Avenues Cash Mandated – CRR Not Mandated Investments Mandated – SLR Not mandated Loans Mandated – Priority sector advances Not mandated
Mandated reserves Held as % of Net Demand and Time Liabilities (NDTL) Demand deposits + time deposits – ( paid up capital + reserves & surplus + amount of refinance availed from RBI, provision for income tax held in excess etc) Cash Reserve Ratio Amount held as cash / bank balance with RBI Provide liquidity comfort to depositor Means to control money supply No interest being paid by RBI ( post March 2007) RBI free to decide levels to be maintained Current requirement ?
Mandated reserves Statutory Liquidity Ratio Amount of money to be held in ‘eligible securities ( G-sec) , carrying only sovereign risk Provide liquidity comfort Also reduces overall risk of portfolio Tool for monetary policy , fiscal policy management RBI can decide on levels to be maintained (post March 2007) Current levels ? Narrow banking ….
Money to lend Amount that can be lent = capital + deposits + borrowings + provisions – investment in SLR investments - CRR holdings - fixed assets.
Cash Cash : though offers comfort of liquidity, is not a ‘productive asset’ Vault cash – currency /coins in bank’s vault Predictable and manageable Demand deposits with RBI Demand deposits with banks offering CH services Cash under collection Emphasis on keeping just the required amount.
CD ratio Why should banks hold more money in SLR securities than mandated ?
Incremental CD ratio Can we infer something ?
CD ratio When CRR and SLR are to be maintained at 6% and 24% of NDTL how is that some banks have high CD ratio ?
Segmenting Retail Typically individuals Wholesale Group of individuals Small enterprises Typically proprietorship , partnership firms , Pvt Ltd companies in early stage of growth . Size up to approx INR 25 Cr Small Corporate segment Small Pvt Ltd companies , large & mature partnership firms , approx INR 100 Cr Mid / Emerging Corporate segment Large Pvt Ltd companies, Pub Ltd companies , approx INR 500 Cr Large Corporate segment Large Public and pvt Ltd companies, above INR 500 Cr or forming part of a group of companies , with a group turnover exceeding say INR 1000 – 1500 Cr
Segments Differences in Constitution of the borrower Risk in taking exposure Information available to decide Comfort available for an exposure Type of products to offer Income potential
Retail lending - characteristics +++++ Good avenue for deployment Granular exposure Risk diversified among borrowers Demand driven – hence lower marketing expenses compared to corporate Cross selling possible Helpful in economic growth Origination is the key – servicing can be automated ----- Template driven Manpower intensive Consumer loans tend to give higher nominal returns Highly sensitive to business cycles Thrives on rate and TAT Inadequate life cycle study
Success factors Highly rate and TAT dependant Access to cheap funds Strong origination capabilities – read selling skills Strong and dynamic risk control units ( credit , market reference units and compliance) Geographical spread is an advantage Technology vital for servicing Important to know when to exit Strong collections and recovery capabilities
Consumer durable loans
Loan against shares
Other personal loans
Installment Loans Housing loans Auto loans ‘Personal’ loans Consumer durable loans Educational loans Other personal loans Revolving Loans Credit cards Loan against shares
Housing loans Extended for Purchase / construction of a house Repair of a house Relatively lower risk & longest tenor Enjoys regulatory and fiscal support Regulatory Lower capital charge ( 50% for loans upto Rs 20 lakhs) Inclusion under Priority sector Fiscal Tax benefits for installment and interest payments
Retail Credit Judgmental Quantitative – credit scoring models Payment history Amount owed Length of credit history New credit Type of credit in use
Credit scoring Payment history Payment information on many types of accounts Public record and collection items Judgement / suits / collections made etc Details on late and missed payments Delay buckets , how recent , how frequent How many accounts show no late payments
Credit scoring Amounts owed Amount owed on all accounts Amount owed on different types of accounts Number of accounts that have balances Total credit line used on revolving lines Installments pending compared to original lines
Credit scoring Length of credit history How long the credit accounts have been established New credit How old is the relationship ? How many inquiries have been made to credit reporting agencies ? Length of time since lenders made inquiries ? Type of credit
Wholesale banking Based on type Fund / Non Fund Based on purpose Project finance / working capital Domestic / export credit Based on tenor Short term / long term Based on comfort Secured / unsecured
Fund based facilities Revolving facilities Cash credit Overdraft Repayable facilities Short term Bills / invoice finance Short term loans / working capital demand loans Long term Project term loans Working capital term loans
Working capital cycle Cash Raw materials Receivables Work in process Finished Goods
WC facility - fund Cash Raw materials Receivables Finance for the entire working cycle – against stock and book debts . If revolving facility : Cash credit (OCC /KCC) If repayable : WCDL Work in process Finished Goods
WC facility - fund Supplier raises an invoice / bill – which can be discounted. Customer pays the bank – Purchase bill finance Cash Raw materials Receivables Work in process Finished Goods
WC facility - fund Customer raises an invoice / bill on buyer , which buyer accepts to pay after a usance – which can be discounted. Customer pays the bank. Sales invoice / bill discounting Cash Raw materials Receivables Work in process Finished Goods
WC facility - fund Cash Revolving facility against receivables - Overdraft Raw materials Receivables Work in process Finished Goods
WC Cycle - export Buyer places an order Buyer remits the amount Raw materials Export done – shipping docs and bill prepared Work in process Finished Goods
WC facility - export Buyer remits the amount Buyer places an order Bills raised are discounted. Post Shipment credit / Foreign bill discounting. Proceeds used to close PCL Raw materials Finance against the order for purchase of RM and manufacture – Packing credit / Pre-shipment credit Export done – shipping docs and bill prepared Work in process Finished Goods
Term debt Short term ( for cash flow mismatches) Long term For incurring capital expenditure For funding margin for working capital (WCTL) For ‘general corporate purposes’ – acquisition etc.,
LC transaction Buyer applicant Seller beneficiary 1. Places order 5.Sends Materials Reimbursing bank 2.Request to issue LC 6.Sends Dox Negotiating bank 9.beneficiary is paid Pays the bank Confirming bank 4.Advises LC Buyer’s bank Issuing bank 8. Bank is paid Advising bank 7.Dox forwarded 3. LC issued
Parties to the transaction Applicant Issuing bank Advising bank Confirming bank can be the same Negotiating bank Reimbursing bank Beneficiary Governed by ICC’s UCPDC 600
Types of LCs Revocable (?) and Irrevocable LC Confirmed LC Sight and Usance LC Revolving LC Transferable LC Back to back LC Red Clause LC – advising bank gives PSL Green Clause LC – in addition provides for cost of storage (in the name of the issuing bank) SBLC
Buyer’s credit Way to provide extended credit to the buyer for purchases made ( RM , capital equipment) Rides on an LC transaction ( sight / usance) Buyer’s bank sends LOU to a bank providing the BC Seller is paid off. BC providing bank is paid off on maturity / is rolled over ( if permitted )
Other fund instruments Long term Plain debt NCDs Convertible into equity FCCBs Preference shares Short term Commercial paper
Bank guarantees Financial guarantee Bid bond BG Advance payment BG Retention money BG Deferred payment guarantee BG favoring customs , ST etc Performance guarantee Export Promotion Credit Guarantee
W/c assessment How much to fund ? Assessment methods Operating cycle method Traditional method Projected turnover method MPBF method(s) Cash flow method
Operating cycle method Time lapse between cash outlay and cash realization Components Acquisition and holding of RM Process time for conversion Holding time for FG Average collection time WCR = Operating expenses / no of cycles p.a
Projected turnover method Recommended by the ‘Nayak Committee’ Generally used for limits upto Rs 5 Cr
MPBF methods Based on the recommendations of Tandon and Chore committees Three methods were suggested
Assessments Fund : cash flow method LC assessment BG assessment
What if a single bank cant fund ? Consortium banking arrangements Lead bank and member banks Common assessment, documentation (inter se agreement, joint deed ), security and agreed share of business. Multiple banking arrangements No Leader Increases flexibility for customer Also requires dealing with several banks
What if a single bank cant fund ? Loan syndication Arranger / Lead manager Co-arranger Prepares the Information memorandum Responsible for administering the loan Underwriting Facility manager Prepares, negotiates and gets the loan agreement executed. + borrower gets to deal with single bank , easy to raise , useful if a large quantum of money is to be raised + lead manager gets to retain relationship , earn a good fee , advantageous for the participating banks as well
Security Essential features Credible deterrent against default Fall back in case assumptions go wrong Should be as liquid and as easily marketable as possible Security creation formalities vary with Type of security Moveable Immoveable Constitution of borrower
Mortgage Transfer of an interest in a specific immovable property for the purpose of securing Existing debt Future debt Performance of an engagement , which may give rise to a pecuniary liability Mortgager Mortgagee Mortgage money Mortgage deed
Types of mortgage Simple mortgage Bank not in possession of the property , but registration is mandatory. Bank needs to approach court to sell and recovery money Proceeds from property remain with mortgagor Mortgage by conditional sale ‘ostensible sale’ to the bank If debt is not serviced, bank can cause foreclosure – borrower loses right to redeem property Not preferred
Types of mortgage Usufructuary mortgage Bank is in legal possession of property + income proceeds If borrower fails to redeem ( within 30 yrs), bank becomes owner English mortgage There is an absolute transfer of property – if the due is paid , property is transferred back to borrower In case of shortfall, bank can look to other assets
Types of mortgage Equitable mortgage Most preferred form – less costly and easy Mortgage by deposit of title deeds – with an intent to create mortgage Precautions to be taken Registration of EM ( in TN and few other states) Anomalous mortgage ?
Pledge and hypothecation Pledge ‘bailment of goods as security for payment of debts or performance of a promise’ Possession is with the bank ( pledgee) Used for movable fixed assets of high value Hypothecation Charge on movable assets Possession given on demand Precautions Audit and inspection needed Should be fully paid stock Should be adequately insured – bank as first loss payee
Charge Used specifically for ‘charges’ under Companies Act, 1956 Fixed charge Over designated fixed assets of the company Floating charge Floats over present and future assets of the company Assets can be sold Crystallizes into a fixed charge in case of default First charge , second charge , subservient charge Pari – passu charge Registered with ROC within 30 days of signing loan dox
Assignment ‘Actionable claims’ can be assigned by borrower to a bank Book debts (usually specific ) Money from govt / other agencies / companies Life insurance policies etc Takes precedence over other creditors (if they do not have prior / superior charge)