of recession – credit professionals are under increased pressure toproductively manage this key responsibility.

What’s the secret to successfully tackling this challenge? Consistentoperational processes.

Effectively managing accounts receivable is all about well-orderedprocesses from beginning to end. Yet, surveys have shown that only abouthalf of all credit departments have a written credit policy in place – andonly one-quarter of those regularly review that policy.

If you’ve been putting off drafting a credit and collections policy - orhaven’t updated yours in awhile – this is an excellent time to do just that.Following are six essential elements you should include to ensure you’retaking a consistent and structured approach to limiting bad debt andimproving the cash flow position of your company.

Elements of an Effective Credit and Collection Policy

1. Mission Statement

A thoughtful ly designed mission statement is basic to a funct ional credi tand collection policy. The mission statement should define the purpose ofthe credit department and express the long-range focus of the policywithin the framework of the organization’s mission as a whole.


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A key po int to cons ider when developing the Mission Statement : theprimary purpose of every credit department should be to maximize saleswithin the framework of the organization’s “appetite for risk”.

2. Statement of Goals

Goals should track with current market conditions and the strategicdirection of your organization. In addition, they should function as driversto improve receivable management. Therefore, goals must be linked totargets and monitored and measured against established metrics.

Many credit departments utilize the following metrics in establishing goals:

DSO – Days Sales Outstanding

CEI – Collection Effectiveness Index

Aging Bucket Performance

Percent Current

Bad Debt Write-off Percentage (see Accounting for Uncollectible Accounts )

Benchmarking statistics – by industry – can be found in the CreditResearch Foundation ’s Quarterly National Summary of Domestic TradeReceivables.

3. Credit Department Organization

Including a section in the policy that spells out specific roles,responsibilities and especially levels of authority of the various credit andcollections staff streamlines operations, prevents redundancy andimproves productivity.

4. Credit Evaluation and Approval Process

The most important function of this section of the policy should be to:

1. Define what your company considers an “acceptable” credit risk.

2. Outline a credit evaluation process that allows for quick, consistentand objective decision making and, thus, delays as few orders aspossible.

3. Assign credit limits to every acceptable account to minimize the

need for manual intervention to release orders.

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Items that should be covered:

Credit terms. Your terms may differ by product line and location ofthe customer (domestic or international, country by country).However, keep exceptions to the minimum and ensure they are

based on competitive practices and generate a satisfactory return oninvestment.

Credit evaluation process.

Do you require a signed credit application? (Werecommendalways, see Getting the Most Out of Your Credit Appl icat ions .)

When do you require financials? What types of financial

statements are acceptable? (See Reliability of FinancialStatements on U.S. Firms) What ratios are used to analyzefinancial information?

What third-party sources do you utilize: credit bureau reports,credit references, bank references, public records, industrycredit group? (See, Getting Results with Industry CreditGroups)

Do you use a credit scoring system? What and how?

Credit limits. How are credit limits calculated and assigned?

Substandard and unacceptable credit risks. Saying “no” to creditshould not negate the sale. Have a plan in place to: (1) notify thecustomer and the sales department; (2) outline acceptable forms ofsecurity or collateral; (3) offer alternative methods of payment; andespecially, (4) describe when you will reevaluate the account, andhow the customer can become creditworthy.

5. Credit Continuation Procedures

Granting, or withholding credit facilities should never be considered a one-time decision. Today's business climate is erratic, to say the least.Companies that appeared secure six months ago may now be on theverge of collapse. It’s essential to continually monito r your receivablesportfolio to ensure you are maintaining an overall appropriate level of risk.Items to cover in this section:

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Incentives for prompt payment. If you find your DSO (days salesoutstanding) isn’t tracking where you’d like, you might considerdiscounting invoices for early payment, or charging interest on latepayment.

Frequency of and procedures for credit re-evaluation. It’s good

practice to schedule all or a portion of your larger accounts (usingthe80:20 rule) for routine review, so you can quickly revise limitsbased on changing levels of creditworthiness.

Procedures for approving orders when a customer has reachedits credit limit.

6. Collection

Uncollected dollars nibble away at your company’s cash flow andprofitability, and can ultimately threaten its very survival. A survey by theCommercial Law League of America revealed that after three months, theprobability of collecting delinquent accounts drops to 73%. After 6 months,collectability drops to 50%. And after 1 year, collectability is just 25%. It’sessential that you have a plan in place to follow up on every past dueaccount.

WHAT ARE THE 4 CS OF CREDIT?

Credit investigation could get intricate and dense. The information that is beinggathered could be getting strewn and scattered all over the place. The 4 Cs of Credithelps in making the evaluation of credit risk systematic.

They provide a framework within which the information could be gathered,segregated and analyzed. It binds the information collected into 4 broad categoriesnamelyCharacter; Capacity; Capital and Conditions.

No matter how many Cs we come up with, the fundamental question that remains tobe answered by the framework of our analysis is:'Will I get paid on time?'

So let's discuss the structure of our credit analysis within the context of the 4 Cs ofCredit :

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Character:

JP Morgan, a successful businessman once said that 'I will do business with anyoneas long as he/she is honest!'

In analyzing Consumer Credit one would consider the following:

Has the person declared bankruptcy in the past Does the person have a good credit record Does he/she have a stable job What is the level of education/experience What is the person earning and what is the earning potential Stability at the place of residence, whether rented or owned.

In analyzing Commercial Credit one would consider the following:

The size of the operations The number of years in business The legal form of the business By this one means 'Retail', 'Wholesale',

'Service' or 'Manufacturing'. Typically the incidence of business failures is highin the Retail and Service segments.

Is the business a Parent, Subsidiary or a division Does the business have a Holding company?

" The structure of the business Is the business a Sole Proprietor, Partnership or Corporation? For Sole proprietor or Partnership type one would further seek personal

information on individual(s) running the business. The number of employees There are Industry specific Norms for 'Employees to Sales' ratio. The management record of the company The location of the company Any previous evidence of fraud Any previous Insolvency record? Any Labor disputes or issues? Are the products/service sold by the prospect complimenting products/service

to the ones that you may sell? Is the business practice ethical?

Is the business seasonal/ non-seasonal Is the business Local/ National or International.

o The economy of a business accordingly could depend upon local/ nationalor international economy.

Is there a growing or a going market for this business or the businessredefining itself and what would be the impact of the internet on this business.o See what computer downloads (free peer-to-peer file sharing (P2P) E.g.Napster, Limewire) has done to the music industry

How willing is the prospect to share information? How diligently does the prospect fill your Credit Agreement/Application? What are the references saying? Are there too many lay-offs especially of key personnel? Are there any Law suits pending against the company?


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What does the website of the company say and look like? Is there any recent media coverage about the company?

o Is it positive or negativeo Or are there any rumors floating?

If the company's stock is publicly traded then see how its stock is performing? One can also check the indices for a particular type of Industry to see how in

general the Industry is doing. The collapse of the NASDAQ is a warning of thedebacle of the tech companies.

Capacity

What does one analyze under this segment?Is it:

Capacity of the business to pay? Capacity of the business in getting paid? Capacity of the business to receive/absorb? Capacity of the credit grantor to expose?

Sometime a business that you are analyzing might not have the required Capacity inkind but the same could be latent and hidden in some other form. For example astart-up business should have a good business blue-print of succeeding namely agood business plan.

A contractor might have a good media advertising plan, say an Ad in the localYellow Pages. All this adds to the capacity of a business to carry on trade andperhaps be successful.

Innovation, Education, Experience, Knowledge would be some other considerations.Management should be able to foresee trends in the marketplace and blendaccordingly.

It should have plans both for good and bad turns in the economy. Adoption of soundmanagement techniques and computer-related technologies is important.Companies must remain Relevant with their processes; products and operate with

Speed in today's Digital age.

Larger businesses should also have people that know how not just to manage thecompany but also its main asset, its people.


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cash and only cash can pay bills

The capacity of a business to pay its bills would stem from good cash-flow. Abusiness could become cash strapped if it does not collect its accounts receivable ontime. You must have heard of DSO! What is DSO? Isn't it a measure of ones

capacity to pay? Say if a business has a DSO of 55 days. This means that at anaverage this business gets paid by its customers in 55 days. The question thenarises that when will this business then pay its suppliers? In all probability theanswer is that its capacity to pay its suppliers will be after 55 days. In this event youmay want to evaluate its borrowing capacity to see if you can cajole this company topay you in time even if it means that this business borrows to pay you.

This would bring on the analysis of how the debt of the company is structured interms of secured and unsecured debt with an operating lender, generally the bank.Short term borrowing could be calculated as a percentage of the inventory and A/Ron hand. One should look at the line of credit and see if there is capacity for more

borrowing. Also check for any negative occurrences as bad checks (cheques) or anydefault against operating loans or covenants.

The capacity of your product to influence payment is also important. If your productbeing sold is fiercely competitive then it may not have the capacity to influence timelypayment. If your product does not directly contribute to the COGS of the buyer thenagain it might not have the capacity of influencing timely payment. Competitiondefinitely influences Capacity.

The Capacity to expose and increase your credit risk also depends upon your ownability and resilience to getting hit with either slow payment or perhaps no payment!Credit departments that have a lot of confidence in their collection ability and abilityto influence payment have a wider capacity to expose and absorb. Your product-margin will also influence this capacity.

Capital

Capital would refer to the financial resources obtained from financial records that acompany may have in order to deal with its debt. Many a time's credit analysts would

make this portion of the credit analysis the most important one. Weight is given onBalance Sheet items and components like Working Capital , Net Worth and CashFlow.

One must know how to read financial statements and that too from the perspective ofa creditor. Short term liquidity is important if you are expecting to get paid in the shortterm. You should be able to see whether this company has the ability to absorb moredebt and then where does your loan (selling on credit is a loan - isn't it?) fit in theoverall debt-framework of this business

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You should also evaluate to see if you can depend on the numbers whether they areaudited, unaudited or company prepared. If required speak with the firm or personwho has prepared the statements.

Leveraged borrowing depends on the equity/ net worth that a company has and it isa good idea to see if the company is committed to improve its borrowing-power bycontributing to its Equity/Capital/Net Worth . One way of doing this is by retaining allor portions of its earnings.

But all said, done and then undone Cash and ONLY Cash pays bills. Thus, keep aneye of the company's cash-flow and cash-position.

But one must be cognizant of the fact that financial records are snapshots of the pastand credit analysis is trying to figure out the future. Thus all 4 Cs of credit are

important in the overall analysis of a company or an individual where you combineelements of the past to make a futuristic prediction.

Conditions

This refers to the external conditions surrounding the business that you areanalyzing.

For example the construction industry might get influenced with the changes in thegovernment's wide range of policies on immigration, interest rates and taxation.

There might be likelihood that a company that you are evaluating deals ininternational trade and a shift in the currency rates might have a detrimental orbeneficial effect on it.

Business with local economies would be prone to the social climate and theirinfluence on the local society. Torontonians must have heard of the flamboyantdiscount retailer "Honest" Ed Mirvish who treats the local community to free turkeysevery Christmas.

On another note a lot of businesses became insolvent in the Ice Storm a few yearsago in eastern parts of the US and Canada that were totally dependant on the localeconomy. If winter is very mild the businesses that depend on snow feel the crunch..

All of this can again influence the ability or intention of a customer to pay his/herbills.Thus in evaluating the degree of risk of a customer, information revolvingaround the 4Cs of credit would be normally necessary.


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WHY TO HAVE A WRITTEN CREDIT POLICY….?

First, the responsibility of managing receivables is a serious undertaking. It involveslimiting bad debts and improving cash flow. With outstanding receivables often beinga firm's major asset, it is obvious that a reasoned and structured approach to creditmanagement is necessary.

Second, a policy assures a degree of consistency among departments. By writingdown what is expected, the arms of your company (whether marketing, production,or finance) will realize that they have a common set of goals. Conversely, a writtenpolicy can delineate each department's functions so that duplication of effort andneedless friction are avoided.

Third, it provides for a consistent approach among customers. Decision makingbecomes a logical function based on pre-determined parameters. This simplifies thedecision process and yields a sense of fairness that will only improve customerrelations.

Finally, it can provide some recognition of the credit department as a separate entity,one which is worthy of providing input into the overall strategy of the firm. This allowsthe department to be an important resource to upper management.

One can see that developing a policy is more than a necessity. It is an opportunity toimprove the efficiency of your entire organization.

4 WAYS TO CREATE A GOOD CREDIT POLICY

Every business owner knows the importance of cash flow. When you have a plan inplace to take care of the ebbs and flows of sales, most finance headachesdisappear. A business can be profitable but still have insufficient cash to manage itseveryday operations.

This occurs at times of seasonal changes to consumer behaviour and if you have not

put sufficient cash aside in the good times, your business can flounder when salesdrop. MYOB is a sophisticated accounting software package that can help youpredict the times when you need to rely upon accumulated cash rather thancontinuing sales.

We have previously discussed how you can put plans in place to overcome thesefluctuations, by having an overdraft for example. Another way to ensure that yourcash flow fluctuations are minimised is to ensure that your debtors pay bills on time. Attendees at MYOB courses will probably already have learned this.


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In fact, granting credit terms to a customer needs to be a carefully consideredpractice, so let's take a look at some of the ways you can create a good credit policyto ensure that you don't extend credit to customers who do not deserve it.

The aim of any good credit policy should be to identify which customers to trust.

Granting credit is a great way to maximise sales when it is done properly. Customersfeel a greater sense of loyalty when credit is extended to them and, provided thisprocess is properly managed, credit can become an important part of your businessdevelopment strategy.

Measuring the performance of debtors is an important part of credit policy. The moreinformation you gather about the ways in which your customers conduct theiraccounts, the better position you will be in to manage the credit facilities you havegranted. Accounting packages like MYOB give you the capacity to analyse everycustomer to ensure that they are keeping within their credit terms.

Developing a customer profile is also important. When you have a sophisticatednumber of tools to measure the performance of every customer, you can not onlymanage the terms under which they operate, but you will also know which customersare likely to bring you further sales making it easier for you to offer them some moreattractive terms to encourage more sales.

Many businesses rely on the instinct, but a good credit policy is one that relies uponactual measured performance. That's why it is necessary to have a good accountingsoftware package to keep a tab on every customer's performance. When grantingcredit for the first time however, it may well be a pig in a poke type situation, butbusiness references

WHY POLICIES DIFFER

Credit policies differ in both length and content.

Concerning length, some are as short as several paragraphs, while others can go on

for many pages. As one might suspect, there are advantages and drawbacks to eachapproach. In a positive sense, a detailed policy leaves little room for doubt.Procedures are spelled out, and employees need only refer to their manual to knowhow to perform. There will be no gray areas between departments, and consistencywill reign.

On the other hand, a long and excessively detailed policy can limit employeecreativity or empowerment. New ideas on how to work in a changing world will besuperseded by a set of omniscient regulations. Also, a huge volume of rules can beoverwhelming.

There is the story of a cartographer who wanted to map his country so perfectly thathe drew it on a scale of one to one. When completed, he found that he had nowhere


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to place the map. Similarly, too many written regulations can actually get in the wayof productivity.

The above arguments present a question of balance. As noted in our initial definition,a policy must express a general course of action. It can be supplemented, however,

with some procedures that can guide daily functions. We will use this approach inour later examples.

The question of companies having policies with differing contents is worthmentioning. This can result from many factors which may include thecompetitiveness of your industry, the location, profit margins, your company's goalsfor market share, the company's own cash requirements, production needs, or thesize and culture of your firm. It is a truth that many policies can be designed, andeach one may be correct for a particular firm.

With this in mind, we will not try to provide a generic credit policy. Instead, we will

offer an approach for the development of your own policy and a format which mayprove effective.

WHY BANK CREDIT POLICIES FLUCTUATE

In a rational profit-maximizing world, banks should maintain a credit policy of lendingif and only if borrowers have positive net present value projects. Why then arechanges in credit policy seemingly correlated with changes in the condition of thosedemanding credit?This paper argues that rational bank managers with short horizons will set credit

policies that influence and are influenced by other banks and demand sideconditions. This leads to a theory of low frequency business cycles driven by bankcredit policies. Evidence from the banking crisis in New England in the early 1990s is consistentwith the assumptions and predictions of the theory.


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THE NEED TO DEFINE CREDIT POLICY STANDARDS AND

PRACTICES

A new 501c3 research and education based non-profit focused on assuring that

banks, regulatory agencies, and policy makers have access to collaboratively

developed and empirically validated credit policy standards and best practices.

Introduction

Given that the primary reason identified in surveys, by regulators, andresearchers for the current, and past, credit crisis is a ‘gradual’ decline in creditstandards, it seems it is time to try a different approach. The Credit Policy Institute isthe first 501c3 research and education based non-profit association focused onworking with a variety of financial, academic, and non-profit institutions to help

assure that banks, regulatory agencies, and policy makers have access tocollaboratively developed and empirically validated credit policy standards and bestpractices.

The goal is to try and find a solution to what seem to be commonly agreed uponissues that continue to be inadequately addressed – at least in enough majorinstitutions to account for the vast majority of the historic and current losses.

To begin with, banking executives, as well as taxpayers, are concerned with keepingfinancial institutions’ credit processes aligned with emerging market realities, as such

a key issue is understanding how to better manage and optimize regulatory capitalrequirements while meeting borrower and investor requirements.

A critical success factor in this effort is the development and implementation ofeffective credit policy and practices. However, while the Further Readings listedbelow demonstrate that there has been a robust debate about various approaches,to date there has been no empirical analysis of actual bank credit policy andpractices, only very high level surveys of bankers and regulators as to their views onchanges in lending ‘standards’ without any examination of the actual standards. The

Institute’s efforts are focused on helping banks and regulators finally justify the stepsnecessary to mitigate future credit ‘boom and bust’ cycles.

Consequently, the Institute's primary mission is to provide the infrastructure to helpthe industry define, standardize, document, and share credit policy best practices,and allow bankers and regulators to free up related resources for other purposes.Without an empirical examination of actual credit policies and practices and therepotential related impact on loan portfolio performance, it is unclear how moreeffective approaches can be identified and publicly supported.

To accomplish this mission, the Institute's first order of business is working withsenior credit executives to help securely collect and analyze a cross-section of the

industry’s existing credit policies and practices. To date, the discussions reinforceprevious anecdotal indications that there is not uniform agreement as to what even

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basic terms like credit policy or guideline mean, much less commonly agreed’standards’ or ‘best practices’.

The project is beginning with commercial real estate (CRE), the sector that seems tobe the most current concern and over time will expand to cover other credit products

such as Equipment Finance, SBA, and Asset Based Lending.The Institute will incorporate evolving best practices and regulatory requirementsthrough on-going interaction with the appropriate stakeholders.

Current Management and Theoretical Discussion

There is an ongoing debate about the existence of generally accepted credit policystandards and best practices, their impact on an individual bank’s competitive ability

and long term business survival, as well as on economy. There is even a robustdebate along the contingency theory front as to whether there is even such a thingas 'best practices', and on the management front as to whether there is a tippingpoint in size and risk complexity that is just too 'big to manage', let alone regulate.

In general, this topic relates to how industries identify and implement effectiveoperating standards and what, if any, role they play in corporate governance, inparticular risk management. Consequently, this article is meant to be an evolvingdiscussion of this topic, with the hope that practitioners and academics from aroundthe world will help inform and direct it.

Business Challenge this Discussion Aims to Address

In the financial institution sector there are ‘espoused’ commercial credit policy

standards and generally recognized best practices; however, there are significantloan portfolio performance differences between banks of similar size and servingsimilar markets which raise a question about the adequacy of existing credit policies

and/or how the related practices are implemented.

To focus this discussion, I have chosen the commercial real estate (CRE) lendingsegment because it has historically been a highly competitive and volatile marketsubject to economically significant boom and bust cycles. Just after the last majorCRE related credit crisis in 1992 the regulators published a list of lessons learnedand related best practices, unfortunately they thought it was necessary to reissuethem 2006 and again in 2008.

What are they seeing or concerned about, and has the industry really learned fromthe mistakes of the past?


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Consequently, the specific research question, is whether there a way to improveexisting credit policy and practice, or its implementation, to help banks moreeffectively manage through, or mitigate, these cycles? While it is assumed they playa positive role, there is no research on whether the banking industry has defined andaccepted any CRE credit policy and practice standards, nor what, if any, specific role

‘standards’ may play in loan portfolio performance.

For example, there are surveys of whether a bank’s ‘lending standards’ have

tightened or loosened, but no information on what those standards were before orafter the survey.

Specific Discussion Questions

Have banks agreed that there are credit policy and/or practice ‘standards’, and what,if any, gaps exist and why ?Is there any relationship between existing policies and/or supporting practices andloan performance ?Even though some 'prior' research indicates that regulatory assessments of credit'standards' are effective as early warning systems, does recent experience reallysupport a continued reliance on those findings?

Broader Practical Application of This Discussion

As partially covered in the Further Readings listed below, there has been a richdiscussion about credit risk, principles versus rules based regulatory approachesand the role of minimum capital requirements, organizational effectiveness,behavioral economics, and implementation theory that has yet to be broadly appliedto existing credit policies and practices. Given recent experiences, there is the thepotential to create and justify new and innovative approaches that could savebillions, if not trillions, of dollars in future credit cycles.

IDBI BANK

The Industrial Development Bank of India Limited (IDBI) (BSE: 50011) is oneof India's leading public sector banks and 4th largest Bank in overall ratings. RBIcategorised IDBI as an "other public sector bank". It was established in 1964 byan Act of Parliament to provide credit and other facilities for the development of thefledgling Indian industry

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It is currently 10th largest development bank in the world in terms of reach with 1455 ATMs, 883 branches including one overseas branch at DIFC, Dubai and 598 centersincluding two overseas centres at Singapore & Beijing.

Some of the institutions built by IDBI are the National Stock Exchange of

India (NSE), the National Securities Depository Services Ltd (NSDL), the StockHolding Corporation of India (SHCIL), the Credit Analysis & Research Ltd, the Export-Import Bank of India(Exim Bank), the Small Industries Development Bankof India(SIDBI), the Entrepreneurship Development Institute of India, and IDBIBANK, which is owned by the Indian Government.IDBI Bank is on a par withnationalized banks and the SBI Group as far as government ownership is concerned

It is one among the 26 commercial banks owned by the Government of India.TheBank has an aggregate balance sheet size of Rs. 2,53,378 crore as on March 31,2011.

IDBI Bank, with which the parent IDBI was merged, was a new generation Bank. ThePvt Bank was the fastest growing banking company in India. The bank was pioneerin adapting to policy of first mover in tier 2 cities. The Bank has one of the highestproductivity per employee in Indian banking industry.

On 29 July 2004, the Board of Directors of IDBI and IDBI Bank accorded in principle

approval to the merger of IDBI Bank with the Industrial Development Bank of India

Ltd. to be formed incorporated under the Companies Act, 1956 pursuant to theIDB

(Transfer of Undertaking and Repeal) Act, 2003 (53 of 2003), subject to the approval

of shareholders and other regulatory and statutory approvals.

A mutually gainful proposition with positive implications for all stakeholders and

clients, the merger process is expected to be completed during the current financial

year ending 31 March 2005.

The immediate fall out of the merger of IDBI and IDBI Bank was the exit of

employees of IDBI bank. The cultures in the two organizations have taken its toll.

The IDBI Bank now is in a growing fold. With its retail banking arm expanding further

after the merger of United western Bank.

CREDIT POLICY OF IDBI BANK

Policy for micro, small & medium enterprises:

1. The Policy shall guide the Bank’s MSME Advances as defined by RBI from time totime. The Policy shall also be applicable to the Bank’s MSME Advances as definedby it from time to time. At present, the Advances to units with turnover upto Rs. 100

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crore are treated as MSME Advances. Any parameter that is not detailed in thispolicy, shall be guided by Bank’s Credit Policy from time to time.

2. Bank is committed to the Code of Conduct given by The Banking Codes andStandards Board of India (BCSBI) for Micro & Small Enterprises, released on May

31,2008. The Code of Bank’s Commitment to Micro and Small Enterprises (MSECode) is a voluntary code, which sets minimum standards of banking practices forbanks to follow when they are dealing with Micro and Small Enterprises (MSEs) asdefined in the Micro Small and Medium Enterprises Development (MSMED) Act,2006. It explains norms that banks are expected to follow while dealing with MSEsfor day-to-day operations and in times of financial difficulty.

3. The Bank would adopt cluster-based approach for financing MSME sector in linewith RBI guidelines.

4. The cases under the Government Sponsored Schemes shall be processed,

sanctioned, disbursed and monitored at the Branch level as per the extantDelegation of Powers and the processes/procedures defined by the Bank from timeto time.

5. The Bank would comply with RBI guidelines issued from time to time in respect ofRehabilitation of Sick MSME units and Debt Restructuring.MSME Credit Policy

6. The Bank has been actively engaged in providing a major thrust to financing ofMSMEs. With a view to improving the credit delivery mechanism and shorten theTurn Around Time (TAT), the Bank has set up City MSME Centers (CSCs) at majorcenters across the country. A number of products have been rolled out for the MSMEsector, which considerably expanded the Bank’s offerings to its MSME borrowers.The sourcing of the business would primarily be at the designated MSME branchesand the CSCs (located in one of the identified branches in the city). A dedicatedSales Force will be put in place in all potential centers to market MSME products.Relationship Managers at the Branches would take care of the customerrequirements and do up-sell/cross-sell at the identified Branches.

7. MSME Finance Products

Asset Products:

a) Dealer Finance

b) Funding under Credit Gurantee Scheme for Mico & Small Enterprises

c) Direct Credit Scheme – SIDBI

d) Preferred Customer Scheme- IDBI Bank/SIDBI

e) Vendor Financing Program


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f) Lending against security of Future Credit Card Receivables

g) Working capital Finance for IT & ITEs

h) Finance to Medical Practitioner

i) Loans to Small Road & Water Transport Operators

j) IDBI Sulabh Vyapar Loan

k) Laghu Udyami Credit Card Scheme

8. Loans applications from MSME units are to be disposed off within a reasonabletime as per the below mentioned time norms, provided such applications are

completed in all respects provided and accompanied by a 'check list'.

i. Loans up to Rs.25000/- within two weeks from the date of receipt.

ii. Loans upto Rs.5 lakh, within four weeks from the date of receipt.

iii. Loans over Rs. 5 lakhs, within a maximum period of 8 weeks from the date ofreceipt.

9. Security

No collateral security/ third party guarantee is insisted upon in respect of loans toSEs (Erstwhile SSI) as under:

a. Upto Rs.10 lakhs

b. Upto Rs.25 lakhs in respect of units whose track record and financial positions aregood as per Bank records; and

c. Upto Rs.100 lakhs in respect of units whose borrowal accounts are covered underthe Scheme of Credit Guarantee Fund Trust for Micro & Small Enterprises(CGTMSE). In respect of other SE and ME units, collateral security/ third partyguarantee may be stipulated by the bank.

10. ROI on Loans/Advances under MSME advances shall be linked to Base Rateand priced at a spread, based upon:

• The internal risk rating of client.

• Tenor of loan


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• Competitive market rates of interest for client

• Internal transfer pricing

• Overall value of client relationship MSME Credit Policy

11. Rejection of credit proposals

i. Applications for credit facilities from SC/ ST customers shall not be rejected at theBranch / CSCs level and such applications shall be referred to the next higherauthorities for their prior decisions/ permission;

ii. Whenever applications for loans under Govt sponsored schemes are rejected bythe CSCs/ Branches for valid reasons, a register is to be maintained to this effect,

which shall be examined by the controlling authorities during their visits;

iii. Rejection of MSME proposals shall be subject to concurrence of the next higherauthority;

iv. MSME proposals once rejected by a higher authority shall be placed before suchhigher authority even through the subsequent proposals say, for lesser amount fallswithin the powers of a lower authority;

v. Rejection of exports credit proposals under MSME shall be immediately reported

to Head-MSME; and

vi. Rejection of Credit proposals by the CSC level authorities shall be recorded in aregister maintained for this purpose, which shall be reviewed by the controllingauthorities visiting CSCs.

12. Bank is committed to address the Grievances of the Micro & Small Enterprises.The aggrieved borrowers can address their grievances to the CSC Head/RegionalHead/Head MSME, whose address and telephone are provided with the branch/CSCor may approach to Banking Ombudsman as per Banking Ombudsman Scheme,2006 of the Reserve Bank of India.

ICICI BANK

ICICI Bank Limited (NSE: ICICIBANK, BSE: 532174, NYSE: IBN) is the second

largest financial services company in India. Headquartered in Mumbai, it offers a

wide range of banking products and financial services to corporate and retail

customers through a variety of delivery channels and through its specialised

subsidiaries in the areas of investment banking, life and non-life insurance, venture

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capital and asset management. The Bank has a network of 2,533 branches and

6,800 ATMs in India, and has a presence in 19 countries, including India.

The bank has subsidiaries in the United Kingdom, Russia, and Canada; branches in

United States, Singapore, Bahrain, Hong Kong, Sri Lanka, Qatar and DubaiInternational Finance Centre; and representative offices in United Arab Emirates,

China, South Africa, Bangladesh, Thailand, Malaysia and Indonesia. The company's

UK subsidiary has established branches in Belgium and Germany.

ICICI Bank's equity shares are listed in India on Bombay Stock Exchange and

the National Stock Exchange of India Limited and its American Depositary Receipts

(ADRs) are listed on the New York Stock Exchange (NYSE).

ICICI Bank was established in 1994 by the Industrial Credit and Investment

Corporation of India, an Indian financial institution, as a wholly owned subsidiary.The parent company was formed in 1955 as a joint-venture of the World Bank,

India's public-sector banks and public-sector insurance companies to provide project

financing to Indian industry. The bank was initially known as the Industrial Credit and

Investment Corporation of India Bank, before it changed its name to the

abbreviated ICICI Bank. The parent company was later merged into ICICI Bank.

ICICI Bank launched internet banking operations in 1994.

ICICI's shareholding in ICICI Bank was reduced to 46 percent, through a public

offering of shares in India in 1998, followed by an equity offering in the form

of American Depositary Receipts on the NYSE in 2000. ICICI Bank acquired

the Bank of Madura Limited in an all-stock deal in 2001, and sold additional stakes to

institutional investors during 2001-02.

In the 1990s, ICICI transformed its business from a development financial institution

offering only project finance to a diversified financial services group, offering a wide

variety of products and services, both directly and through a number of subsidiaries

and affiliates like ICICI Bank. In 1999, ICICI become the first Indian company and the

first bank or financial institution from non-Japan Asia to be listed on the NYSE.

In 2000, ICICI Bank became the first Indian bank to list on the New York Stock

Exchange with its five million American depository shares issue generating a

demand book 13 times the offer size.

In October 2001, the Boards of Directors of ICICI and ICICI Bank approved the

merger of ICICI and two of its wholly owned retail finance subsidiaries, ICICI

Personal Financial Services Limited and ICICI Capital Services Limited, with ICICI

Bank. The merger was approved by shareholders of ICICI and ICICI Bank in January

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2002, by the High Court of Gujarat at Ahmedabad in March 2002, and by the High

Court of Judicature at Mumbai and the Reserve Bank of India in April 2002.

In 2008, following the 2008 financial crisis, customers rushed to ATM's and branches

in some locations due to rumors of adverse financial position of ICICI Bank. TheReserve Bank of India issued a clarification on the financial strength of ICICI Bank to

dispel the rumors.

Credit policy of icici bank

POLICY ON STEPPING UP CREDIT TO SMEs

1. Background

The Bank has proactively put in place a comprehensive strategy to cater to the

banking requirements of Small and Medium Enterprise (SME) sector in line with the

guidelines issued by Reserve Bank on India (RBI) for this sector from time to time.

The extant guidelines are issued by RBI vide its circular

RPCD.PLNFS.BC.No.6/06.02.31/2007-08 dated July 2, 2007.

A separate business group viz Small Enterprises Group (SEG group) was set up to

cater to all banking requirements of SME sector.

2. Products and Services

At present, the SEG group covers customers through over 200 locations throughout

the country. SEG group has over 2000 professionals and has acquired over 9,00,000

customers. The products and services offered by SEG group is customized to the

business requirements of SME sector from time to time. This group, as on date

provides customized solution through three business subgroups, viz, BusinessBanking Group, Cluster Banking Group and Corporate Linked Business.

2(a) Business Banking Group

This group offers a bouquet of customised products /services (secured and

unsecured) suited to the various requirements of the SME customer. These products

cater to the entire working capital cycle including trade finance products like LCs/

Bank Guarantees/ bills discounting facilities, export finance, term loans,

collection/payment accounts, anywhere banking current account services and other

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financing requirements including forex risk management products in a simplified

manner to the SME sector.

2(b) Cluster Banking Group

The cluster banking group provides customized banking solutions to various clusters

like :

Life Sciences Chemicals Auto components ECG (Emerging Corporate Group) Construction Wearing Apparel Gems and Jewellery Logistics Electricals IT and ITES (Information Technology) EXIM (Export Import) GLB(Govt. linked business) SEZ (Special Economic Zone) Special Projects

The above list would undergo modification depending on business requirement in

this sector from time to time.

2(c) Corporate Linked Business Group

The Corporate Linked Business Group provides comprehensive banking to the

supply chain partners who are associated with several large corporates in sectors

like petroleum, FMCG, commodities, engineering etc. The division has introducedseveral innovative products like e-banking to these SMEs which combine financing

and help in seamless and real time fund transfer across locations.

The above structure is based on the business requirements of customers in SME

sector as on date, however, the same would undergo amendments depending on the

market requirement in this sector from time to time.


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3. Other initiatives

The Bank also provides card based products like credit cards and debit cards aimed

exclusively at SMEs. Some of the innovative solutions to the SMEs include forex

services through the internet, mobile banking services and card to card fund transfer

etc.

The Bank has also taken a leading role in setting up a platform along with CNBC-TV

and CRISIL for recognising the spirit of entrepreneurship through Emerging India

Awards. The Bank has a regular feature in the mass media (including a magazine

devoted to SMEs) bringing recognition to highly successful SMEs and disseminating

information on issues of interest to SMEs in the respective sectors.

4. Customer categories

As on date, the SEG group acquires Sole Proprietorship Firms, Partnership Firms,

Private Limited and Public Limited company with net worth of up to Rs. 500.0 million

(mn), which is retained in the business group till the net worth reaches Rs. 900.0 mn.

5. Customer selection and credit process

Appreciating the SME customers need for simplified and reliable credit processes,

the Bank as on date offers pre-templated standardized products through easydelivery mechanism thereby ensuring minimum turnaround time. The credit product

offered are broadly categorised as under:

5(a) Program Lending

The program lending involves a cluster-based approach wherein a lending program

is implemented for a homogeneous group of individuals / business entities, which

comply with certain laid down parameterised norms. Each program has a specific

scoring model that evaluates the borrower or its group entities. This scoring model

evaluates both quantitative and qualitative information of the borrower. A customer

become eligible for funds depending on minimum cut-off score stipulated in the

program and other conditioned as stipulated in the program from time to time.

5(b) Pre-approved limits

Further, in order to offer credit facilities to borrowers at short notice, the group also

offers a pre-approved limit, to certain borrowers (who have been selected based ontransaction history) to ensure faster turn around time when the actual need of the


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borrower arises. These limits are mainly for working capital. The credit facilities are

primarily offered on unsecured basis.

5(c) Other lending

In addition to the above, credit facilities are also given to customers in this sector as

per the extant credit policy guidelines of the Bank. These facilities are approved by

authorities as per the Credit Approval Authorisation manual approved by Board from

time to time.

All above program/pre-approved limits are approved by Credit Risk Management

Group (CRMG) and SME Policy and Risk Group (SPRG) before being placed for

approval.

As indicated earlier, the product/service offerings to the customers (including delivery

mechanism) in this sector is customized to the business requirements from time to

time subject to adherence with extant guidelines issued from time to time.

6. Multichannel Servicing

In order to meet the SME customer’s requirements, as on date the Bank services

these customers through a combination of channels like the branch as well as a

relationship officer, internet, call centre services and ATMs. Most of our brancheswork 12 hours a day and the ATMs, internet and the call centre provide 24X7 access

to the customer.

7. Monitoring

The Bank has a regular mechanism for monitoring and reporting of the portfolio

performance. The MIS reports on the exceptions to the defined norms as per the

product policies are being provided by the Credit Middle Office Group (CMOG).

Based on the reports furnished by CMOG, SEG group interacts with customers and

resolves the exceptions.

Further, the Bank’s Internal Audit Department conducts portfolio and branch audits

on regular basis. The CRMG and SPRG also conducts portfolio reviews to evaluate

and monitor the performance and quality of the portfolio.

Restructuring and Rehabilitation Policy at ICICI Bank


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In the case of non-performing loans / stress cases where settlement or exit is not

possible immediately, handholding could be provided subject to long term viability of

the company and possibility to retain the loan as earning asset. The handholding

could include incremental exposure, wherever needed. However, such increase in

exposure should be covered, as far as possible, by collateral / corporate guaranteesof a good company / escrow or securitisation of cash flows.

Restructuring of the liabilities of the borrower by giving appropriate reliefs and

concessions such as reduction in interest rate, funding of interest, conversion of

interest / principal / other dues into equity / debentures or any other instruments,

reschedulement of principal, waiver of dues etc. under RBI guidelines, would be

used as a tool to improve the long-term viability of the borrower. Restructuring shall

however be used selectively and without diluting the Bank’s focus on collections. The

following aspects would be taken into account while preparing a restructuring

package:

1. The proposed restructuring would be based on the realistic projections for the

borrower including the estimated cash flows in the future.

2. As far as possible, efforts would be made to ensure commensurate sacrifices from

all the stakeholders including existing promoters.

3. Efforts would be made, wherever possible, to include the following covenants /

conditions in the restructuring package:

· Enhancement in security package and payment security mechanisms e.g. Trust &

Retention (T&R) / escrow of cash flows of the borrower

· Up-front trigger conditions, non-compliance of which would result into automatic

change of management

· Personal guarantees of the promoters

· Appointment of professionals on the Board or as executives to strengthen the

existing management

· Mechanism to capture the upside potential consequent to restructuring through

equity, acceleration and recompense clauses

· Appointment of concurrent auditors

· In certain cases, where the Bank is already a part of the term lending consortium,

the Bank would endeavour to enter the working capital consortium as well. The

objective of this initiative would be to gain control of the borrower’s cash flows. In

some cases ICICI Bank may give fresh credit facilities to the company to achieve


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this. However the Credit Policy recognises the fact that actual entry might be a

gradual process

(a) Wherever considered necessary, the Bank would insist on

- change of management and/or

- pledge of promoter’s stake subject to extant regulatory stipulations

(b) Mechanism for monitoring the compliance of the conditions stipulated and the

performance of the company post restructuring would be put in place. Various

milestones would be worked out to monitor the implementation of the restructuring

package.

The restructuring package would be worked out within the existing regulatory

framework and in compliance with various prevailing guidelines.

The Bank would undertake the restructuring of the credit facilities to the Small and

Medium Enterprises (SME) borrowers taking into account the guidelines of RBI

issued from time to time. The guidelines require the restructuring to be undertaken

with reference to a set of criteria provided, which includes, eligible SMEs for

restructuring, viability criteria, prudential & asset classification norms etc. Further the

Bank would work out the restructuring package and implement the same inaccordance with the guidelines within a maximum period of 60 days from the date of

receipt of request from the eligible SME borrower.

Further, as the repaying capacity of the people affected by natural calamities gets

severely impaired due to the damage to the economic pursuits and loss of economic

assets, restructuring of existing loans of such borrowers would be undertaken in a

flexible manner as per the guidelines of RBI issued from time to time. The Bank

would ensure that the restructuring mechanism in such cases would synchronisewith the measures which are appropriate in a given situation


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RESERVE BANK OF INDIA

The Reserve Bank of India (RBI) is the central banking institution of India andcontrols the monetary policy of the rupee as well as US$300.21 billion(2010) ofcurrency reserves. The institution was established on 1 April 1935 during

the British Raj in accordance with the provisions of the Reserve Bank of India Act,1934. The share capital was divided into shares of Rs. 100 each fully paid which wasentirely owned by private shareholders in the beginning. Reserve Bank of Indiaplays an important part in the development strategy of the government.

It is a member bank of the Asian Clearing Union. Reserve Bank of India wasnationalised in the year 1949. The general superintendence and direction of theBank is entrusted to Central Board of Directors of 20 members, the Governor andfour Deputy Governors, one Government official from the Ministry of Finance, tennominated Directors by the Government to give representation to important elementsin the economic life of the country, and four nominated Directors by the CentralGovernment to represent the four local Boards with the headquarters at Mumbai,Kolkata, Chennai and New Delhi. Local Boards consist of five members each CentralGovernment appointed for a term of four years to represent territorial and economicinterests and the interests of co-operative and indigenous banks.

Structure of RBI:

Central Board of Directors

The Central Board of Directors is the main committee of the central bank.

The Government of India appoints the directors for a four-year term. The Board

consists of a governor, four deputy governors, four directors to represent the regional

boards, and ten other directors from various fields.

Governors

The central bank till now was governed by 21 governors. The 22nd, Current

Governor of Reserve Bank of India is Dr Subbarao.

Supportive bodies

The Reserve Bank of India has four regional representations: North in New Delhi,

South in Chennai, East in Kolkata and West in Mumbai. The representations are

formed by five members, appointed for four years by the central government and

serve - beside the advice of the Central Board of Directors - as a forum for regional

banks and to deal with delegated tasks from the central board. The institution has 22

regional offices.

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The Board of Financial Supervision (BFS), formed in November 1994, serves as a

CCBD committee to control the financial institutions. It has four members, appointed

for two years, and takes measures to strength the role of statutory auditors in the

financial sector, external monitoring and internal controlling systems.

The Tarapore committee was set up by the Reserve Bank of India under the

chairmanship of former RBI deputy governor S S Tarapore to "lay the road map"

to capital account convertibility. The five-member committee recommended a three-

year time frame for complete convertibility by 1999-2000.

On 1 July 2006, in an attempt to enhance the quality of customer service and

strengthen the grievance redressal mechanism, the Reserve Bank of India

constituted a new department — Customer Service Department (CSD).

Offices and branches

The Reserve Bank of India has 4 regional offices,15 branches and 5 sub-offices. It

has 22 branch offices at most state capitals and at a few major cities in India. Few of

them arelocatedin Ahmedabad, Bangalore, Bhopal, Bhubaneswar ,Chandigarh,

Chennai, Delhi, Guwahati, Hyderabad, Jaipur, Jammu, Kanpur, Kolkata, Lucknow,

Mumbai, Nagpur, Patna, and Thiruvananthapuram. Besides it has sub-offices

at Agartala, Dehradun, Gangtok, Kochi, Panaji, Raipur, Ranchi, Shimla andSrinagar.

The bank has also two training colleges for its officers, viz. Reserve Bank Staff

College at Chennai and College of Agricultural Banking at Pune. There are also

four Zonal Training Centres at Belapur, Chennai, Kolkata and New Delhi.

Bank Rate: RBI lends to the commercial banks through its discount window to help

the banks meet depositor’s demands and reserve requirements. The interest rate the

RBI charges the banks for this purpose is called bank rate. If the RBI wants to

increase the liquidity and money supply in the market, it will decrease the bank rateand if it wants to reduce the liquidity and money supply in the system, it will increase

the bank rate. As of 5 May, 2011 the bank rate was 6%.

Cash Reserve Ratio (CRR): Every commercial bank has to keep certain minimum

cash reserves with RBI. RBI can vary this rate between 3% and 15%. RBI uses this

tool to increase or decrease the reserve requirement depending on whether it wants

to affect a decrease or an increase in the money supply. An increase in Cash

Reserve Ratio (CRR) will make it mandatory on the part of the banks to hold a largeproportion of their deposits in the form of deposits with the RBI. This will reduce the

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size of their deposits and they will lend less. This will in turn decrease the money

supply. The current rate is 6%.

Statutory Liquidity Ratio (SLR): Apart from the CRR, banks are required tomaintain liquid assets in the form of gold, cash and approved securities. Higher

liquidity ratio forces commercial banks to maintain a larger proportion of their

resources in liquid form and thus reduces their capacity to grant loans and advances,

thus it is an anti-inflationary impact. A higher liquidity ratio diverts the bank funds

from loans and advances to investment in government and approved securities.

In well-developed economies, central banks use open market operations--buying

and selling of eligible securities by central bank in the money market--to influence

the volume of cash reserves with commercial banks and thus influence the volume ofloans and advances they can make to the commercial and industrial sectors. In the

open money market, government securities are traded at market related rates of

interest. The RBI is resorting more to open market operations in the more recent

years.

Generally RBI uses three kinds of selective credit controls:

1. Minimum margins for lending against specific securities.

2. Ceiling on the amounts of credit for certain purposes.3. Discriminatory rate of interest charged on certain types of advances.

Direct credit controls in India are of three types:

1. Part of the interest rate structure i.e. on small savings and provident funds,

are administratively set.

2. Banks are mandatorily required to keep 24% of their deposits in the form of

government securities.

3. Banks are required to lend to the priority sectors to the extent of 40% of theiradvances.

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RBI RAISES REPO RATE BY 25 BPS:

The Reserve Bank of India (RBI) raised interest rates for the 12th time in 18 monthsand signalled more was to come, confounding expectations that it was coming to the

end of its tightening cycle and putting it at odds with global peers focused on revivingweak demand.

The RBI lifted its policy lending rate, the repo rate, by 25 basis points to 8.25percent, in line with expectations, in a campaign that has done more to slow growththan contain near double-digit inflation.

The central bank said it was too soon to ease back from its anti-inflationary bias.Investors had expected one more rate increase before heading for a pause.

A Reuters poll after the policy statement showed economists now expect at leastone more rate rise this year.

"A premature change in the policy stance could harden inflationary expectations,thereby diluting the impact of past policy actions. It is, therefore, imperative to persistwith the current anti-inflationary stance," it said in a statement.

The RBI's hawkishness, which saw it raise rates by an unexpectedly steep 50 basispoints in July, makes it an outlier as other central banks turn dovish on the back of afestering global crisis.

The U.S. Federal Reserve has pledged to keep interest rates near zero for twoyears, while emerging heavyweights Brazil and Indonesia have eased policy.

India's headline inflation for August rose to 9.78 percent, its highest in a year andalso highest among the BRIC contingent that includes Brazil, Russia and China.Growth and demand, however, have cooled following the cumulative impact ofearlier rate increases and rising prices.

The benchmark 10-year bond yield rose 4 basis points to 8.36 percent after thecentral bank kept up its hawkish tone, while the one-year swap rate surged 14 basispoints to 7.91 percent. Shares trimmed gains to rise 0.34 percent from 1.4 percentearlier.

CREDIT POLICY OF RBI

where does rbi see indian economy heading?

In its mid-quarter credit policy announced today , RBI Governor, Duvvuri Subbaraoupped repo rate under the liquidity adjustment facility (LAF) by 25 basis points from

7.25% to 7.5% with immediate effect.

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Consequent to the above increase in the repo rate, the reverse repo rate under theLAF will stand automatically adjusted to 6.5% and the marginal standing facility

(MSF) rate to 8.5% with immediate effect.

The RBI's statement on Credit Policy stated:

Since the Reserve Bank' Annual Policy Statement of May 3, the global environmenthas changed for the worse, while domestic conditions are broadly consistent with the

Statement's projections. Growth expectations in advanced economies are visibly

moderating, even as inflationary pressures, primarily from commodity prices, haveincreased. The capacity for conventional policy responses appears limited, with

many countries having already committed to fiscal consolidation amidst growing

sovereign debt risks. From our monetary policy perspective, global commodity pricesstill remain the key external risk though some signs of moderation are becoming

visible.

Domestically, inflation persists at uncomfortable levels. Moreover, the headlinenumbers understate the pressures because fuel prices have yet to reflect global

crude oil prices. On the growth front, even as signs of moderation are visible in some

sectors, broad indicators of activity – 2010-11 fourth quarter profit growth andmargins and credit growth do not suggest a sharp or broad-based deceleration.

Going forward, notwithstanding both signs of moderation in commodity prices andsome deceleration in growth, domestic inflation risks remain high. Against this

backdrop, the monetary policy stance remains firmly anti-inflationary, recognising

that, in the current circumstances, some short-run deceleration in growth may be

unavoidable in bringing inflation under control.

Global economy

The global economy weakened in Q2 of 2011. Lead indicators suggest that growth

moderated in both advanced economies and emerging market economies (EMEs)under the impact of high oil and other commodity prices, the spillover from the

Japanese

credit policies of banks

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