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Bank Credit – Opportunities and Challenges (India) Background:-Basic characteristic of banking business is; accepting money from depositors and lending it to the borrowers. Hence banking is a riskybusiness exposed to credit default.Risk taking ability works as an engine of growth for banks, where better the diversification safer will be the bank. Like in India we havelargely safe and sound Banking environment, where most of the banks are excelling in retail model of business from earlier corporate lending,where focus was on a few large corporate.Considering the recent developments in Cypriot Banking sector, the argument of sticking to traditional form of banking (Taking deposits andLending) to be the right way in banking than to invest, borrowed money in bonds and other assets even backed by sovereign countries is backon table thus highlighting the importance of credit business in Banking.It is the success of credit portfolio which enables the bank to ideally borrow more and more from public as deposits to be deployed in loanbook to show growth in size and profits, which in turn attracts investors and capital. Basics of credit business:-Initially banks lend money as well as took money from only those customers who were known to the bank. As the banking system grew to itspresent form the process got institutionalized and today we have KYC or know your customer as a regulator driven mandate while openingany type of relationship for any type of customers.Knowing the customer has always been important to know the repayment capacity of borrower as well his track record on willingness torepay and on depositor’s side it was to know about the source of funds; genuine or illegal. General practice of Bankers while processing a loan applicant:-Analyzing the 5 Cs of CreditEvery banker goes through 5 aspects of an applicant of a loan, before making his final decision.Let’s understand these Cs.1. CapacityCapacity to repay the loan. Capacity of the applicant will be judged from his existing/ projected future income and expenditure statement.
Capacity also includes analysis of applicant’s credit history.2. CollateralCollateral refers to forms of security provided by customer to the bank. Collateral may be buildings/land/stocks etc owned by the customer. Itcan also include guarantee by a third party committing repayment of loan in case of default by the applicant.3. CapitalCapital brought by the owner to the project, it may be his own funds or borrowed from friends and relatives etc. Bank will analyze thequantity and quality of capital offered.4. ConditionsCondition means, the overall economic climate and external factors affecting the business/ performance of the loan.Secondly it refers to the purpose of the loan. Purpose should be clear and should not be vague, suggesting diversion of funds.5. CharacterCharacter of the applicant is a subjective judgment and applicant’s education, exposure, presentation, references, family back ground allmatters here.Now 5C’s scope will change according to the profile of the customer from retail to sme’s to large corporate. But essentially 5C analysis enablesthe bank in knowing/ making a judgment on the applicant with respect to his capacity & willingness to repay the loan. Various tools available for banks to know the applicant/customer:-KYC –Definition by Reserve Bank of IndiaKYC is an acronym for “Know your Customer”, a term used for customer identification process. It involves making reasonable efforts todetermine true identity and beneficial ownership of accounts, source of funds, the nature of customer’s business, reasonableness ofoperations in the account in relation to the customer’s business, etc which in turn helps the banks to manage their risks prudently. Theobjective of the KYC guidelines is to prevent banks being used, intentionally or unintentionally by criminal elements for money laundering.KYC has two components - Identity and Address. While identity remains the same, the address may change and hence the banks are requiredto periodically update their records.Thus KYC requirements ensure the proof on individual’s identity and his address proof ensures about his whereabouts or existence.Once Customer’s identity and address is verified and satisfied, next information required is his willingness & capacity to repay the loans.In India we have Credit Information Companies set up, providing the necessary information on loan applicants from across the country, letsdiscuss. Credit Information CompaniesA working group constituted by RBI under the chairmanship of N H Siddiqui, recommended setting up a company by the name of CIBIL,promoted by SBI in collaboration with HDFC and two foreign technology partners in 2001 to act as the first credit information company inIndia.CIBIL since then is India’s pioneer credit information company. It creates immense value for financial institutions by providing objectivedata and tools to help them manage risk, and devise appropriate lending strategies thus reducing cost and maximizing portfolio profitability.
CIBIL benefits both credit grantors and consumers by collecting, analyzing, and delivering information on credit histories of millions ofborrowers. It provides its members with information on both consumer and commercial borrowers, thus enabling them make sound creditdecisions across both individuals and businesses.Banks are able to know the credit history of borrower, his credit exposure, repayment habits, essentially helps Banks in identifying thecustomer’s track record or credit behavior. Present Indian banking scenario and opportunities on credit business:-India has one of the most, well regulated and sound Banking sector in the world. Our banks are well capitalized with low levels of NPAs(1.28% as of 2011-12, RBI Data).But while being sound and secure, if we analyze India’s % of domestic credit to private sector as a % of GDP was pretty low at 50.6% (2011,World Bank Report), compare to the 100% + ratio of major economies like US /UK/Germany and China, thus highlighting a major gap andopportunity for Indian banks.In India our banking system is fairly matured when it comes to lending to Corporate, SMEs and Consumer/ Retail loans and majority ofcustomers comes with good past track records and good professional/ salaried backgrounds, hence the 50% we discussed earlier comes underthe existing loan book where Banks have excelled in credit delivery and management and the real challenge lies ahead in tapping in to theremaining 50% or more potential who are yet to be banked profitably.Lending in small towns, unbanked centers is still considered a risky business by big players and mostly serviced by small regional banks,which have been successful purely based on KYC principle. Ways and means to improve credit business portfolio to more than 100% to GDP:-Identifying and encouraging the entrepreneurshipsEntrepreneurship culture is pre requisite to increased business activity. In India unfortunately barring a few communities like Gujarati’s ,Marwari’s etc , not many communities have rich entrepreneurship culture , which meant many opportunities available around are notexploited by want of knowledge and experience or background.But it does not mean, it is a taboo, as many entrepreneurs from other communities have made it big at national and international level.Hence if there is a focus on building entrepreneurships amongst larger public, there can be a business boom in our country, providing moreand more opportunities for banks to deploy their funds effectively.Banks for a start can look to replicate their success in loan melas on consumer loans (Home/Car etc), where Banks gets both Builders /Dealers to the table along with interested applicants. Same model can be replicated between Industrial houses / forums, GovernmentAgencies and Interested applicants.Modalities needs to be worked out, as unlike consumer loans here the industrial houses / forums are the buyers of various products andservices presented by the applicants, many of which might be covered under various government schemes for concessions, promotions etcand Banks role is to provide loan to the applicants based on his order book.Banks needs to attract and involve Universities, Management and Engineering Colleges and even Medical Colleges, where there have manyinstances of students/doctors developing medical equipments, now sold by companies like Johnson & Johnson.The model if developed effectively as a channel to deliver credit growth and thus development can effect a remarkable improvement in theoverall economy along with banking.Some banks may be already practicing the model, but success will come when the model is picked up by the giants and small alike and spreadit to the nooks and corner of country.
Changing the engagement methodUnder the conventional banking method, Loan customer’s relationship with the Bank is that of a debtor owning money to the bank.Loan’s risk is completely owned by the loan customer from the time loan amount is debited in his account.Under Islamic Banking, there is a different concept, where risk is shared equally by Bank and the customer; in India we don’t have IslamicBanking systems in practice but government agencies like CGTMSE (credit Guarantee Corporation for micro and small enterprises) sharesthe risk on a fee.When we are discussing about increasing the credit volumes by more than 50% by active engagement and identification of entrepreneurships,it won’t be a bad idea to try out the concept of risk sharing by banks not in terms of material risk but performance risk. This will be aninternal mechanism, nothing to do with the customer on letter but spirit.Bank’s has Credit sourcing , processing and recovery /NPA management channels implemented successfully over the years but till now thereis no channel which will act as a cure and not prevention for loss accounts.That’s where a “Loan Performance Ownership Channel” will add to the existing channels in making the credit management process robustalong with targeted higher growth. Loan Performance Ownership Channel:-Key attribute to the channel will Relationship management /Knowledge support /Handholding the customer throughout the period of loan soas to ensure the performance of the loan. Relationship Management:-It is practiced even now, but we know many a times RMs either looks to cross sell few products or do a courier service between customerrequests and bank’s demands.But under LPOC, relationship managers should be assigned to a LPOC Manager, who needs to have complete access to the customer’sbusiness by way of agreement to start with.Who will act as a link between customer and knowledge support help facilitated by the bank. Knowledge support:-Knowledge support help involves Technical / Managerial / Marketing & Sales and Legal and Tax expert’s services on behalf of the banks tothe customer.Customer being small and inexperienced will be benefited with such services available to him at every stage of business, referred by hisbanker. This may become a major differentiator to the performance of loans. Hand Holding:-LPOC Manager should be experienced and knowledgeable to identify the areas of help needed by customers and refer them to the rightservices. LPOC Manager should visit the customers to understand the performance of business, difficulties and guide them to respectiveknowledge support helps.LPOC model, modalities and process have to be worked out by banks as per their respective business models and success of such a model willhave huge bearing on banks reputation and future business prospects.
Banks will be not merely known for their ability to process loan faster or service customer faster and adequately but also for guidance andsupport, which will be a big business differentiator amongst Banks. Conclusion:-Thus Credit- Business remains the most critical aspect of banking business and those banks that are able to increase their credit portfoliowithout deteriorating its quality by innovative methods will lead the banking space in the coming years. Challenge will be in identifying theopportunities and handholding the opportunities by innovative ideas.