Chapter 07   credit process in banks
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Chapter 07 credit process in banks

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  • 7`1

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  • 1. CREDIT PROCESS IN INDIAN BANKS
  • 2. TERM LOANS
    • Also referred as Term Finance , represents a source of debt finance, which is generally repayable in more than one year and less than ten years.
    • Employed to finance acquisition of Fixed Assets and WC margins .
    • Carry fixed interest rates , monthly or quarterly repayment schedules and a set maturity date
  • 3. TERM LOAN Acquisition of New P &M, Expansion, Modernization, Technology up gradation; Debt swap SHORT TERM LOAN Repayable within 3 years MEDIUM TERM LOAN Repayable in more than 3 years and less than 6 years LONG TERM LOAN Repayable in more than 6 years
  • 4. ADVANTAGES & DISADVANTAGES OF TERM LOAN
    • Advantages:
    • Cost of capital lower than cost of private equity and preference capital.
    • TL do not result in dilution of control.
    • TL are preferred since they are backed by security.
    • Disadvantages :
    • TL do not carry voting rights.
    • Generally do not represent negotiable securities.
    • Upon failure to repay or delay in payment beyond 1 years entails serious consequences.
  • 5. BASIC FEATURES
    • Generally maturity period is 6 to 10 years. In some cases grace period of 2 year may be granted.
    • Borrower company or any of Directors should not violate Sec 274 (1) (g) of CA
    • It avoids underwriting commission and other flotation costs.
    • Provided on the basis of general agreement (Term Loan) containing terms and conditions.
    • Granted after detailed Project appraisal of the.
    • Secured, specifically by the assets acquired using the term loan funds. This is called Primary Security .
  • 6. Basic Features (contd.)
    • Generally also secured by company’s other F/A and C/A. This is called Secondary security.
    • Some times, Promoters` Guarantee/their shareholdings are given; called Collateral security.
    • Fixed or Floating charge on assets of borrower company.
    • Restrictive Covenants : usually put for monitoring of deployment of funds:
    • Asset-related covenants :
    • Capital employed, minimum asset base, provision in AOA for Nominee Directors
    • Minimum Current Ratio to be maintained
    • Not to dispose off Assets without lender’s permission
  • 7. Basic Features (Contd.)
    • b . Liability related covenants:
    • Restrained from incurring additional debt
    • Repay existing loan; Acceptable D/E Ratio
    • c. Cash-outflow related covenants :
    • Restricting dividends outflow Restricting capital expenditures.
    • Restricting salaries and perks of managerial staff, etc.
    • d. Positive covenants :
    • Furnishing of periodical reports/statements
    • Maintenance of a min. level of working capital.
    • Creation to sinking fund, and
    • Maintenance of certain Net Worth
  • 8. FACTORS THAT BANKS CONSIDER
    • Credit worthiness of the borrower
    • Integrity/reputation
    • Credit risk profile
    • Sensitivity to economic and market developments
    • Liquidity
    • Solvency
    • Profitability of business
    • Resource efficiency
  • 9. CREDIT DECISIONS
    • Safety of loans is directly related
      • basis on which decision to lend is taken
      • type and quantum of credit to be provided
      • terms and conditions of the loan
    • Two-pronged approach
      • Pre-Sanction appraisal
      • To determine the ‘bankability’ of each loan proposal
      • Post-Sanction control
      • To ensure proper documentation, follow-up and supervision
  • 10. PRE-SANCTION CREDIT DECISIONS- FINANCIAL APPRAISAL
    • Concerned with measurement of risk( iness ) of a loan proposal
      • Financial Analysis – past and projected
      • Cash Flow Analysis
      • Credit Rating
      • Assessment of credit needs
      • Income tax and other tax returns/ assessments
      • Confidential reports from other banks and financial institutions
    • Credit Report (CR) needs to be regularly updated
    • Appraisal should reveal whether a loan proposal is a fair banking risk
  • 11. Financial Appraisal (Contd.)
    • The objectives of Financial Appraisal :
      • Assess credit risk profile of the borrower
      • Stipulation of terms and conditions
      • Assess utilization of credit facility
      • Establish sound well defined credit granting criteria
      • Ensure safety of bank funds
    • Purpose of analysis of financial ratios
      • Ascertaining overall financial position of a business organisation
      • Interpretation of key information in the financial statements
  • 12. MEASURES OF LIQUIDITY
    • Net Working Capital = investment required to be made by borrower in Current Assets
    • Current Ratio = Current Assets/ Current Liabilities
    • Quick Ratio = Current Assets- Inventory/Current Liabilities
    • Net Working Capital/Current Assets = contribution of Long Term funds towards financing Current Assets
    • DSCR =( Net profit +Dep.+ Annual amount of int. on LTLs)/Interest + principal
    • RoA = PBIT/Total Assets
    • Interest Coverage Ratio = PBDIT/Annual Int. Obligation
  • 13. CASH FLOW ANALYSIS
    • Provides an excellent forecast of when funding is needed
    • Typically, cash disbursements are high at the beginning of the project life cycle and diminish gradually
    • Outcome of Analysis
    • Statement of financing needed
    • Amount of funds
    • Timing
    • Sources and application of funds
  • 14. LOAN SYNDICATION
    • Provided by a group of Lenders is structured, arranged and administered by one or several commercial or investment banks known as Arrangers
    • Arrangers serve investment-banking role of raising the amount for an issuer in need of capital.
    • Issuer pays Arranger a fee for this service, this fee increases with the complexity and risk factors of the loan .