ASSIGNMENT OF BANKING Steps in Credit Appraisal and disbursal Submitted By: Nitika Sharma FC11150
OVERVIEW OF CREDIT APPRAISALCredit Appraisal is a process to ascertain the risks associated with the extension ofthe credit facility. It is generally carried by the financial institutions, which areinvolved in providing financial funding to its customers. Credit risk is a risk relatedto non-repayment of the credit obtained by the customer of a bank. Thus it isnecessary to appraise the credibility of the customer in order to mitigate the creditrisk. Proper evaluation of the customer is performed this measures the financialcondition and the ability of the customer to repay back the Loan in future.Generally the credits facilities are extended against the security know as collateral.But even though the Loans are backed by the collateral, banks are normallyinterested in the actual Loan amount to be repaid along with the interest. Thus, thecustomers cash flows are ascertained to ensure the timely payment of principal andthe 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.However the 3 ‘C’ of credit are crucial & relevant to all borrowers/ lending, whichmust be kept in mind, at all times. Character Capacity CollateralIf any one of these are missing in the equation then the lending officer mustquestion the viability of credit. There is no guarantee to ensure a Loan does not runinto problems; however if proper credit evaluation techniques and monitoring areimplemented then naturally the Loan loss probability / problems will beminimized, which should be the objective of every lending Officer.Credit is the provision of resources (such as granting a Loan) by one party toanother party where that second party does not reimburse the first partyimmediately, thereby generating a debt, and instead arranges either to repay orreturn those resources (or material(s) of equal value) at a later date. The first partyis called a creditor, also known as a lender, while the second party is called adebtor, also known as a borrower.
Credit allows you to buy goods or commodities now, and pay for them later. Weuse credit to buy things with an agreement to repay the Loans over a period oftime. The most common way to avail credit is by the use of credit cards. Othercredit plans include personal Loans, home Loans, vehicle Loans, student Loans,small business Loans, trade. A credit is a legal contract where one party receivesresource or wealth from another party and promises to repay him on a future datealong with interest. In simple Terms, a credit is an agreement of postponedpayments of goods bought or Loan. With the issuance of a credit, a debt is formed.Basic types of creditThere are four basic types of credit. By understanding how each works, you will beable 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 yourpayment is not on time.Loans let you borrow cash. Loans can be for small or large amounts and for a fewdays or several years. Money can be repaid in one lump sum or in several regularpayments 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 thestore or the easy payment plan. The borrower takes the goods home in exchangefor a promise to pay later. Cars, major appliances, and furniture are oftenpurchased this way. You usually sign a contract, make a down payment, and agreeto 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 beused as security for the Loan.Credit cards are issued by individual retail stores, banks, or businesses. Using acredit card can be the equivalent of an interest-free Loan- end of each month.-ifyou 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 Non-fund Base includes: Letter of Credit Bank Guarantee Bill Discounting
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
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)
Loan administration pre- sanction processAppraisal, Assessment and Sanction functions 1. Appraisal A. Preliminary appraisal Sound credit appraisal involves analysis of the viability of operations of a business and the capacity of the promoters to run it profitably and repay the bank the dues as and when they fall Towards this end the preliminary appraisal will examine the following aspects of a proposal. Bank’s lending policy and other relevant guidelines/RBI guidelines, Prudential Exposure norms, Industry Exposure restrictions, Group Exposure restrictions, Industry related risk factors, Credit risk rating, Profile of the promoters/senior management personnel of the project, List of defaulters, Caution lists, Acceptability of the promoters, Compliance regarding transfer of borrower accounts from one bank to another, if applicable; Government regulations/legislation impacting on the industry; e.g., ban on financing of industries producing/ consuming Ozone depleting substances; Applicant’s status vis-à-vis other units in the industry, Financial status in broad Terms and whether it is acceptable The Company’s Memorandum and Articles of Association should be scrutinized carefully to ensure (i) that there are no clauses prejudicial to the Bank’s interests, (ii) no limitations have been placed on the Company’s borrowing powers and operations and (iii) the scope of activity of the company. Further, if the proposal is to finance a project, the following aspects have to be examined: Whether project cost is prima facie acceptable
Debt/equity gearing proposed and whether acceptable Promoters’ ability to access capital market for debt/equity support Whether critical aspects of project - demand, cost of production, profitability, etc. are prima facie in order Required Documents for Process of Loan a) Application for requirement of loan b) Copy of Memorandum & Article of Association c) Copy of incorporation of business d) Copy of commencement of business e) Copy of resolution regarding the requirement of credit facilities f) Brief history of company, its customers & supplies, previous track records, orders In hand. Also provide some information about the directors of the company g) Financial statements of last 3 years including the provisional financial statement for the year 2007-08 h) Copy of PAN/TAN number of company i) Copy of last Electricity bill of company j) Copy of GST/CST number k) Copy of Excise number l) Photo I.D. of all the directors m) Address proof of all the directors n) Copies related to the property such as 7/12 & 8A utara, lease/ sales deed, 2R Permission, Allotment letter, Possession o) Bio-data form of all the directors duly filled & notarized p) Financial statements of associate concern for the last 3 years After undertaking the above preliminary examination of the proposal, the branch will arrive at a decision whether to support the request or not. If the branch (a reference to the branch includes a reference to SECC/CPC etc. as the case may be) finds the proposal acceptable, it will call for from the applicant(s), a comprehensive application in the prescribed proforma, along with a copy of the proposal/project report, covering specific credit requirement of the company and other essential data/ information. The information, among other things, should include: Organizational set up with a list of Board of Directors and indicating the qualifications, experience and competence of the key personnel in charge of the main functional areas
e.g., purchase, production, marketing and finance; in other words a brief on the managerial resources and whether these are compatible with the size and scope of the proposed activity. Demand and supply projections based on the overall market prospects together with a copy of the market survey report. The report may comment on the geographic spread of the market where the unit proposes to operate, demand and supply gap, the competitors’ share, competitive advantage of the applicant, proposed marketing arrangement, etc. Current practices for the particular product/service especially relating to Terms of credit sales, probability of bad debts, etc. Estimates of sales cost of production and profitability. Projected profit and loss account and balance sheet for the operating years during the Currency of the Bank assistance. If request includes financing of project(s), branch should obtain additionally a) Appraisal report from any other bank/financial institution in case appraisal has been done by them. b) ‘No Objection Certificate’ from Term lenders if already financed by them and c) Report from Merchant bankers in case the company plans to access capital market, wherever necessary. In respect of existing concerns, in addition to the above, particulars regarding the history of the concern, its past performance, present financial position, etc. should also be called for. This data/information should be supplemented by the supporting statements Such as: a) Audited profit loss account and balance sheet for the past three years (if the latest audited balance sheet is more than 6 months old, a pro-forma balance sheet as on a recent date should be obtained and analysed). For non- corporate borrowers, irrespective of market segment, enjoying credit limits of Rs.10 lacs and above from the banking system, audited balance sheet in the IBA approved formats should be submitted by the borrowers. b) Details of existing borrowing arrangements, if any, c) Credit information reports from the existing bankers on the applicant Company, and
d) Financial statements and borrowing relationship of Associate firms/Group Companies.B. Detailed Appraisal The viability of a project is examined to ascertain that the company would have the ability to service its Loan and interest obligations out of cash accruals from the business. While appraising a project or a Loan proposal, all the data/information furnished by the borrower should be counter checked and, wherever possible, inter-firm and inter-industry comparisons should be made to establish their veracity. The financial analysis carried out on the basis of the company’s audited balance sheets and profit and loss accounts for the last three years should help to establish the current viability. In addition to the financials, the following aspects should also be examined: The method of depreciation followed by the company-whether the company is following straight line method or written down value method and whether the company has changed the method of depreciation in the past and, if so, the reason therefore; Whether the company has revalued any of its fixed assets any time in the past and the present status of the revaluation reserve, if any created for the purpose; Record of major defaults, if any, in repayment in the past and history of past sickness, If any; The position regarding the company’s tax assessment - whether the provisions made in the balance sheets are adequate to take care of the company’s tax liabilities; The nature and purpose of the contingent liabilities, together with comments thereon; Pending suits by or against the company and their financial implications (e.g. cases relating to customs and excise, sales tax, etc.); Qualifications/adverse remarks, if any, made by the statutory auditors on the company’s accounts; Dividend policy; Apart from financial ratios, other ratios relevant to the project; Trends in sales and profitability, past deviations in sales and profit projections, and estimates/projections of sales values;
Production capacity & use: past and projected; o Estimated requirement of working capital finance with reference to acceptable build up of inventory/ receivables/ other current assets; Projected levels: whether acceptable; and Compliance with lending norms and other mandatory guidelines as applicable Project financing:If the proposal involves financing a new project, the commercial, economic andFinancial viability and other aspects are to be examined as indicated below: Statutory clearances from various Government Depts. / Agencies Licenses/permits/approvals/clearances/NOCs/Collaboration agreements, as applicable Details of sourcing of energy requirements, power, fuel etc. Pollution control clearance Cost of project and source of finance Build-up of fixed assets (requirement of funds for investments in fixed assets to be critically examined with regard to production factors, improvement in quality of products, economies of scale etc.) Arrangements proposed for raising debt and equity Capital structure (position of Authorized, Issued/ Paid-up Capital, Redeemable Preference Shares, etc.) Debt component i.e., debentures, Term Loans, deferred payment facilities, unsecured Loans/ deposits. All unsecured Loans/ deposits raised by the company for financing a project should be subordinate to the Term Loans of the banks/ financial institutions and should be permitted to be repaid only with the prior approval of all the banks and the financial institutions concerned. Where central or state sales tax Loan or developmental Loan is taken as source of financing the project, furnish details of the Terms and conditions governing the Loan like the rate of interest (if applicable), the manner of repayment, etc. Feasibility of arrangements to access capital market Feasibility of the projections/ estimates of sales, cost of production and profits covering the period of repayment
Break Even Point in Terms of sales value and percentage of installed capacity under a Normal production year Cash flows and fund flows Proposed amortization schedule Whether profitability is adequate to meet stipulated repayments with reference to Debt Service Coverage Ratio, Return on Investment Industry profile & prospects Critical factors of the industry and whether the assessment of these and management plans in this regard are acceptable Technical feasibility with reference to report of technical consultants, if available Management quality, competence, track record Company’s structure & systems Applicant’s strength on inter-firm comparisonsFor the purpose of inter-firm comparison and other information, where necessary,source data from Stock Exchange Directory, financial journals/ publications,professional entities like CRIS-INFAC, CMIE, etc. with emphasis on followingaspects: o Market share of the units under comparison o Unique features o Profitability factors o Financing pattern of the business o Inventory/Receivable levels o Capacity utilization o Production efficiency and costs o Bank borrowings patterns o Financial ratios & other relevant ratios o Capital Market Perceptions o Current price o 52week high and low of the share price o P/E ratio or P/E Multiple o Yield (%)- half yearly and yearlyAlso examine and comment on the status of approvals from other Term lenders,market view (if anything adverse), and project implementation schedule. A pre-
sanction inspection of the project site or the factory should be carried out in thecase of existing units. To ensure a higher degree of commitment from thepromoters, the portion of the equity / Loans which is proposed to be brought in bythe promoters, their family members, friends and relatives will have to be broughtupfront. However, relaxation in this regard may be considered on a case to casebasis for genuine and acceptable reasons. Under such circumstances, the promotershould furnish a definite plan indicating clearly the sources for meeting hiscontribution. The balance amount proposed to be raised from other sources, viz.,debentures, public equity etc., should also be fully tied up.C. Present relationship with Bank: Compile for existing customers, profile of present exposures: Credit facilities now granted Conduct of the existing account Utilization of limits - FB & NFB Occurrence of irregularities, if any Frequency of irregularity i.e., number of times and total number of days the account was irregular during the last twelve months Repayment of Term commitments Compliance with requirements regarding submission of stock statements, Financial Follow-up Reports, renewal data, etc. Stock turnover, realization of book debts Value of account with break-up of income earned Pro-rata share of non-fund and foreign exchange business Concessions extended and value thereof Compliance with other Terms and conditions Action taken on Comments/observations contained in RBI Inspection Reports: CO Inspection & Audit ReportsD. Credit risk rating: Draw up rating for (i) Working Capital and (ii) TermFinance.E. Opinion Reports: Compile opinion reports on the company, partners/promoters and the proposed guarantors.F. Existing charges on assets of the unit: If a company, report on search ofcharges with ROC.
G. Structure of facilities and Terms of Sanction:Fix Terms and conditions for exposures proposed - facility wise and overall: Limit for each facility – sub-limits Security - Primary & Collateral, Guarantee Margins - For each facility as applicable Rate of interest Rate of commission/exchange/other fees Concessional facilities and value thereof Repayment Terms, where applicable ECGC cover where applicable Other standard covenantsH. Review of the proposal:Review of the proposal should be done covering (i) strengths and weaknesses ofthe exposure proposed (ii) risk factors and steps proposed to mitigate them(ii) Deviations, if any, proposed from usual norms of the Bank and the reasonsthereforeI. Proposal for sanction:Prepare a draft proposal in prescribed format with required backup details and withrecommendations for sanctionJ. Assistance to Assessment:Interact with the assessor, provide additional inputs arising from the assessment,incorporate these and required modifications in the draft proposal and generate anintegrated final proposal for sanction.2. Assessment:Indicative List of Activities Involved in Assessment Function is given below: Review the draft proposal together with the back-up details/notes, and the borrower’s application, financial statements and other reports/documents examined by the appraiser. Interact with the borrower and the appraiser. Carry out pre-sanction visit to the applicant company and their project/factory site.
Peruse the financial analysis (Balance Sheet/ Operating Statement/ Ratio Analysis/ Fund Flow Statement/ Working Capital assessment/Project cost & sources/ Break Even analysis/Debt Service/Security Cover, etc.) to see if this is prima facie in order. If any deficiencies are seen, arrange with the appraiser for the analysis on the correct lines. Examine critically the following aspects of the proposed exposure.o Bank’s lending policy and other guidelines issued by the Bank from time to timeo RBI guidelineso Background of promoters/ senior managemento Inter-firm comparisono Technology in use in the companyo Market conditionso Projected performance of the borrower vis-à-vis past estimates and performanceo Viability of the projecto Strengths and Weaknesses of the borrower entity.o Proposed structure of facilities.o Adequacy/ correctness of limits/ sub limits, margins, moratorium and repayment scheduleo Adequacy of proposed security cover o Credit risk ratingo Pricing and other charges and concessions, if any, proposed for the facilitieso Risk factors of the proposal and steps proposed to mitigate the risko Deviations proposed from the norms of the Bank and justifications therefore To the extent the inputs/comments are inadequate or require modification, arrange for additional inputs/ modifications to be incorporated in the proposal, with any required modification to the initial recommendation by the Appraiser Arrange with the Appraiser to draw up the proposal in the final form. Recommendation for sanction: Recapitulate briefly the conclusions of the appraisal and state whether the proposal is economically viable. Recount briefly the value of the company’s (and the Group’s) connections. State whether, all considered, the proposal is a fair banking risk. Finally, give recommendations for grant of the requisite fund-based and non-fund based credit facilities.
3. Sanction:Indicative list of activities involved in the sanction function is given below: Peruse the proposal to see if the report prima facie presents the proposal in a comprehensive manner as required. If any critical information is not provided in the proposal, remit it back to the Assessor for supply of the required data/clarifications. Examine critically the following aspects of the proposed exposure in the light of corresponding instructions in force: Bank’s lending policy and other relevant guidelines RBI guidelines Borrower’s status in the industry Industry prospects Experience of the Bank with other units in similar industry Overall strength of the borrower Projected level of operations Risk factors critical to the exposure and adequacy of safeguards proposed There against Value of the existing connection with the borrower Credit risk rating Security, pricing, charges and concessions proposed for the exposure and covenants o Stipulated vis-à-vis the risk perception. Accord sanction of the proposal on the Terms proposed or by stipulating modified or additional conditions/ safeguards, or Defer decision on the proposal and return it for additional data/clarifications, or Reject the proposal, if it is not acceptable, setting out the reasons.Loan administration - Post sanction Credit process.Need Lending decisions are made on sound appraisal and assessment of credit worthiness. Past record of satisfactory performance and integrity are no guarantee for future though they serve as a useful guide to project the trend in performance. Credit assessment is made based on promises and
projections. A loan granted on the basis of sound appraisal may go bad because the borrower did not carry out his promises regarding performance. It is for this reason that proper follow up and supervision is essential. A banker cannot take solace in sufficiency of security for his loans. He has to - a) Make a proper selection of borrower b) Ensure compliance with terms and conditions c) Monitor performance to check continued viability of operations d) Ensure end use of funds. e) Ultimately ensure safety of funds lent.Stages of post sanction processThe post-sanction credit process can be broadly classified into three stages viz.,follow-up, supervision and monitoring, which together facilitate efficient andeffective credit management and maintaining high level of standard assets. Theobjectives of the three stages of post sanction process are detailed below.Types of Lending ArrangementsIntroductionBusiness entities can have various types of borrowing arrangements. They are One Borrower – One Bank One Borrower – Several Banks (with consortium arrangement) One Borrower – Several Banks (without consortium arrangements – Multiple Banking One Borrower – Several Banks (Loan Syndication) One BankThe most familiar amongst the above for smaller loans is the One Borrower-OneBank arrangement where the borrower confines all his financial dealings with onlyone bank.
Sometimes, units would prefer to have banking arrangements with more than onebank on account of the large financial requirement or the resource constraint of hisown banker or due to varying terms & conditions offered by different banks or forsheer administrative convenience. The advantages to the bank in a multiplebanking arrangement/ consortium arrangement are that the exposure to anindividual customer is limited & risk is proportionate. The bank is also able tospread its portfolio. In the case of borrowing business entity, it is able to meet itsfunds requirement without being constrained by the limited resource of its ownbanker. Besides this, consortium arrangement enables participating banks to savemanpower & resources through common appraisal & inspection & sharing creditinformation.The various arrangements under borrowings from more than one bank will differon account of terms & conditions, method of appraisal, coordination,documentation & supervision & control. Consortium LendingWhen one borrower avails loans from several banks under an arrangement amongall the lending bankers, this leads to a consortium lending arrangements. Inconsortium lending, several banks pool banking recourses & expertise in creditmanagement together & finance a single borrower with a common appraisal,common documentation & joint supervision & follow up. The borrower enjoys theadvantage similar to single window availing of credit facilities from several banks.The arrangement continues until any one of the bank moves out of the consortium.The bank taking the highest share of the credit will usually be the leader ofconsortium. There is no ceiling on the number of banks in a consortium. Multiple Banking ArrangementMultiple Banking Arrangement is one where the rules of consortium do not apply& no inter se agreement among banks exists. The borrower avails credit facilityfrom various banks providing separate securities on different terms & conditions.There is no such arrangement called ‘Multiple Banking Arrangement’ & the termis used only to denote the existence of banking arrangement with more than onebank. Banking Arrangement has come to stay as it has some advantages for theborrower & the banks have the freedom to price their credit products & non-fundbased facility according to their commercial judgment. Consortium arrangementoccasioned delays in credit decisions & the borrower has found his way around thisdifficulty by the multiple banking arrangement. Additionally, when units were notdoing well, consensus was rarely prevalent among the consortium members. If onebank wanted to call up the advance & protect the security, another bank wasinterested in continuing the facility on account of group considerations.
Points to be noted in case of multiple banking arrangements Though no formal arrangement exists among the financing banks, it is preferable to have informal exchange of information to ensure financial discipline Charges on the security given to the bank should be created with utmost care to guard against dilution in our security offered & to avoid double financing Certificates on the outstanding with the other banks should be obtained on the periodical basis & also verified from the Balance sheet of the unit to avoid excess financing Credit SyndicationA syndicated credit is an agreement between two or more lending institutions toprovide a borrower a credit facility using common loan documentation. It is aconvenient mode of raising long-term funds.The borrower mandates a lead manager of his choice to arrange a loan for him. Themandate spells out the terms of the loan & the mandated bank’s rights &responsibilities.The mandated banker – the lead manger – prepares an information memorandum& Circulates among prospective lender banks soliciting their participation in theloan. On the basis of the memorandum & on their own independent economic &financial evolution the leading banks take a view on the proposal. The mandatedbank convenes the meeting to discuss the syndication strategy relating tocoordination, communication & control within the syndication process & finalizesdeal timing, management fees, cost of credit etc. The loan agreement is signed byall the participating banks. The borrower is required to give prior notice to the leadmanger about loan withdrawls to enable him to tie up disbursements with the otherlending banks.Features of syndicated loans Arranger brings together group of banks Borrower is not required to have interface with participating banks, thus easy & hassle fee Large loans can be raised through syndication by accessing global markets For the borrower, the competition among the lenders leads to finer terms Risk is shared Small banks can also have access to large ticket loans & top class credit appraisal
& managementAdvantages Strict, time-bound delivery schedule & withdrawals Streamlined process of documentation with clearly laid down roles & responsibilities Market driven pricing linked to the risk perception Competitive pricing but scope for fee-based income is also available Syndicated portions can be sold to another bank, if required Fixed repayment schedule & strict monitoring of default by markets which punish indiscipline