Financing to msme units andhra bank


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a project work done in andhrabank regarding financing to msme units

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Financing to msme units andhra bank

  2. 2. DECLARATION I hereby declare that the project work entitled “Financing to MSME’s in theperspective of Banks as well as Borrowers” with reference to Andhra Bank, ZonalOffice, Visakhapatnam is a bonafide work submitted by me in partial fulfillment forthe award of Master of Business Administration, Andhra University, Visakhapatnam. I also declare that this project is a result of my own effort and that it has notbeen submitted to any other university for the award of any Degree or Diploma. Theempirical findings in the project report are based on the data collected by me. RAVI KUMAR CH Rg.No: PG111201084
  3. 3. CERTIFICATE This is to certify that the project entitled a study on “FINANCING TO MSME’sIN THE PERSPECTIVE OF BANKS AS WELL AS BORROWERS” is thebonafide record for work done by Mr. RAVI KUMAR CH during the period 2011-2013in partial fulfillment of the requirement for the award of the degree of MASTER OFBUSINESS ADMINISTRATION in GAYATRI VIDYA PARISHAD COLLEGE FORDEGREE AND P.G COURSES, VISAKHAPATNAM, under my guidance andsupervision.Visakhapatnam Mrs. P.HIMAJAGATHIDate: Asst. Professor School of Management Studies GVP College for Degree and PG Courses
  4. 4. ACKNOWLEDGEMENTS I express my sincere gratitude to Prof.S.RAJANI, the Director; School ofManagement studies Gayatri Vidya Parishad College for Degree and P.G courses forgiving me opportunity to work on this Project. I am grateful to Dr.K.V.V.MURALI SOMESWARA RAO Head ofDepartment; School of Management studies Gayatri Vidya Parishad College for Degreeand P.G courses for giving me opportunity to work on this Project and for valuableadvices. I wish to take great Pleasure in recording my profound gratitude and sincerethanks to Mrs.P.HIMAJAGATHI Assistant Professor in School of Managementstudies Gayatri Vidya Parishad College for Degree and P.G courses for her inspiringguidance and keen interest and critical evaluation of the work for the successfulcompletion of the project work. It’s immense pleasure to thank Ms.K.VIMALA, Financial Analyst; AndhraBank, Zonal Office at Visakhapatnam, and her team for their co-operation in providingthe required information at each stage to complete my project successfully. RAVI KUMAR CH
  6. 6. INTRODUCTION Page | 1
  7. 7. Introduction: Micro, Small and Medium Enterprises (MSMEs) have played a significant roleworld over in the economic development of various countries. India, certainly, is no exception.Keeping in view its importance, the promotion and development of MSMEs has beenan important plank in our policy for industrial development and a well- structured programmeof support has been pursued in successive five-year plans for the promotion and development ofMSMEs in the country. There exists a well-developed network of financial institutions atnational and state level to channelize credit to MSMEs. SIDBI is the national levelprincipal financial institution for promotion, financing and development of MSMEs. Itprovides direct assistance to the SSI sector through several schemes like direct discounting,project finance, assistance for technological up gradation and modernization,marketing, finance, resource support to institutions engaged in developing SSIs, venturecapital, factoring services, etc. It also provides indirect assistance comprising refinance, bills re-discounting (equipment) and against inland supply of bills through an organizednetwork of 910 Primary Lending Institutions (PLIs) including banks and SFCs with morethan 65,000 outlets throughout the country. Lending norms of the banks has been changing from time to time. So it isnecessary to know the basis for the banks to provide credit to different sectors. In Indiamost of the business entities are in MSME sector. They need adequate funds to run andexpand their businesses. For getting loans from banks, they need to fulfill someeligibility criteria and norms. So the main purpose of this study is to study theavailability of credit for Micro, Small and Medium scale enterprises. Page | 2
  8. 8. Need for the study: The MSME sector is a very vast area and contributing nearly 7% of GDP. This study is usefulfor the MSME organizations as it contains RBI guidelines for raising funds for MSMEsector, eligibility criteria and norms. It helps new entrepreneurs to know whether they will getthe credit from the banks or not according to their business plan and how much they can get accordingto their financial structure. The wide range of information regarding the lending norms andconditions will help the business man to take decision about funding of long term,working capital and other requirements of the organization.Objectives of the study:  To learn the financing procedures for MSMEs i.e., To study the chain of events of processing a loan proposal- from receiving the application from the borrower, doing credit rating of the borrower and the company, analyzing the financial statements, sanctioning to disbursement and the post sanction reviews for MSMEs.  To study the borrowers opinion towards fund raising norms and other criteria.  To study the structure of MSMEs.Scope of the study: The study was intended to obtain the information about:  To study the Credit Appraisal Methods.  In understanding the commercial, financial & technical viability of the project proposed & it’s funding pattern.  To know the knowledge of the borrowers and their responses on different criteria. Page | 3
  9. 9. Research methodology: The study is mainly relying up on both Primary and as well as Secondary Data. A sample oflimited number of customers (Borrowers) has been taken for the study. It includes various websites andarticles.Tools used for analyzing the Secondary data: For analyzing the Secondary data, the tools used are the Financial Ratios such as Current Ratio,Debt equity Ratio, Debt Service Coverage Ratio (DSCR), TOL / TNW, and some Profitability Ratios,capitalization ratios as well as Activity Ratios.Tools used for analyzing the primary data:  Tool used: Percentage Formula: Xi * 100 / N  Tool used: Weighted Average Formula: n ∑ WiXi i=1 ------------------------- n ∑ Wi i=1Limitations of the study:  This study is limited to only one zone of Andhra Bank, the geographical scope of the project was limited to Andhra Bank circle and the loans studied were of solely of businesses established majorly in Visakhapatnam.  There are the constraints of time and cost.  Banks are more confidential about their internal data.  RBI internal guidelines are not available. Page | 4
  10. 10. Industrial profile Page | 5
  11. 11. INDUSTRY PROFILE:Banking Industry: The Webster’s dictionary defines Bank as “an establishment for the custody, loan,exchange, or issue of money, for the extension of credit, and for facilitating thetransmission of funds: the table, counters, or place of business of a money changer.” ABank can also be defined as a financial institution that accepts deposits and channelsthe money into lending activities.History of Banking: The first banks were probably the religious temples of the ancient world, and wereprobably established sometime during the 3rd millennium B.C. Banks probablypredated the invention of money. Deposits initially consisted of grain and later othergoods including cattle, agricultural implements, and eventually precious metals such asgold, in the form of easy-to-carry compressed plates. Temples and palaces were thesafest places to store gold as they were constantly attended and well built. As sacredplaces, temples presented an extra deterrent to would-be thieves. There are extantrecords of loans from the 18th century BC in Babylon that were made by temple prieststo merchants. Modern western economic and financial history is usually traced back to the coffeehouses of London. The London Royal Exchange was established in 1565. At that timemoneychangers were already called bankers, though the term "bank" usually referred totheir offices, and did not carry the meaning it does today. There was also a hierarchicalorder among professionals; at the top were the bankers who did business with heads ofstate, next were the city exchanges, and at the bottom were the pawn shops orLombard’s. Global banking and capital market services proliferated during the 1980sand 1990s as a result of a great increase in demand from companies, governments, andfinancial institutions, but also because financial market conditions were buoyant and,on the whole, bullish. Page | 6
  12. 12. Growing internationalization and opportunity in financial services entirely changedthe competitive landscape, and now many banks prefer the “universal banking” model.Today universal banks are free to engage in all forms of financial services, makeinvestments in client companies, and function as much as possible as a “one-stop”supplier of both retail and wholesale financial services.The Indian Story: Banking in India originated in the first decade of 18th century with The GeneralBank of India coming into existence in 1786. This was followed by Bank of Hindustan.Both these banks are now defunct. The oldest bank in existence in India is the StateBank of India being established as "The Bank of Bengal" in Calcutta in June 1806. Acouple of decades later, foreign banks like Credit Lyonnais started their Calcuttaoperations in the 1850s. At that point of time, Calcutta was the most active trading port,mainly due to the trade of the British Empire, and due to which banking activity tookroots there and prospered. The first fully Indian owned bank was the Allahabad Bank,which was established in 1865. By the 1900s, the market expanded with the establishment of banks such as PunjabNational Bank in 1895 in Lahore and Bank of India in 1906 in Mumbai - both of whichwere founded under private ownership. The Reserve Bank of India formally took on theresponsibility of regulating the Indian banking sector from 1935. After Indiasindependence in 1947, the Reserve Bank was nationalized and given broader powers. Page | 7
  13. 13. Introduction to the Banking Sector in India: Banks are the most significant players in the Indian financial market. They are the biggestpurveyor of credit, and they also attract most of the savings from the population. Dominated bypublic sector, the banking industry has so far acted as an efficient partner in the growthand the development of the country. Driven by the socialist ideologies and the welfare stateconcept, public sector banks have long been the supporters of agriculture and otherpriority sectors. They act as crucial channels of the government in its efforts to economicdevelopment. The Indian banking can be broadly categorized into nationalized (governmentowned), private banks and specialized banking institutions. The Reserve Bank of India acts a centralized body monitoring any discrepancies andshortcoming in the system. Since the nationalization of banks in 1969, the nationalizedbanks have acquired a place of prominence and has since then seen tremendous progress. Theneed to become highly customer focused has forced the slow-moving public sector banks toadopt a fast track approach. In India the banks are being segregated in different groups.Each group has their own benefits and limitations in operating in India. Each has theirown dedicated target market. Few of them only work in rural sector while others in both rural aswell as urban and many even only catering in cities. The banks are of several types. Types of banks in India are (a) Public sector banks (b) Privatesector banks (c) Cooperative banks (d) Regional Rural banks and (e) Foreign banks. Page | 8
  14. 14. Classification of Banks: The Indian banking industry, which is governed by the Banking Regulation Act of India1949 can be broadly classified into two major categories, non-scheduled banks andscheduled banks. Scheduled banks comprise commercial banks and the co-operative banks. InTerms of ownership, commercial banks can be further grouped into nationalized banks, theState Bank of India and its group banks, regional rural banks and private sector banks(domestic and foreign). These banks have over 67,000 branches spread across the county. TheIndian banking industry is a mix of the public sector, private sector and foreign banks. Theprivate sector banks are again spilt into Indian banks and foreign banks. Page | 9
  15. 15. Competitive forces model in the banking industry:(PORTER’S FIVE-FORCE MODEL) Prof. Michael Porter’s competitive forces Model applies to each and every company aswell as industry. This model with regards to the Banking Industry is presented below. (2) Potential Entrants is high as development financial institutions as well as private and foreign banks have entered in a big way. (5) (1) (4)Organizing power of the Rivalry among existing Bargaining power ofsupplier is high. With the firms has increased with buyers is high asnew financial instruments liberalization. New products corporate can raise fundsthey are asking higher and improved customer easily due to highreturn on the investments. services is the focus. competition. (3) Threat from substitute is high due to competition from NBFCs and insurance companies as they offer a high rate of interest than banks. Page | 10
  16. 16. 1. Rivalry among existing firms With the process of liberalization, competition among the existing banks hasincreased. Each bank is coming up with new products to attract the customers and tailormade loans are provided. The quality of services provided by banks has improveddrastically.2. Potential Entrants Previously the Development Financial Institutions mainly provided project financeand development activities. But they now entered into retail banking which has resultedinto stiff competition among the exiting players.3. Threats from Substitutes Banks face threats from Non-Banking Financial Companies. NBFCs offer a higherrate of interest.4. Bargaining Power of Buyers Corporate can raise their funds through primary market or by issue of GDRs,FCCBs. As a result they have a higher bargaining power. Even in the case of personalfinance, the buyers have a high bargaining power. This is mainly because ofcompetition.5. Bargaining Power of Suppliers With the advent of new financial instruments providing a higher rate of returns tothe investors, the investments in deposits is not growing in a phased manner. Thesuppliers demand a higher return for the investments.6. Overall Analysis The key issue is how banks can leverage their strengths to have a better future.Since the availability of funds is more and deployment of funds is less, banks shouldevolve new products and services to the customers. There should be a rational thinkingin sanctioning loans, which will bring down the NPAs. As there is a expected revival inthe Indian economy Banks have a major role to play. Funding corporate at a low cost ofcapital is a special requisite. Page | 11
  17. 17. INTRODUCTION TO MSMEs: Micro, Small and Medium Enterprises (MSMEs) have played a significant roleworld over in the economic development of various countries. Over a period of time, ithas been proved that MSMEs are dynamic, innovative and most importantly, theemployer of first resort to millions of people in the country. The sector is a breedingground for entrepreneurship. The importance of MSME sector is well-recognized world over owing to itssignificant contribution in achieving various socio-economic objectives, such asemployment generation, contribution to national output and exports, fostering newentrepreneurship and to provide depth to the industrial base of the economy. Micro,Small and medium-sized enterprises (MSMEs) are the backbone of all economies andare a key source of economic growth, dynamism and flexibility in advancedindustrialized countries, as well as in emerging and developing economies. MSMEsconstitute the dominant form of business organization, accounting for over 95% and upto 99% of enterprises depending on the country. They are responsible for between 60-70% net job creations in Developing countries. Small businesses are particularly important for bringing innovative products ortechniques to the market. Microsoft may be a software giant today, but it started off intypical MSME fashion, as a dream developed by a young student with the help offamily and friends. Only when Bill Gates and his colleagues had a saleable productwere they able to take it to the marketplace and look for investment from moretraditional sources. MSMEs are vital for economic growth and development in bothindustrialized and developing countries, by playing a key role in creating new jobs.Financing is necessary to help them set up and expand their operations, develop newproducts, and invest in new staff or production facilities. Page | 12
  18. 18. Many small businesses start out as an idea from one or two people, who investtheir own money and probably turn to family and friends for financial help in return fora share in the business. But if they are successful, there comes a time for all developingMSMEs when they need new investment to expand or innovate further. That is wherethey often run into problems, because they find it much harder than larger businesses toobtain financing from banks, capital markets or other suppliers of credit.Common Characteristics of MSMEs:(a) Born out of individual initiatives & skills MSME startups tend to evolve along a single entrepreneur or a small group ofentrepreneurs; in many cases; leveraging on a skill set. There are other MSMEs beingset up purely as a means of earning livelihood. These includes many trading and retailestablishments while most countries continue MSMEs to manufacturing services,others adopt a broader definition and include retailing as well.(b) Greater operational flexibility The direct involvement of owner(s), coupled with flat hierarchical structures andless number of people ensure that there is greater operational flexibility. Decisionmaking such as changes in price mix or product mix in response to market conditions isfaster.(c) Low cost of production MSMEs have lower overheads. This translates to lower cost of production, leastupto limited volumes.(d) High propensity to adopt technology Traditionally MSMEs have shown a propensity of being able to adopt andinternalize the technology being used by them.(e) High capacity to innovate export: MSMEs skill in innovation, improvisation and reverse engineering are legendary.By being able to meet niche requirements, they are also able to capture export marketswhere volumes are not huge. Page | 13
  19. 19. (f) High employment orientation: MSMEs are usually the prime drives of jobs, in some cases creating up to 80%.Jobs MSMEs tend to be labour intensive per se and are able to generate more jobs forevery unit of investment, compared to their bigger counterparts.(g) Reduction of regional imbalances Unlike large industries where divisibility of operations is more difficult, MSMEsenjoy the flexibility of location. Thus, any country, MSMEs can be found spreadvirtually right across, even through some specific location s emerge as ‘clusters’.MSMEs in India: India has a vibrant MSME sector that plays an important role in sustainingeconomic growth, increasing trade, generating employment and creating newentrepreneurship in India. In keeping in view its importance, the promotion anddevelopment of MSMEs has been an important plank in our policy for industrialdevelopment and a well-structured programme of support has been pursued insuccessive five-year plans for. MSMEs in India have recorded a sustained growthduring last five decades. The number of MSMEs in India is estimated to be around 13million while the estimated employment provided by this sector is over 31 million. TheMSME sector accounts for about 45 per cent of the manufacturing output and over 40per cent of the national exports of the country. India embarked on the path of opening up its economy and integrating it with theglobal economy in 1991. The liberalization of economy, while offering tremendousopportunities for the growth and development of Indian industry including MSMEs, hasalso thrown up new challenges in terms of fierce competition. The very rules whichprovide increased access for our products in the global markets also put domesticindustry under increased competition from other countries. In today’s world, access ona global basis to modern technology, capital resources and markets have become themost critical determinants of international competitiveness. Page | 14
  20. 20. Defining MSMEs:In India, the enterprises have been classified broadly into two categories:(i) Manufacturing; and(ii) Those engaged in providing/rendering of services. Both categories of enterprises have been further classified into micro, small andmedium enterprises based on their investment in plant and machinery (formanufacturing enterprises) or on equipments (in case of enterprises providing orrendering services).The classification on basis of investment is as under: For the Manufacturing Sector, the MSMED Act 2010 defines micro, small and medium enterprises (MSMEs) as mentioned below:  A micro enterprise is an enterprise where investment in plant and machinery does not exceed Rs 25 lakh.  The investment in plant and machinery in a small enterprise is more than Rs 25 lakh, but does not exceed Rs 5 crore.  A medium enterprise is one where the investment in plant and machinery is more than Rs 5 crore, but does not exceed Rs 10 crore. Enterprises engaged in providing or rendering of services and whose investment in equipment under MSMED Act, 2010 are specified below:  A micro enterprise is an enterprise where the investment in equipment doesn’t exceed 10 lakh.  A small enterprise is an enterprise where the investment in equipment is more than Rs.10 lakh but not exceed Rs.2crore.  A medium enterprise is an enterprise where the investment in equipment is more than Rs.2crore but not exceed Rs.5crore. Page | 15
  21. 21. While calculating the investment in plant and machinery/equipment referred toabove, the original price thereof shall be taken into account, irrespective of whether theplant and machinery/equipment are new or second hand. In case of importedmachinery/equipment, the following duty/charges/costs shall be included in calculatingtheir value:  Import Duty (not to include miscellaneous expenses such as transportation from the port to the site of the factory, demurrage paid at the port);  Shipping Charges;  Customs Clearance charges; and Sales Tax or Value-added Tax. Cost of the following plant & machinery/equipments etc would be excluded:;  Equipments such as tools, jigs, dies, moulds, and spare parts for maintenance and the cost of consumable stores;  Installation of plant &machinery;  Research and development and pollution control equipments;  Power generation set and extra transformer installed by the enterprises as per the Regulations of the State Electricity Board;  Bank charges and Service Charges paid to the National Small Industries Corporation or the State Small Industries Corporation;  Procurement or Installation of cables, wiring bus bars, electrical control panels (not mounted on individual machines)  Oil circuit breakers or miniature circuit breakers which are necessarily to be used for providing electrical power to the plant and machinery or for safety measures;  Gas producer plants;  Transportation charges (other than sales tax or value-added tax and excise duty) for indigenous machinery from the place of their manufacture to the site of the enterprise);  Charges paid for technical know-how for erection of plant machinery; Page | 16
  22. 22.  Such storage tanks which store raw materials and finished products only and are not linked with the manufacturing process;  Fire-fighting equipment; and  Such other items as may be specified, by notification from time to time.  In case of Service Enterprises, the original cost to exclude furniture, fittings and other items not directly related to the services rendered. Land and Building would also not be included while computing the machinery/equipments cost. MSME would be meant to include Micro Small and Medium Enterprises(MSMEs). The above definitions of Micro, Small and Medium Enterprises would be inplace of the existing definitions of Small & Medium Industries and SSSBEs/TinyEnterprises.  Micro Enterprises would include Tiny Industries also.  Small Enterprises (Manufacturing) would mean Small Scale Industries (SSIs).  Medium Enterprises (Manufacturing) would mean Medium Industries (MIs).  Small Enterprises (Services) and Medium Enterprises (Services) would mean other Small & Medium Enterprises. Thus, MSME Advances would be categorized as under:  All advances to segments viz. Micro, Small and Medium Enterprises in the Manufacturing sector irrespective of sanctioned limits, (including advances against TDRs/Govt. Securities etc for business purposes to these categories of Borrowers), and  Advances to Services Sectors such as Professional & Self-Employed, Small Business Enterprises, and Small Road/Water Transport Operators and other enterprises, engaged in providing/rendering of services, conforming to the above investment criteria and enjoying borrowing/non-borrowing facilities with the Bank (including advances against TDRs/Govt. Securities etc for business purposes to these categories of Borrowers).  Those enterprises exceeding the investment ceilings would be categorized as Large Enterprises and be outside the purview of MSME. Page | 17
  23. 23.  The sanctioned limits would no longer be the criteria determining the status as micro or small or medium enterprises in these cases.Development of MSMEs in India: Making the best use of the material resources by employing higher order of skilland artistic talents through traditional handicrafts, India has occupied a permanent placeof pride in the world before industrial resolution. However, the advent of modern largescale mechanized industry, the imposition of restrictions on Indian trade by the Britishrulers and deteriorating socio-economic conditions lead to the decline of Small ScaleIndustry. But with the provisions of permanent place in the nations policy of economicdevelopment after the attainment of the Independence, it has staged a grand recoveryand is now well entrenched on the path of progress towards great expansion. MSME has emerged into prominent sector in Indian economy in general andindustry in particular. SSI sector in India has posted impressive growth in 1990s from15% in 1991-92 to 55% in 2001-02.The growth in employment generation has beenequally impressive from 3% to 45% during the same period. Employment in MSMEtouched 19 million, just behind agriculture. Share of SSI exports crosses 40% of totalexports. Growth by itself in MSME sector is impressive enough indicating a positiveresponse to the Economic Reform process initiated in the country since 1991.  Development of infrastructure  Assured supply of Raw Materials  Availability of Cheap Credit  Concessionary Taxes and Tariffs.  Financial subsidies  Equity contributions are all the protective measures for the sector Page | 18
  24. 24. Role of MSME sector in Nation Development: The Small and Medium sector plays an important role in the Indian economy interms of employment and growth has recorded a high rate of growth afterindependence. MSMEs play a vital role for the growth of Indian economy bycontributing 45% of the industrial output, 40% of exports, 42 million in employment,create one million jobs every year and produces more than 8000 quality products forthe Indian and international markets. As a result, MSMEs are today exposed to greateropportunities for expansion and diversification across the sectors. The root cause for unemployment in India is the over growing population whichhas outpaced the development of industry and agriculture. For a country like ours, withlimited financial resources and huge reservoir of human resources, Small and Mediumindustry is the only means for solving the unemployment problem. Small and Mediumindustry is providing employment at an increased rate. The Indian market is growing rapidly and Indian industry is making remarkableprogress in various Industries like Manufacturing, Precision Engineering, FoodProcessing, Pharmaceuticals, Textile & Garments, Retail, IT, Agro and Service sectors.MSMEs are finding increasing opportunities to enhance their business activities in coresectors. The good performance of the small scale units is evident from their number,production, employment and foreign exchange earnings. Page | 19
  25. 25. Problems of MSMEs Despite its commendable contribution to the Nations economy, MSME Sectordoes not get the required support from the concerned Government Departments,Banking Sector, Financial Institutions and Corporate Sector, which is a handicap inbecoming more competitive in the National and International Markets and which needsto be taken up for immediate and proper redressal. MSME sector faces a number ofproblems - absence of adequate and timely banking finance, limited knowledge andnon-availability of suitable technology, low production capacity, follow up with variousagencies in solving regular activities and lack of interaction with government agencieson various matters.Some of the major problems are briefly as follows:a) Financial problems of MSMEs: The financial problem of MSMEs is the Root Cause for all the other problemsfaced by the MSME sector. The small and medium industrialists are generally poor andthere are no facilities for cheap credit. They fall into the clutches of money lender whocharges very high rates of interest, or else they borrow from the dealers of their goods,who exploit them by completing them to sell their products at very low price. After thenationalization of 14 major Indian Banks in July, 1969, the Commercial banks wereproviding only a small proportion of MSMEs financial requirements. Credit to theMSME sector continues to be non-commensurate with its contribution to the totalindustrial output. As against the share of the village and MSME at 40% in the industrialoutput, its share in total credit to the industrial sector is only about 30%.b) Raw Material problem of MSMEs: This difficulty is experienced in a very pronounced form. The quantity, quality andregularity of the supply of raw materials are not satisfactory. There are no quantitydiscounts, since they are purchased in small quantities and hence charged, higher pricesby suppliers. Difficulty is also experienced in procuring semi-manufactured materials. Page | 20
  26. 26. Financial weakness stands in the way of securing raw materials in bulk in a competitivemarket.c) Production problem of MSMEs: MSME units suffer from inadequate work space, power, lighting and ventilation,and safety measures etc. These short comings have tended to endanger the health ofworkmen and have adversely affected the rate of production. Many units are followingprimitive methods of production. Adoption of modern techniques is either disliked bythe entrepreneurs is not feasible. Wage rates and service conditions of small industriesare not attractive to skilled labor.d) Technological problem of MSMEs: Today technology is changing at a very fast phase; it becomes difficult for MSMEsto cope up with changing technology. Technology up gradation and the frequent needto renew the equipment has emerged as a big problem.e) Marketing problem of MSMEs: As marketing is not properly organized, the helpless artisans are completely at themercy of middle man. The potential demand for their goods remains under developed.The MSMEs have to face the competitions from large scale units in marketing theirproducts. It causes damage to the growth and stability of MSMEs. MSMEs cannotafford to spend lavishly for advertisement to promote their sales.f) Managerial problem of MSMEs: Small scale industries in our country have suffered from the lack of entrepreneurialability to develop initiative and undertake risks in the unexplored industrial fields. Thein efficiency in management comes first among managerial problems. Theentrepreneurial ability of promoters of cottage industries and MSMEs are handicappedby technical knowhow in the areas of production, finance, accounting and marketingmanagement. Page | 21
  27. 27. g) Sickness of MSMEs: A serious problem which is hampering small and medium sector has been sickness.Many small units have fallen sick due to one problem or the other. Sickness is causedby two sets of factors, Internal and external factors. From among the various internaland external causes of sickness the important ones are bud management, high rate ofcapital gearing, inadequacy of finance, short of raw materials, outdated plant andmachinery, low labor productivity etc. Page | 22
  28. 28. COMPANYPROFILE Page | 23
  29. 29. COMPANY PROFILE: Andhra Bank is a medium-sized public sector bank (PSB), with a network of1,712 branches, 15 extension counters, 38 satellite offices and 1056 automated tellermachines (ATMs) as on march 31, 2012. Andhra Bank was founded by the eminentfreedom fighter, Dr. Bhogaraju Pattabhi Sitaramayya. The Government of India owns51.55% of its share capital and is going to increase it to 58% by infusing 1100 crore.The state owned Life Insurance Corporation of India holds 10% of the shares. The bank has done a total business of Rs. 1,90,535 crore as on 31.03.2012. Thebanks operations are mostly concentrated in southern India, the region accounts forover 60% of the bank’s advances and deposits. Bank is migrating to "Centralized Core Banking Solution"118 Branches havealready migrated to CBS. It is proposed to cover 550 branches by September 2009. Thiswill benefit the customers, who will have access to banking and financial servicesanytime, anywhere through multiple delivery channels. Andhra Bank is a pioneer inintroducing Credit Cards in the country in 1981. The Bank introduced Internet Banking Facility (AB INFI-net) to all customers ofcluster linked branches. Rail Ticket Booking Facility is made available to all debit cardholders through IRCTC Website through a separate gateway. Corporate Website isavailable in English, Hindi and Telugu Languages communicating Banks image andinformation. Bank has been given BEST BANK AWARD a banking technology awardby IDRBT, Hyderabad for extensive use of IT in Semi Urban and Rural Areas on02.09.2010. IBA Jointly with TFCI has conferred the Joint Runner-up Award to theBank in the Bet Payments initiative in recognition of outstanding achievement of the Page | 24
  30. 30. Bank in promoting ATM Channel. Bank successfully conducted " Bancon 2010", a twoday event at Hyderabad, deliberating on Inclusive Growth - A New Challenge. KiddyBank Scheme, with insurance benefits, was re-launched to inculcate savings habitamong the children. Bank has mobilized nearly 90000 new accounts during 2011-08. As a part of "Financial Inclusion", Bank adopted two districts, namely,Srikakulam in Andhra Pradesh and Ganjam in Orissa and achieved 100% coverage.Bank has introduced Smart Card Scheme Pilot project in Warangal District and thesame will be extended to other Lead Districts in due course. Bank has opened 2.11 lakhaccounts under "No-frill accounts" category till 30.06.2008. Andhra Bank, along with A P State Government, NABARD, Canara Bank, IndianBank, IOB and SBH sponsored the Andhra Pradesh Bankers Institute ofEntrepreneurship Development, which will offer training to unemployed youth forimproving their skills in Andhra Pradesh. Bank adopted Gundugolanu village, West Godavari District, Andhra Pradesh -birth place of Dr. Bhogaraju Pattabhi Sitaramayya for all-round development. Acomprehensive budget with an outlay of Rs.5.50 Crore is finalized for improvinghealth, sanitation, education and social service facilities in the village. Page | 25
  31. 31. History: Andhra Bank was founded by Dr. Bhogaraju Pattabhi Sitaramayya in 1923 inMachilipatnam, Andhra Pradesh. The founder Dr. Bhogaraju Pattabhi Sitaramayya wasan eminent freedom fighter and a multifaceted genius. The Bank was registered onNovember 20, 1923 and commenced business on 28 November 1923 with a paid upcapital of Rs 1.00 lakh and an authorised capital of Rs 10.00 lakhs. In 1956, linguisticdivision of States was promulgated and Hyderabad was made the capital of AndhraPradesh. The registered office of the Bank was subsequently shifted to Andhra BankBuildings, Sultan Bazaar, Hyderabad, and Andhra Pradesh. In the second phase ofnationalization of commercial banks commenced in April 1980, the bank became awholly owned Government bank. In 1964, the bank merged with Bharat Lakshmi Bankand further consolidated its position in Andhra Pradesh. Page | 26
  32. 32. Corporate Identity: “TOGETHERNESS IS THE THEME”  The Symbol of Infinity denotes a Bank that is prepared to do anything, to go to any lengths, for the customer  The Blue pointer on the top represents the philosophy of a Bank that is always looking for growth and newer directions.  The Key hole represents Safety and Security  The Chain indicates togetherness  The colours Red and Blue denote dynamism and solidity Page | 27
  33. 33. VISION AND MISSION:Vision: “Andhra Bank is committed to create a customer centric organization with a deepsense of social responsibility and to continuously leverage technology to attain worldclass standards of performance.”Mission: “Beside the core activity of banking, Andhra Bank will venture into a spectrum ofFinancial Services. Utmost concern will be accorded to customer satisfaction byoffering innovative and need-based financial products and services using state of the arttechnology.”Products and Services: The products and services provided by the bank are mainly categorized intobusinesses of Retail, Corporate, NRI, MSME, and Agricultural industries. Under theRetail Business, the bank offers Deposits, Loans, Cards, DMAT Services, PaymentServices, Insurance, and Mutual Funds to individual customers. Under the CorporateBusiness, the bank offers Loans & Advances, Project Appraisal services, andSyndication of Loans to the business entities. Under the NRI business segment, thebank offers Deposit schemes, Loans, Remittance services, and Investment services tothe Non Resident Indians. Under the MSME business segment, the bank offers different schemes thataimed at providing loan and transaction services to Micro Small and MediumEnterprises (MSME). Some of the MSME schemes available are OTS Scheme,Composite loan scheme, Open cash credit (OCC), Artisans Credit Card (ACC), ABLaghu Udhyami Credit Card (LUCC), AB Power Tools (Shakti), Technologyupgradation fund scheme (TUFs), Credit guarantee fund trust for small industries(CGTSI), AB Doctor Plus...etc. Under the Agriculture business segment, bank providesdifferent credit schemes to farmers, Women Empowerment schemes, and Andhra Bank Page | 28
  34. 34. Rural Development Trust (ABRDT) helps Rural Self Employment Training Institutes(RSETIs).  Deposit Schemes o AB Savings Accounts o AB Current Accounts o AB Term Deposits o AB Arogyadaan Scheme o AB Bancassurance Life o AB Bancassurance (Non Life)  Retail Loans  Agricultural Loans  Corporate Banking  NRI Banking o NRI Products and Services o NOSTOR details for remittance o Western Union Money Transfer  Technology Products o Multi City Cheque Facility o On-Line Tax Accounting System (OLTAS) o Real Time Gross Settlement (RTGS) o Instant Funds Transfer o ATM Services o Any Branch Banking o Electronic Clearing Service (ECS) o National Electronic Funds Transfer Page | 29
  35. 35. Value added services: Introduced 8 a.m. to 8 p.m. and 7 day banking in select branches to extend the Service hours to clientele. Opened a Representative Office in Dubai to coordinate with NRIs for increasing our NRI customer base. Imparting training to Agriculturists, Rural Un- employed youth on vocational courses by our 9 Rural Development Institutes. Mobile Banking – Connected branches improved to 453, registered users 4175 Daily ATM hits crossed 1 lakh per day. Mobile Recharging facility Tech savvy products such as e-Seva, e-Hundi, Utility Bill Payment, Visa Electron Debit Card, Instant Funds Transfer, On-line Tax Accounting System, RTGS etc. Various Insurance Linked Deposit products like AB Jeevan Abhaya, AB Jeevan Prakash, AB Jeevan Prakash Plus, AB Arogyadaan and AB Flex. New Tech savvy product AB Kisan Vikas ATM Card has been introduced. Shortly introducing – Internet Payment Gateway, Internet Banking. Page | 30
  36. 36. Corporate Social Responsibility (CSR): Being an integral part of society, Bank is aware of its corporate socialresponsibilities and has engaged in community and social investments. During the year,Bank has taken many initiatives with the objective of providing philanthropic assistancefor development, education etc. Under the aegis Andhra bank rural development trust bank is imparting training to youth in rural and semi urban areas so that poor people can take up self employment ventures. They also conduct vocational and human resource development training. So far they have provided training to 71,666 participants. The bank has taken initiatives for including more people from the marginalized and down trodden sections into the banking system. The bank has already implemented financial inclusions in districts of Orissa and Andhra Pradesh. During the year 07-08 the bank has adopted Gundugolanu village in Andhra Pradesh for improving health, sanitation, education facilities with a comprehensive budget of 5.50 cr. The bank is setting up a school in the campus of Andhra University in Vishakhapatnam. Along with the Andhra Pradesh Government and NABARD, it has set up APBIRED for providing training to unemployed youth for improving their skills. In the year 2011-2008, the bank has donated 2.14 cr to various trusts and NGOs. Under the aegis of Andhra Bank Rural Development Trust, Bank is imparting training to youth in rural and semi-urban areas so that the poor people can take up self-employment ventures. This also conducts various vocational and human resource development training programmes. So far, training has been imparted to 71,666 participants in self-employment ventures and in capacity building. The Bank has taken initiatives towards implementing financial inclusion in some of the districts for bringing more and more people of the marginalized and the downtrodden sections into banking system. The Bank has already implemented 100% financial inclusion in the districts of Srikakulam (Andhra Pradesh) and Ganjam (Orissa). During the year 2011-08, Page | 31
  37. 37. Bank has adopted the Gundugolanu village in the district of West Godavari in Andhra Pradesh tor improving health, sanitation, education and social service facilities in the village, with a comprehensive budget of Rs. 5.50 crore. In a move towards encouraging higher studies, Bank is setting up Andhra Bank School of Business in the campus of Andhra University, Visakhapatnam (Andhra Pradesh). The Bank along with Government of Andhra Pradesh, NABARD and other selectbanks sponsored the Andhra Pradesh Bankers / Institute of Rural & EntrepreneurshipDevelopment (APBIRED), which will offer training to unemployed youth forimproving their skills. This is located at Hyderabad. The Bank is also making donationsto charitable trusts and other institutions engaged in the upliftment of the society. As per research work they ranked Andhra Bank as No. 3organization out of top organizations with regard to corporate social responsibility. Page | 32
  38. 38. CONCEPTUALFRAME WORK Page | 33
  39. 39. Theoretical Aspects:Overview of Credit Appraisal Credit appraisal means an investigation/assessment done by the banks beforeproviding 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 ofthe credit facility. It is generally carried by the financial institutions, which are involvedin providing financial funding to its customers. Credit risk is a risk related to non-repayment 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 berepaid along with the interest. Thus, the customers cash flows are ascertained to ensurethe timely payment of principal and the interest. It is the process of appraising the credit worthiness of a Loan applicant. Factorslike age, income, number of dependents, nature of employment, continuity ofemployment, repayment capacity, previous Loans, credit cards, etc. are taken intoaccount while appraising the credit worthiness of a person. Every bank or lendinginstitution has its own panel of officials for this purpose. Page | 34
  40. 40. However the 3 ‘C’ of credit are crucial & relevant to all borrowers/ lending, whichmust be kept in mind, at all times.  Character  Capacity  Collateral If any one of these are missing in the equation then the lending officer must questionthe viability of credit. There is no guarantee to ensure a Loan does not run intoproblems; however if proper credit evaluation techniques and monitoring areimplemented then naturally the Loan loss probability / problems will be minimized,which should be the objective of every lending 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, therebygenerating 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. Page | 35
  41. 41. Basic types of credit There are four basic types of credit. By understanding how each works, youwill be able to get the most for your money and avoid paying unnecessary charges.  Service credit is monthly payments for utilities such as telephone, gas, electricity, and water. You often have to pay a deposit, and you may pay a late charge if your payment is not on time.  Loans let you borrow cash. Loans can be for small or large amounts and for a few days or several years. Money can be repaid in one lump sum or in several regular payments until the amount you borrowed and the finance charges are paid in full. Loans can be secured or unsecured.  Installment credit may be described as buying on time, financing through the store or the easy payment plan. The borrower takes the goods home in exchange for a promise to pay later. Cars, major appliances, and furniture are often purchased this way. You usually sign a contract, make a down payment, and agree to pay the balance with a specified number of equal payments called installments. The finance charges are included 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 credit card can be the equivalent of an interest-free Loan- end of each month.-if you pay for the use of it in full at theBrief overview of LoansLoans can be of two types fund base & non-fund base: Fund Base includes:  Working Capital  Term Loan Page | 36
  42. 42.  Non-fund Base includes:  Letter of Credit  Bank Guarantee  Bill Discounting  Fund Base:  Working capital The 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, for employmentof labor, for power charges etc. financing the sales by way of sundry debtors/receivables. Capital or funds required for an industry can therefore be bifurcated as fixed capital& working capital. Working capital in this context is the excess of current assets overcurrent liabilities. The excess of current assets over current liabilities is treated as net,for storing finishing goods till they are sold out & for working capital or liquid surplus& represents that portion of the working capital, which has been provided from the long-Term source. Term Loan 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 not exceeding 8years. A Term Loan is a Loan granted for the purpose of capital assets, such as purchase ofland, construction of, buildings, purchase of machinery, modernization, renovation or Page | 37
  43. 43. rationalization of plant, & repayable from out of the future earning of the enterprise, ininstallments, as per a prearranged schedule. From the above definition, the following differences between a Term Loan & theworking capital credit afforded by the Bank are apparent:o The purpose of the Term Loan is for acquisition of capital assets.o The Term Loan is an advance not repayable on demand but only in installments ranging over a period of years.o The repayment of Term Loan is not out of sale proceeds of the goods & commodities per se, whether given as security or not. The repayment should come out of the future cash accruals from the activity of the unit.o The security is not the readily saleable goods & commodities but the fixed assets of the units. 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 risk isinherent in any type of Loan because of the uncertainty of the repayment. Longer theduration of the credit, greater is the attendant uncertainty of repayment & consequentlythe risk involved also becomes greater. However, it may be observed that Term Loans are not so lacking in liquidity as theyappear to be. These Loans are subject to a definite repayment programme unlike shortTerm Loans for working capital (especially the cash credits) which are being renewedyear after year. Term Loans would be repaid in a regular way from the anticipatedincome of the industry/ trade. These distinctive characteristics of Term Loans distinguish them from the short Termcredit granted by the banks & it becomes necessary therefore, to adopt a differentapproach in examining the applications of borrowers for such credit & for appraisingsuch proposals. The repayment of a Term Loan depends on the future income of the borrowing unit.Hence, the primary task of the bank before granting Term Loans is to assure itself that Page | 38
  44. 44. the anticipated income from the unit would provide the necessary amount for therepayment of the Loan. This will involve a detailed scrutiny of the scheme, its capitalassets. Financial aspects, economic aspects, technical aspects, a projection of futuretrends of outputs & sales & estimates of cost, returns, flow of funds & profits. Non-fund Base: Letter of credit The expectation of the seller of any goods or services is that he should get thepayment immediately on delivery of the same. This may not materialize if the seller &the buyer are at different places (either within the same country or in differentcountries). The seller desires to have an assurance for payment by the purchaser. At thesame time the purchaser desires that the amount should be paid only when the goods areactually received. Here arises the need of Letter of Credit (LCs). The objective of LC isto provide a means of payment to the seller & the delivery of goods & services to thebuyer at the same time.DefinitionA Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting atthe request & on the instructions of the customer (the applicant) or on its own behalf,o Is to make a payment to or to the order of a third party (the beneficiary), or is to accept & pay bills of exchange (drafts drawn by the beneficiary); oro Authorizes another bank to effect such payment, or to accept & pay such bills of exchanges (drafts); oro Authorizes another bank to negotiate the Terms & conditions of the credit are complied with against stipulated document(s), provided. Page | 39
  45. 45.  Bank Guarantees: A contract of guarantee is defined as ‘a contract to perform the promise or discharge the liability of the third person in case of the default’. The parties to the contract of guarantees are:a) Applicant: The principal debtor – person at whose request the guarantee is executedb) 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 the applicant in case of his default. Thus, guarantee is a collateral contract, consequential to a main co applicant & the beneficiary.Purpose of Bank GuaranteesBank Guarantees are used to for both preventive & remedial purposes. The guaranteesexecuted by banks comprise both performance guarantees & financial guarantees. Theguarantees are structured according to the Terms of agreement, viz., security, maturity &purpose.Branches may issue guarantees generally for the following purposes:a) In lieu of security deposit/earnest money deposit for participating in tenders;b) Mobilization advance or advance money before commencement of the project by the contractor & for money to be received in various stages like plant layout, design/drawings in project finance;c) In respect of raw materials supplies or for advances by the buyers;d) In respect of due performance of specific contracts by the borrowers & for obtaining full payment of the bills;e) Performance guarantee for warranty period on completion of contract which would enable the suppliers to period to be over; realize the proceeds without waiting for warranty) To allow units to draw funds from time to time from the concerned indenters against part execution of contracts, etc. Page | 40
  46. 46. f) Bid bonds on behalf of exportersg) Export performance guarantees on behalf of exporters favoring the Customs Department under EPCG scheme. Bill discounting:Definition: As per Negotiable Instrument Act, “The bill of exchange is an instrument inwriting containing an unconditional order, signed by the maker, directing a certainperson to pay a certain sum of money only to, or to the order of, a certain person, or tothe bearer of that instrument.”Discounting of bill of exchange: A seller (Drawer) if need cash, may handover the B/E to the Bank, NBFC, acompany or a high Net worth Individual and obtain ready cash this is known asdiscounting of bill. the practice in India is that, the financing organization holds theoriginal B/E till the drawee pays on maturity. For discounting the bill, financiers chargean interest on the bill amount for the duration of the bill which is called discountcharges.normal maturity periods are 30, 60, 90, 120 days. Types of Bills1. Demand Bill2. Usance Bill3. Documentary Billsa. Documents against acceptance (D/A) billsb. Documents against payment (D/P) bills4. Clean Bills Page | 41
  47. 47. Advantages To Investors1. Short Term source of finance2. Outside the purview of Section 370 of Indian Companies Act 19563. No tax deducted at source4. Flexibility To Banks1. Safety of funds2. Certainty of payment3. Profitability Page | 42
  48. 48. Credit Appraisal Process Receipt of application from applicant Receipt of documents (Balance sheet, KYC papers, Different govt. registration no., MOA, AOA, and properties documents Pre-sanction visit by bank officersCheck for RBI defaulters list, willful defaulters list, CIBIL data, ECGC, Caution list etc Title clearance reports of the properties to be obtained from empanelled AdvocatesValuation reports of the properties to be obtained from empanelled valuer/engineers Preparation of financial data Proposal preparation Assessment of proposal Page | 43
  49. 49. Sanction/approval of proposal by appropriate sanctioning authority Documentations, agreements, mortgages Disbursement of LoanPost sanction activities such as receiving stock statements, review of accounts, renew of accounts, etc (On regular basis) Page | 44
  50. 50. CREDIT PROCESS Pre-Sanction Process Indicative list of Activities in the Appraisal Function A. Preliminary appraisal  Obtain i. Application for working capital Finance ii. Audited financial for the previous three years iii. Details of existing borrowing arrangements iv. Reports from existing Banker on the application copy v. Financial statements, borrowings relationship of Associate firm/group companies vi. Profile of promoters /senior management personnel  If request includes project financing, obtain additional: i. Project report ii. Appraisal report form Financial institutions in case Appraisal has been done by them iii. NOC form term lenders if already financed by them iv. Report form Merchant bankers in case capital market is being accessed  Examine the following: i. Bank’s lending policy/RBI guidelines, policies ii. Prudential Exposure norms iii. Industry Exposure restrictions iv. Group Exposure restrictions v. Industry related risk factor List of defaulters vi. Caution lists vii. Compliances regarding transfer of borrowal accounts from one bank to another, it applicable viii. Gov. regulation/legislation impacting on the industry Page | 45
  51. 51. ix. Acceptability of the promoters x. Application’s status vis-à-vis other units in the industry xi. Financial status in broad term and whether it is acceptable xii. Examine also the following in case of request of project finance : xiii. Weather the project cost is prima facie acceptable xiv. Debt/equity gearing proposed and whether acceptable xv. Promoter’s ability to access capital market for debt/equity support xvi. Whether critical aspect of project –demand, product cost profitability etc. are prima facie in order xvii. Arrived at a preliminary decision to support or not to support the request.B. Detailed appraisalCarry out a detailed appraisal alter a pre-sanction visit to applicant Company/theiroffice/project site.  Working capital facilities Examine/Analyze/Assess; i. Financials (in the prescribed form) ii. Financial ratio and other ratios relevant to the project- Dividend policy iii. Other aspects viz.  Depreciation method and Revaluation method  Record of defaults (tax duties etc.)  Pending suits having financial implications (custom excise etc.)  Qualification of balance sheets, Auditor remarks etc. iv. Trends in sale and probability v. Past deviation in sale and profit projections vi. Product capacity & use-past and projected vii. Estimate/ projections of sales values viii. Estimated working capital gap with reference to acceptable build up of inventory/receivable/other current asset. ix. Project levels whether acceptable Page | 46
  52. 52. By sourcing information where necessary from:Stock Exchange Directory financial journals/ publications, professional entities likeINFAC, CMIE etc. with emphasis on following aspects:  Market share of the units under comparison  Unique features  Profitability factors  Financial pattern of the business  Inventory receivable levels  Capacity utilizations  Production efficiency and costs  Bank borrowing patterns  Financial ratio & other relevant ratioCredit rating Draw up trading for:  Working capital  Term finance Opinion reports Compile opinion report on partners/promoters and the proposed guarantors Review of the proposal  Strength and weakness of the exposure proposed  Risk factor and steps proposed to mitigate them  Deviations proposed from usual norms of the bank and the reasons Proposal of sanction: Prepare a draft proposal in prescribed format with required back-up details and with recommendations for sanction Page | 47
  53. 53. Sanction Indicative list of Activities Involve in the sanction Function  Peruse the proposal to see if the report prima facie presents the proposal; remit it back to the Assessor for the required data/clarifications.  Examine critically the following aspect of the proposed exposure 1. Bank’s lending policy 2. Borrowers status in the industry 3. Industry aspect 4. Experience with units in similar industry 5. Overall strength of the borrower 6. Project level of operation 7. Risk Factors critical to the exposure and adequacy of safeguards there against proposed. 8. Value of existing connection with the borrower 9. Credit risk rating 10. Security pricing charges and concessions proposed for the exposure and covenants stipulated vis-à-vis the risk perceptionPOST SANCTION PROCESS 1. Follow up The follow-up functions will cover the following: (a) Ensuring on an ongoing basis compliance with terms and conditions of sanction through the system of control measures/feedback viz. Inspection visits, prescribed financial/ operation statements from the borrower interaction with borrower etc. Page | 48
  54. 54. (b) Tracking performance of the borrower, ensuring safety and recoverability of the advances (c) Ensuring compliance with all the internal and external reporting requirements covering the advances. Indicative list of the activities involved in the Follow-up function is as follows:  Conveying sanction of advances to the borrower detailing the terms and conditions and obtaining acceptance thereof  Preparation-submission of control returns for sanction  CMA reporting of sanction where applicable  Completion of applicable documentation; maintaining custody and validity of the documents.  Creation of charge over security and completion of all relevant and applicable formalities, including: 1. Creation of Registered or Equitable mortgage 2. Creation of second charge 3. Registration of charge with ROC 4. Periodical search of charge with ROC Ongoing scrutiny of transaction in the various accounts by perusal of leaders,registers, vouchers etc. to watch for proper conduct of the accounts, healthy turnovertherein and proper- end use of funds. Ongoing verification of assets charged as security, to ensure availability and safetyof the assets. Maintaining ongoing contact with the borrower and co-leaders and keeping abreastof developments in the borrower entities and business environment. Preparation of reviews of IRAC, identification of deterioration assets andinitiations of corrective action where warranted. Account wise follow up of NPAs for recovery /rehabilitation, preparation ofrelated recommendations to appropriate authority for approval. Page | 49
  55. 55. Supervision i. Supervision function should primarily ensure that the effective fallow of advances is in the place of the asset quality of good order is maintained. Supervisor should look out for early warning signals, identity ‘incipient sickness’ and initiate proactive remedial actions. ii. Indicative list of activities involved in supervision function is as follows  Ensuring proper flow-up of advances and observations at the operating level of the system laid down by the bank. Periodic and random examination of statements received, control register and files/record covering the advance will assist this process.  Ensuring the security documents are kept current and that all related documentation formalities are observed by the officials responsible.  Ensure that the function at the follow-up level are performed diligently and as per extant instructions of the bank.Monitoring and Controlling i. Monitoring and controlling function ensures that effective supervision is maintained on advance and appropriate responses are initiated whenever early warning signals are seen. The function also tracks customer satisfaction and provides responses where necessary.ii. Indicative list of activity involved in monitoring control function are as follows:  Ensure that the effective supervision id maintained on advance by the lower level functionaries responsible for follow-up and supervision scrutiny of returns / reports received from these line functionaries, interaction with them, feedback from the customer, commentary in inspection/audit reports etc. will assess this process.  Monitoring high value advances through specific focus on these in the return/report received on advance and by keeping watch on the developments in the borrower company/industry Page | 50
  56. 56.  Ensuring non-recurrence at the operating level of the company noticed lapses/irregularities pointed out in various audit reports.  Ongoing monitoring of asset portfolio by tracking changes from time to time; chalk out and arrange for carrying out specific action to ensure high standard asset content.  Extending guidelines to down the line functionaries on the follow-up and ‘supervision’ of the exposures at risk.Assessment of Risk, Profitability and Efficiency: 1. Industry Risks 2. Management Risks 3. Operational Risks 4. Collateral Security 5. Financial Risks a) Industry Risks: i) Production stage (1) Raw materials (2) Power, Fuel, Labour (3) Technology (4) Infrastructure (5) R & D ii) Post Production Process (1) Demand (2) Competition (3) Marketing arrangements Page | 51
  57. 57. b) Management risks: i) Promoters (1) Experience of the group (2) Management proficiency (3) Experience of promoters (4) Employed executivesc) Operational risks: i) Supply of information to banks ii) Record of irregularity iii) Limit management iv) Compliance of sanction stipulationsd) Collateral security: i) Collateral covere) Financial risks: i) Liquidity (1) Current ratio (2) Non-working capital ii) Profitability (1) Operational profit (2) Return of capital employed (3) Net profit iii) Interest coverage (1) PBDIT / Interest (2) Term indebtness (3) Overall indebtness iv) Efficiency in utilization of current assets Page | 52
  58. 58. Interpretation: Above tables shows how Banks assess the risk, profitability and efficiency. Inorder to award loan to the business entity banks has to look in to the risk, return andefficiency by using the past and present information available about the company. Banksconsider the following factors to assess the risk.Industry Risk Here the banks will look in to the all risk factors that related to an industry. Includethe production stage risk and post production risk. Production stage risk assessed byconsidering the factors like raw materials, technology, Infrastructure etc and postproduction risk involves demand, competition and marketing challenges.Management Risk Promotes experience, management proficiency, employed executives are thefactors which comes here.Operational risk Here banks look in to the past records of the customer’s transactions. Supply ofinformation to the bank, record of the irregularities and compliance of sanctions andstipulations are considered here.Collateral security The collateral cover offered by the customer review comes here.Financial risk Liquidity, profitability and interest coverage ratios are assessed here to determineshort term and long term solvency of the company. Page | 53
  59. 59. CREDIT APPRAISAL STANDARDS: QUALITATIVE: At the outset, the proposition is examined from the angle of viability and also from the bank prudential levels of exposure to the borrower, group and industry. Thereafter, a view is taken about bank’s past experience with the promoters, if there is a track record to go by. Where it is a new connection for the bank but the entrepreneurs are already in business, opinion reports from existing bankers and published data if available are carefully perused. In case of a maiden venture, in addition to the drill mentioned heretofore, an element of subjectivity has to be perforce introduced as scant historical data would be available and weightage has to be placed on impressions gained out of the serious dialogues with the promoters and his business contacts. QUANTITATIVE: 1. Working capital: the basic quantitative parameters underpinning the Bank’s credit appraisal are as follows: i. Liquidity: current ratio (CR) of 1.33 will generally be considered as a benchmark level of liquidity. However, the approach has to be flexible. Cr of 1.33 is only indicative and may not be deemed mandatory. In cases where the Cr is projected at a level lower than the benchmark or a slippage in the CR is proposed, it alone will not be a reason for rejection of the loan proposal or for sanction of loan. In such cases, the reasons for low CR should be carefully examined and in deserving cases the CR as projected may be accepted. In cases where projected CR is found acceptable, working capital finance as requested may be sanctioned. ii. Net working capital: although this is a corollary of current ratio, the movements in Net working capital are watched to ascertain whether there is a mismatch of long term sources via-a-vis long term uses for purposes which may not be readily acceptable to the Bank so that corrective measures can be suggested. Page | 54
  60. 60. iii. Financial Soundness: this will be dependent upon the owner’s stake or the leverage. Here again the benchmark will be different for manufacturing, trading, hire purchase and leasing concerns. For industrial ventures Total Outside Liability/Tangible Net Worth ratio of 6.0 is reasonable but deviations in selective cases for understandable reasons may be accepted by the sanctioning authority.iv. Turn –over: the trend in turn-over is carefully gone into both in terms of quantity and value as also market share wherever such data are available. What is more important is to establish a steady output if not a rising trend in quantitative terms because sales realization may be varying on account of price fluctuations. v. Profits: while net Profit is the ultimate yardstick, cash accruals, i.e. profit before depreciation and taxation conveys the more comparable picture in view of changes in rate of depreciation and taxation which may have taken place in the intervening years. However, for the sake of proper assessment, the non- operating incomes are excluded, as these are usually one time or extraordinary income. Companies incurring net losses consistently over 2 or more years will be given special attention, their accounts closely monitored, and if necessary, exit options Credit Rating: wherever a Credit Rating Agency for any instrument has rated the company, this will be taken into account while arriving at a final decision. However, as the credit rating involves additional expenditure, bank would not normally insist on this tool if such an agency had already looked into the company finances.vii. Capital Market: where the company’s shares are listed in stock exchanges, the movement of the price of its share, the market value of shares like those of competitors in the same industry, response to public/right issues are also kept in view as these are reflective of the corporate image in the eyes of the investors’ community. Page | 55
  61. 61. 2. Term Loan / Deferred Payment Guarantees i. In case of term loans and deferred payment guarantees, the project report is obtained from the customer, which may have been compiled either in-house or by a firm or consultants/ merchant bankers. The technical feasibility and economic viability is vetted by the Bank and wherever it is felt necessary.ii. Promoter’s contribution of at least 20% in the total equity is what bank normally expects. But the promoter contribution may vary largely in mega projects. Therefore, there cannot be a definitive benchmark. The sanctioning authority will have the necessary discretion to permit deviations. Page | 56
  62. 62. Financial tools used in credit assessment:  Financial performance The tool in its current form uses various parameters for rating a borrower on itsfinancial strength. These various parameters give us an idea of the different sources ofrisk being faced by a company in different areas. Sr. No. Parameters Weightage (%) F1 Net Sales Growth Rate (%) 10 F2 PBDIT Growth Rate (%) 7 F3 PBDIT/Sales (%) 10 F6 TOL/TNW 10 F7 Current Ratio 10 F8 Operating Cash Flow 8 F9 DSCR 8 F12*$ Foreign exchange risk 10 F13 Expected values of D/E, if 50% of NFB credit 5 devolves (corrected for margin) F24 Realisability of Debtors 12 F27* State of export country economy 5 F28* Fund repatriation risk 5 TOTAL 100* Applicable for export units$Applicable for units having imports and or exports Page | 57
  63. 63. Definition of Parameters used w.r.t financial performance: F1 - Net Sales Growth RateImportance of this indicator This ratio refers to the compounded annual growth rate of net sales over a periodof three years. The company’s growth ratio vis-à-vis other companies in the industry will be agood tool to assess its performance. If the growth rate is low compared to others in theindustry, then it will enable us to analyse the problems unique to this company.Formula The compounded annual growth rate over the past 3 years is calculated inpercentage Terms.CAGR (Compounded annual growth rate) for three years =[{(Value of sales in current year) / (Value of sales in year –3)}(1/3) – 1}]*100Notes• Net sales = Gross sales – Indirect taxes• For banks, NBFCs, and other financial institutions:  Net sales = net interest income + other income Page | 58
  64. 64. F2 - PBDIT Growth RateImportance of this indicator This ratio refers to the compounded annual growth rate of profits beforedepreciation (non cash), finance costs (interest) and tax over a period of three years. A consistent growth in this ratio indicates an improved performance of thecompany, reflected in increasing profitability (compared to its sales growth).Formula The compounded annual growth rate over the past 3 years is calculated inpercentage Terms.CAGR (Compounded average growth rate) for three years =[{(Value of PBDIT in current year)/(Value of PBDIT 3 years back)}(1/3) – 1}]*100Notes• PBDIT denotes profit before depreciation, interest and tax.• For banks, NBFCs, and other financial institutions, use PBT instead of PBDIT Page | 59
  65. 65. F3 - PBDIT/SalesImportance of this ratio This ratio indicates the profit before depreciation, interest and tax as a percentageof net sales. The profit before interest, depreciation and tax is an indicator of the operationalefficiency. If this ratio as a percentage of sales is high, then it is a positive indication ofthe operating efficiency in Terms of raw material consumption, employee productivityand power consumption among other things. A high value indicates greater profitabilityand hence betters capability to repay the debt. The ratio is a measure of the marginavailable to a company from its operations.FormulaThis ratio (in %) is computed by dividing the PBDIT with Net Sales.(PBDIT/Net Sales) x 100• PBDIT = Operating profit before depreciation, interest and tax• For banks, NBFCs, and other financial institutions:  Net sales = net interest income + other income  Use PBT instead of PBDIT Page | 60
  66. 66. F6 - TOL/TNWImportance of this ratio This ratio gives a holistic representation of total outside liabilities in relation totangible net worth of company. It reflects the capacity of the business unit to assure thecreditors of the security they have for payment of both interest and instalment. Itindicates the extent to which the creditors are covered by asset. This ratio shows how much outside borrowings are resorted to in comparison withowners’ fundsFormula The total outside liabilities are divided with the tangible net worth of the company.  Total Outside Liabilities / Tangible Net Worth• TOL = Total liabilities - TNW• TNW as defined in Debt Equity ratio• Also calculate this ratio for banks, NBFCs and other financial institutions, as it willgive an indication of the capital adequacy of the company Page | 61
  67. 67. F7 - Current RatioImportance of this ratio Current assets of company are the assets that can be easily liquidated andconverted into cash. The current ratio measures short-Term liquidity of the company andability to meet its short-Term financial obligations. A high ratio is good from the pointof view of the bank but a very high ratio may affect profitability through a highinventory carrying cost.Formula The ratio is worked out by dividing the Current Assets with Current Liabilities Current Assets__________________Current liabilities (including installments due during the year)• To get a meaningful current ratio, we should account for the vulnerability of acompany to short Term insolvency. The current ratio could be high because of excessinventory or slow realisation of debtors. Therefore, current assets must not includeinventory which is older than the normal working cycle of company (say 6-8 month),receivables over 6 months, dies, spares required for more than 9 months of productionand disputed receivables. If such “excess assets” exist then please make necessary notesin the remarks column. In such cases please indicate your assessment of the value ofcurrent ratio.• Also calculate this ratio for banks, NBFCs and other financial institutions, as it willgive an indication of the duration mismatch of the company’s balance sheet Page | 62
  68. 68. F8 - Operating Cash FlowImportance of this indicator This measure indicates the company’s cash inflows and outflows arising from itsoperations. It is different from funds flow of business. It helps us to evaluate the company’s ability to generate cash inflows fromoperations to pay debt, interest and dividends, and to explain the difference between netincome and net cash flow for operating activities. The operating cash flow can indicatethe company’s need for external financing. While funds flow is good to match long Term and short Term use and source offunds, this indicator tries to capture the capability of the firm to be able to meet itsbusiness obligations. Page | 63
  69. 69. CalculationOperating cash flow ( for the last financial year) is computed in the following manner Head Amount Net Sales Other income Total receipts Less: COGS Gross Profit Less: SGA/Operating expenses PBDIT - Increase / + decrease in non cash current assets + Increase / - decrease in current liabilities Operating cash Less: Income tax paid Post tax operating cash Less: Interest paid on LT & ST Less: Dividend paid Cash from operations Repayment due of long Term debt Page | 64
  70. 70. How to rateCompare “cash flow from operations” to “repayment due of long Term debt”.The rating is done as explained in the table below. Description Score The company is likely to default on repayment of its Loans and O Interest The company is not in a position to meet its repayment obligations 1 from its own resources and it faces difficulties to arrange outside funds The company is in a position to meet its repayment obligation from 2 its own resources and Term funds that are already applied for (and expected to be sanctioned shortly) The company is in a position to meet its repayment obligation from 3 its own resources and Term funds The company is in a comfortable position to meet its repayment 4 obligation from its own resources (no need for outside funds) Page | 65
  71. 71. F9 - DSCR (Debt Service Coverage Ratio)Importance of this ratio This ratio measures the capacity of the company to service its debt i.e. repaymentof principal and interest. DSCR measures the number of times a company’s earningscover its total long-Term debt-servicing requirement, including interest and principalrepayments in Term Loans, over a period of one year. This ratio will help us to evaluate if an adequate cash flow will be available tomeet debt obligation and also for providing margin of safety to lenders. This ratio alsohelps to determine the time when repayment should commence and the pay-back periodof the Loan. This ratio is a good indicator of the long-Term solvency of a company.FormulaThe profit before depreciation and interest (PBDI) is divided by installments due duringthe year plus interest. P B D I__________Installments for the year + interest Page | 66