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CREDIT APPRAISAL IN BANKING SECTOR       INTRODUCTION TO BANKING             SECTOR & SBIHISTORY OF BANKING INDUSTRY:The R...
CREDIT APPRAISAL IN BANKING SECTORRetail Banking is the new mantra in the banking sector. The home loans alone account for...
CREDIT APPRAISAL IN BANKING SECTORresulted in a shift from Class banking to Mass banking. This in turn resulted in a signi...
CREDIT APPRAISAL IN BANKING SECTORScheduled banks comprise commercial banks and the co-operative banks. In terms ofownersh...
CREDIT APPRAISAL IN BANKING SECTORThe State Bank of India, the country’s oldest Bank and a premier in terms of balance she...
CREDIT APPRAISAL IN BANKING SECTORWith four national level Apex Training Colleges and 54 learning Centres spread all over ...
CREDIT APPRAISAL IN BANKING SECTORThe bank is entering into many new businesses with strategic tie ups – Pension Funds, Ge...
CREDIT APPRAISAL IN BANKING SECTORday workshops across the country and covered over 130,000 employees in a period of 100 d...
CREDIT APPRAISAL IN BANKING SECTORSBI has the largest branch and ATM network spread across every corner of India. Thebank ...
CREDIT APPRAISAL IN BANKING SECTORImperial BankThe Imperial Bank during the three and a half decades of its existence reco...
CREDIT APPRAISAL IN BANKING SECTOR1) Corporate AccountsThis SBU is important for the bank as its loan portfolio constitute...
CREDIT APPRAISAL IN BANKING SECTOROperations Associates & Subsidiaries amount of Rs.42.11bn were in place as against 13 pr...
CREDIT APPRAISAL IN BANKING SECTORThe national banking group has 14 administrative circles encompassing a vast network of ...
CREDIT APPRAISAL IN BANKING SECTORthe SME SBU increased to Rs.1,042.70bn as at the end of March 2006 from Rs.890.60bn ofpr...
CREDIT APPRAISAL IN BANKING SECTORSBI Botswana Ltd. at Gaborone.d) TREASURYThe bank manages an integrated treasury coverin...
CREDIT APPRAISAL IN BANKING SECTOR• State Bank of Travancore• State Bank of Bikaner and Jaipur• State Bank of Mysore• Stat...
CREDIT APPRAISAL IN BANKING SECTORproject advisory has received international acclaim. In addition, the company has been p...
CREDIT APPRAISAL IN BANKING SECTORscheme for its employees in FY01 in which it has reduced it staff by approximately 5,000...
CREDIT APPRAISAL IN BANKING SECTORState Bank of India has an extensive administrative structure to oversee the large netwo...
CREDIT APPRAISAL IN BANKING SECTORfinancial funding to its customers. Credit risk is a risk related to non repayment of th...
CREDIT APPRAISAL IN BANKING SECTORCredit allows you to buy goods or commodities now, and pay for them later. We use credit...
CREDIT APPRAISAL IN BANKING SECTORBRIEF OVERVIEW OF LOANSCredit can be of two types fund base & non-fund base:FUND BASED i...
CREDIT APPRAISAL IN BANKING SECTORFunds required for day to-day working will be to finance production & sales. For product...
CREDIT APPRAISAL IN BANKING SECTOR                    Above Rs 5 cr     Projected Balance Sheet Method4. OPERATING CYCLE M...
CREDIT APPRAISAL IN BANKING SECTOR                        Raw                                      Stock in               ...
CREDIT APPRAISAL IN BANKING SECTOR   •   Average period for which finished goods are in store &   •   Average collection p...
CREDIT APPRAISAL IN BANKING SECTOR      Wages                = Rs. 2,000 p.m. Other manufacturing     Expenses            ...
CREDIT APPRAISAL IN BANKING SECTOR   installments, as per a prearranged schedule.   From the above definition, the followi...
CREDIT APPRAISAL IN BANKING SECTOR   Appraisal of term loan for, say, an industrial unit is a process comprising several s...
CREDIT APPRAISAL IN BANKING SECTOR           size may result in increased production costs & may not be able to sell its p...
CREDIT APPRAISAL IN BANKING SECTORoutput of the product concerned & the existing demand for it with a view to establishing...
CREDIT APPRAISAL IN BANKING SECTORDebt/ Service Coverage:The debt service coverage ratio serves as a guide to determining ...
CREDIT APPRAISAL IN BANKING SECTORIntroductionThe expectation of the seller of any goods or services is that he should get...
CREDIT APPRAISAL IN BANKING SECTOR   4)      Advising Bank – The Bank which advises the LC after confirming authenticity  ...
CREDIT APPRAISAL IN BANKING SECTOR   The LC which authorizes the advising bank to advance a part of LC amount to the selle...
CREDIT APPRAISAL IN BANKING SECTOR                            Illustration for computation of LC limit                    ...
CREDIT APPRAISAL IN BANKING SECTOR       b) Add: Closing stock of raw material       c) Less: Opening stock of raw materia...
CREDIT APPRAISAL IN BANKING SECTOR       contractor & for money to be received in various stages like plant layout,       ...
CREDIT APPRAISAL IN BANKING SECTORby exception, should be for a short period & for relatively small amounts. All deferred ...
CREDIT APPRAISAL IN BANKING SECTORmay be demanded by some of the beneficiary Government departments, it should be ensured ...
CREDIT APPRAISAL IN BANKING SECTORbefore the 31.3.20*1, last date of claim).SUBJECT TO AS AFORESAID(Main Guarantee matter ...
CREDIT APPRAISAL IN BANKING SECTOR                                           |                                Disbursement...
CREDIT APPRAISAL IN BANKING SECTOR       categorized into financial risk, business risk, industrial risk & management risk...
CREDIT APPRAISAL IN BANKING SECTOREXPECTED CONTRIBUTION OF THE STUDY:This study will help in understanding the credit appr...
CREDIT APPRAISAL IN BANKING SECTOR4.1 Concept:The small-scale industries (SSI) produce about 8000 products, contribute 40%...
CREDIT APPRAISAL IN BANKING SECTORhand tools, drugs and pharmaceuticals, stationery items and sports goods, where this inv...
CREDIT APPRAISAL IN BANKING SECTORover the immediately preceding year, while the sub-targets for financing tiny units and ...
CREDIT APPRAISAL IN BANKING SECTORprocesses and available security. There is an immediate need for the banking sector to f...
CREDIT APPRAISAL IN BANKING SECTOR   •   Adequate financial strengthAs such, these are the broad risk categories or risk f...
CREDIT APPRAISAL IN BANKING SECTORIMPORTANCE OF CREDIT RISK ASSESSMENTCredit is a core activity of banks & an important so...
CREDIT APPRAISAL IN BANKING SECTORAs of now, in SBI, CRA is the most important component of the Credit Appraisal exercise ...
CREDIT APPRAISAL IN BANKING SECTOR              •   Experience in the industry              •   Credibility : ability to m...
CREDIT APPRAISAL IN BANKING SECTORNew Rating Scales – Borrower Rating: 16 Rating Grades               There are different ...
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
Credit appraisal in  sbi bank project6 report
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Credit appraisal in sbi bank project6 report

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Credit appraisal in sbi bank project6 report

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Credit appraisal in sbi bank project6 report

  1. 1. CREDIT APPRAISAL IN BANKING SECTOR INTRODUCTION TO BANKING SECTOR & SBIHISTORY OF BANKING INDUSTRY:The Reserve Bank of India (RBI), as the central bank of the country, closely monitorsdevelopments in the whole financial sector.The banking sector is dominated by Scheduled Commercial Banks (SBCs). As at end-March2002, there were 296 Commercial banks operating in India. This included 27 Public SectorBanks (PSBs), 31 Private, 42 Foreign and 196 Regional Rural Banks. Also, there were 67scheduled co-operative banks consisting of 51 scheduled urban co-operative banks and 16scheduled state co-operative banks.Scheduled commercial banks touched, on the deposit front, a growth of 14% as against 18%registered in the previous year. And on advances, the growth was 14.5% against 17.3% of theearlier year.State Bank of India is still the largest bank in India with the market share of 20% ICICI and itstwo subsidiaries merged with ICICI Bank, leading creating the second largest bank in India witha balance sheet size of Rs. 1040bn.Higher provisioning norms, tighter asset classification norms, dispensing with the concept of‘past due’ for recognition of NPAs, lowering of ceiling on exposure to a single borrower andgroup exposure etc., are among the measures in order to improve the banking sector.A minimum stipulated Capital Adequacy Ratio (CAR) was introduced to strengthen the ability ofbanks to absorb losses and the ratio has subsequently been raised from 8% to 9%. It is proposedto hike the CAR to 12% by 2004 based on the Basle Committee recommendations. BSPATIL
  2. 2. CREDIT APPRAISAL IN BANKING SECTORRetail Banking is the new mantra in the banking sector. The home loans alone account for nearlytwo-third of the total retail portfolio of the bank. According to one estimate, the retail segment isexpected to grow at 30-40% in the coming years.Net banking, phone banking, mobile banking, ATMs and bill payments are the new buzz wordsthat banks are using to lure customers.With a view to provide an institutional mechanism for sharing of information on borrowers /potential borrowers by banks and Financial Institutions, the Credit Information Bureau (India)Ltd. (CIBIL) was set up in August 2000. The Bureau provides a framework for collecting,processing and sharing credit information on borrowers of credit institutions. SBI and HDFC arethe promoters of the CIBIL.The RBI is now planning to transfer of its stakes in the SBI, NHB and National bank forAgricultural and Rural Development to the private players. Also, the Government has sought tolower its holding in PSBs to a minimum of 33% of total capital by allowing them to raise capitalfrom the market.Banks are free to acquire shares, convertible debentures of corporate and units of equity-orientedmutual funds, subject to a ceiling of 5% of the total outstanding advances (including commercialpaper) as on March 31 of the previous year.The finance ministry spelt out structure of the government-sponsored ARC called the AssetReconstruction Company (India) Limited (ARCIL), this pilot project of the ministry would paveway for smoother functioning of the credit market in the country. The government will hold 49%stake and private players will hold the rest 51%- the majority being held by ICICI Bank (24.5%).REFORMS IN THE BANKING SECTOR:The first phase of financial reforms resulted in the nationalization of 14 major banks in 1969 and BSPATIL
  3. 3. CREDIT APPRAISAL IN BANKING SECTORresulted in a shift from Class banking to Mass banking. This in turn resulted in a significantgrowth in the geographical coverage of banks. Every bank has to earmark a minimum percentageof their loan portfolio to sectors identified as “priority sectors”. The manufacturing sector alsogrew during the 1970s in protected environs and the banking sector was a critical source. Thenext wave of reforms saw the nationalization of 6 more commercial banks in 1980. Since thenthe number scheduled commercial banks increased four-fold and the number of banks branchesincreased eight-fold.After the second phase of financial sector reforms and liberalization of the sector in the earlynineties, the Public Sector Banks (PSB) s found it extremely difficult to complete with the newprivate sector banks and the foreign banks. The new private sector banks first made theirappearance after the guidelines permitting them were issued in January 1993. Eight new privatesector banks are presently in operation. These banks due to their late start have access to state-of-the-art technology, which in turn helps them to save on manpower costs and provide betterservices.During the year 2000, the State Bank of India (SBI) and its 7 associates accounted for a 25%share in deposits and 28.1% share in credit. The 20 nationalized banks accounted for 53.5% ofthe deposits and 47.5% of credit during the same period. The share of foreign banks ( numbering42 ), regional rural banks and other scheduled commercial banks accounted for 5.7%, 3.9% and12.2% respectively in deposits and 8.41%, 3.14% and 12.85% respectively in credit during theyear 2000.CLASSIFICATION OF BANKS:The Indian banking industry, which is governed by the Banking Regulation Act of India, 1949can be broadly classified into two major categories, non-scheduled banks and scheduled banks. BSPATIL
  4. 4. CREDIT APPRAISAL IN BANKING SECTORScheduled banks comprise commercial banks and the co-operative banks. In terms ofownership, commercial banks can be further grouped into nationalized banks, the State Bank ofIndia and its group banks, regional rural banks and private sector banks (the old / new domesticand foreign). These banks have over 67,000 branches spread across the country. The Indianbanking industry is a mix of the public sector, private sector and foreign banks. The privatesector banks are again spilt into old banks and new banks. Banking System in India Reserve bank of India (Controlling Authority)Development Financial institutions BanksIFCI IDBI ICICI NABARD NHB IRBI EXIM Bank ISIDBI Commercial Regional Rural Land Development Co-operative Banks Banks Banks Banks Public Sector Banks Private Sector Banks SBI Groups Nationalized Banks Indian Banks Foreign BanksABOUT SBI: BSPATIL
  5. 5. CREDIT APPRAISAL IN BANKING SECTORThe State Bank of India, the country’s oldest Bank and a premier in terms of balance sheet size,number of branches, market capitalization and profits is today going through a momentous phaseof Change and Transformation – the two hundred year old Public sector behemoth is todaystirring out of its Public Sector legacy and moving with an agility to give the Private and ForeignBanks a run for their money.The bank is entering into many new businesses with strategic tie ups – Pension Funds, GeneralInsurance, Custodial Services, Private Equity, Mobile Banking, Point of Sale MerchantAcquisition, Advisory Services, structured products etc – each one of these initiatives having ahuge potential for growth.The Bank is forging ahead with cutting edge technology and innovative new banking models, toexpand its Rural Banking base, looking at the vast untapped potential in the hinterland andproposes to cover 100,000 villages in the next two years.It is also focusing at the top end of the market, on whole sale banking capabilities to provideIndia’s growing mid / large Corporate with a complete array of products and services. It isconsolidating its global treasury operations and entering into structured products and derivativeinstruments. Today, the Bank is the largest provider of infrastructure debt and the largestarranger of external commercial borrowings in the country. It is the only Indian bank to featurein the Fortune 500 list.The Bank is changing outdated front and back end processes to modern customer friendlyprocesses to help improve the total customer experience. With about 8500 of its own 10000branches and another 5100 branches of its Associate Banks already networked, today it offers thelargest banking network to the Indian customer. The Bank is also in the process of providingcomplete payment solution to its clientele with its over 8500 ATMs, and other electronicchannels such as Internet banking, debit cards, mobile banking, etc. BSPATIL
  6. 6. CREDIT APPRAISAL IN BANKING SECTORWith four national level Apex Training Colleges and 54 learning Centres spread all over thecountry the Bank is continuously engaged in skill enhancement of its employees. Some of thetraining programes are attended by bankers from banks in other countries.The bank is also looking at opportunities to grow in size in India as well as internationally. Itpresently has 82 foreign offices in 32 countries across the globe. It has also 7 Subsidiaries inIndia – SBI Capital Markets, SBICAP Securities, SBI DFHI, SBI Factors, SBI Life and SBICards - forming a formidable group in the Indian Banking scenario. It is in the process of raisingcapital for its growth and also consolidating its various holdings.Throughout all this change, the Bank is also attempting to change old mindsets, attitudes andtake all employees together on this exciting road to Transformation. In a recently concludedmass internal communication programme termed ‘Parivartan’ the Bank rolled out over 3300 twoday workshops across the country and covered over 130,000 employees in a period of 100 daysusing about 400 Trainers, to drive home the message of Change and inclusiveness. Theworkshops fired the imagination of the employees with some other banks in India as well asother Public Sector Organizations seeking to emulate the programme.The Bank is activelyinvolved since 1973 in non-profit activity called Community Services Banking. All theirbranches and administrative offices throughout the country sponsor and participate in largenumber of welfare activities and social causes.Their business is more than banking because they touch the lives of people anywhere in manyways. Their commitment to nation-building is complete & comprehensive.TRANSFORMATION JOURNEY IN STATE BANK OF INDIA:The State Bank of India, the country’s oldest Bank and a premier in terms of balance sheet size,number of branches, market capitalization and profits is today going through a momentous phaseof Change and Transformation – the two hundred year old Public sector behemoth is todaystirring out of its Public Sector legacy and moving with an agility to give the Private and ForeignBanks a run for their money. BSPATIL
  7. 7. CREDIT APPRAISAL IN BANKING SECTORThe bank is entering into many new businesses with strategic tie ups – Pension Funds, GeneralInsurance, Custodial Services, Private Equity, Mobile Banking, Point of Sale MerchantAcquisition, Advisory Services, structured products etc – each one of these initiatives having ahuge potential for growth.It is also focusing at the top end of the market, on whole sale banking capabilities to provideIndia’s growing mid / large Corporate with a complete array of products and services. It isconsolidating its global treasury operations and entering into structured products and derivativeinstruments. Today, the Bank is the largest provider of infrastructure debt and the largestarranger of external commercial borrowings in the country. It is the only Indian bank to featurein the Fortune 500 list.The Bank is changing outdated front and back end processes to modern customer friendlyprocesses to help improve the total customer experience. With about 8500 of its own 10000branches and another 5100 branches of its Associate Banks already networked, today it offers thelargest banking network to the Indian customer. The Bank is also in the process of providingcomplete payment solution to its clientele with its over 8500 ATMs, and other electronicchannels such as Internet banking, debit cards, mobile banking, etc.With four national level Apex Training Colleges and 54 learning Centers spread all over thecountry the Bank is continuously engaged in skill enhancement of its employees. Some of thetraining programmes are attended by bankers from banks in other countries.The bank is also looking at opportunities to grow in size in India as well as internationally. Itpresently has 82 foreign offices in 32 countries across the globe. It has also 7 Subsidiaries inIndia – SBI Capital Markets, SBICAP Securities, SBI DFHI, SBI Factors, SBI Life and SBICards - forming a formidable group in the Indian Banking scenario. It is in the process of raisingcapital for its growth and also consolidating its various holdings.Throughout all this change, the Bank is also attempting to change old mindsets, attitudes andtake all employees together on this exciting road to Transformation. In a recently concludedmass internal communication programme termed ‘Parivartan’ the Bank rolled out over 3300 two BSPATIL
  8. 8. CREDIT APPRAISAL IN BANKING SECTORday workshops across the country and covered over 130,000 employees in a period of 100 daysusing about 400 Trainers, to drive home the message of Change and inclusiveness. Theworkshops fired the imagination of the employees with some other banks in India as well asother Public Sector Organizations seeking to emulate the programme.The CNN IBN, Network 18 recognized this momentous transformation journey, the State Bankof India is undertaking, and has awarded the prestigious Indian of the Year – Business, to itsChairman, Mr. O. P. Bhatt in January 2008.State Bank of India (SBI) has history of more than 200 years of existence. SBI is the largestcommercial bank in India and accounts for approximately 18% of the total Indian bankingbusiness and the group account for 25% of the total Indian banking business.• The central bank, Reserve Bank of India (RBI) is the largest shareholder in the bank with59.7%stake followed by overseas investors including GDRs with 19.78% shareholdingas on September06. RBI’s stake in the bank is likely to be transferred to the Governmentof India (GOI).• SBI has the largest distribution network in India spread across every nook and corner of India.As on September 06, the bank has 14,061 branches which include 4,755 branches of itsassociated banks. The bank also has the largest network of 5,624 ATMs.Background:State Bank of India is the largest and one of the oldest commercial bank in India, in existence formore than 200 years. The bank provides a full range of corporate, commercial and retail bankingservices in India. Indian central bank namely Reserve Bank of India (RBI) is the major shareholder of the bank with 59.7% stake. The bank is capitalized to the extent of Rs.646bn with thepublic holding (other than promoters) at 40.3%. BSPATIL
  9. 9. CREDIT APPRAISAL IN BANKING SECTORSBI has the largest branch and ATM network spread across every corner of India. Thebank has abranch network of over 14,000 branches (including subsidiaries). Apart fromIndian network italso has a network of 73 overseas offices in 30 countries in all time zones, correspondentrelationship with 520 International banks in 123 countries. In recent past, SBI has acquired banksin Mauritius, Kenya and Indonesia. The bank had total staff strength of 198,774 as on 31stMarch, 2006. Of this, 29.51% are officers, 45.19% clerical staff and the remaining 25.30% weresub-staff. The bank is listed on the Bombay Stock Exchange, National Stock Exchange, KolkataStock Exchange, Chennai Stock Exchange and Ahmedabad Stock Exchange while its GDRs arelisted on the London Stock Exchange.SBI group accounts for around 25% of the total business of the banking industry while itaccountsfor 35% of the total foreign exchange in India. With this type of strong base, SBI has displayed acontinued performance in the last few years in scaling up its efficiency levels. Net InterestIncome of the bank has witnessed a CAGR of 13.3% during the last five years. During the sameperiod, net interest margin (NIM) of the bank has gone up from as low as 2.9% in FY02 to3.40% in FY06 and currently is at 3.32%.EVOLUTION OF SBI:The origin of the State Bank of India goes back to the first decade of the nineteenth centurywith the establishment of the Bank of Calcutta in Calcutta on 2 June 1806. Three years later thebank received its charter and was re-designed as the Bank of Bengal (2 January 1809). A uniqueinstitution, it was the first joint-stock bank of British India sponsored by the Government ofBengal. The Bank of Bombay (15 April 1840) and the Bank of Madras (1 July 1843) followedthe Bank of Bengal. These three banks remained at the apex of modern banking in India till theiramalgamation as the Imperial Bank of India on 27 January 1921. BSPATIL
  10. 10. CREDIT APPRAISAL IN BANKING SECTORImperial BankThe Imperial Bank during the three and a half decades of its existence recorded an impressivegrowth in terms of offices, reserves, deposits, investments and advances, the increases in somecases amounting to more than six-fold. The financial status and security inherited from itsforerunners no doubt provided a firm and durable platform. But the lofty traditions of bankingwhich the Imperial Bank consistently maintained and the high standard of integrity it observed inits operations inspired confidence in its depositors that no other bank in India could perhaps thenequal. All these enabled the Imperial Bank to acquire a pre-eminent position in the Indianbanking industry and also secure a vital place in the countrys economic life.When India attained freedom, the Imperial Bank had a capital base (including reserves) ofRs.11.85 crores, deposits and advances of Rs.275.14 crores and Rs.72.94 crores respectively anda network of 172 branches and more than 200 sub offices extending all over the country.Key Areas of Operations:The business operations of SBI can be broadly classified into the key income generating areassuch as National Banking, International Banking, Corporate Banking, & Treasury operations.The functioning of some of the key divisions is enumerated below:a) CORPORATE BANKINGThe corporate banking segment of the bank has total business of around Rs1,193bn. SBI hascreated various Strategic Business Units (SBU) in order to streamline its operations.These SBUs are as follows: BSPATIL
  11. 11. CREDIT APPRAISAL IN BANKING SECTOR1) Corporate AccountsThis SBU is important for the bank as its loan portfolio constituted about 27.05% of thebank’scommercial and institutional non-food credit and 12.85% of the total domestic credit portfolio ason 31st March 2006.Some of the products under corporate accounts SBU are as follows:• SBI-FAST, which is the cash management product offered by this SBU, had a turnover ofRs.4,705.75bn as of 31st March 2006. This product is now comprehensive cash managementsolution, offering payments in addition to collections.• Vendor financing activity is being integrated with core banking through the internet platform.This is identified as a focus area to capture the credit portfolio of vendors.• The foreign exchange business grew by around 55% y-o-y and reached Rs.1,747.70bn as of31st March 2006. This SBU now handles nearly 12% of the country’s visible trade and about43% of bank’s forex business.2) LeasingThis SBU is not writing any leases since the past few years as unfavorable business climate andavailability of alternative funding options at cheaper cost. As at the end March 2006, thedisbursements and capitalization were zero and profit amounted to Rs.245.9mn.3) Project FinanceThis SBU focuses on funding core projects like power, telecom, roads, ports, airports, specialeconomic zones and others. During FY06, total sanctions for 18 projects involving a total StateBank of India, Corporate Banking, National Banking, International Banking, Treasury BSPATIL
  12. 12. CREDIT APPRAISAL IN BANKING SECTOROperations Associates & Subsidiaries amount of Rs.42.11bn were in place as against 13 projectsinvolving Rs.25.08bn in the previous year. It also handles non-infrastructure projects with certainceilings on minimum project costs. During FY06 sanctions for 29 projects involving a totalamount of Rs.55.80bn were in place as against 27 projects involving Rs.51.63bn in the previousyear. As a whole, this SBU achieved total sanctions of Rs.238.86bn (fund based and non fundbased) including syndication amount of Rs.140.95bn during the period ended March 2006.During FY06, this SBU entered into financing of aviation sector actively by sanctioning loansfor modernization of airports and acquisition of aircrafts.4) Mid Corporate GroupThe Mid Corporate Group (MCG) created in June 2004 has 7 MCG Regional Officescontrolling28 large branches with high concentration of Mid Corporate (MC) business.The entire Off-SiteMC business of all branches at 31 identified centres has been broughtunder the fold of MCG.The average processing time of credit proposals is about 15 daysand quicker decision making oncredit proposals of the Mid Corporate units has resulted in greater customer satisfaction. As ofMarch 2006, 21 MCG branches have been migrated to core banking platform. New technologyproducts like RTGS, CINB, Multi-City cheque facility and Core Power have been introduced inall these branches. These technology products coupled with quick Turn Around Time (TAT)have enabled Mid-Corporate Group to increase its business substantially and generate higherincome, both interest and fee based.5) Stressed Assets ManagementDuring FY06, the banking industry witnessed a major policy initiative by Reserve Bank of Indiawith the opening up of sale / purchase of non performing assets to banks, FIs and non-bankingfinance companies (NBFCs). During FY06, the bank sold NPAs to the tune of Rs.8.9bn againstsecurity receipts and Rs.11.41bn on cash basis to Asset Reconstruction Company (ARCIL). Theprogress in enforcing the security interest has somewhat slowed down due to the requirement ofwithdrawing suits pending before the tribunal prior to action being initiated against thedefaulting borrowers under the SARFAESI Act.b) NATIONAL BANKING BSPATIL
  13. 13. CREDIT APPRAISAL IN BANKING SECTORThe national banking group has 14 administrative circles encompassing a vast network of 9,177branches, 4 sub-offices, 12 exchange bureaus, 104 satellite offices and 679 extension counters, toreach out to customers, even in the remotest corners of the country. Out of the total branches,809 are specialized branches. This group consists of four business group which are enumeratedbelow:1) Personal Banking SBUThis SBU is mainly responsible for retail business. During FY06, personal banking advancesincreased from Rs.464.51bn to Rs.610.67bn, showing a growth of Rs.146.16bn at the rate of31.47 % against a growth rate of 40.12% in the previous year.On the home loan front, several new products were introduced, tailored to fit the needs ofspecific customer segments, such as SBIMaxgain (minimize interest burden, earn on savings, atno extra cost), SBI NRI-Home Loans, SBI Freedom Home Loans (Loans given withoutmortgage of property, but against alternate securities, instead), SBI Tribal Plus Home Loans. Theauto loans portfolio has shown a growth of Rs.17.74bn in absolute terms and 65% which isconsiderably higher than last year’s growth, mainly due to implementation of well plannedstrategies.2) Small & Medium EnterprisesThe SME Business Unit implemented comprehensive strategies, revamped business processesand with its focus on market dynamics and customer preferences, achieved commendablebusiness growth. The initiative was implemented by focusing on specific industry segments, andconcentrating on various players in the value chain. Debt restructuring mechanism for units inSME sector has been devised to ensure restructuring of debt of all eligible Small and MediumEnterprises (SMEs) on favorable terms.Focused on the SME sector, projects under Uptech are taken up in location specific and activityspecific industry clusters. So far the bank has taken 28 projects for modernization under theProject Uptech covering industries like foundry, pumps, glass, auto components, and knitwear,etc. The bank has also covered agro based industries like rice mills, sago and starch andhorticulture activities like Apple Orchards and grape farming under the scheme. The deposits of BSPATIL
  14. 14. CREDIT APPRAISAL IN BANKING SECTORthe SME SBU increased to Rs.1,042.70bn as at the end of March 2006 from Rs.890.60bn ofprevious year recording a growth of 17.08% during the year. SME advances increased toRs.456.53bn from Rs.328.30bn of previous year, recording a growth of 39.06 %. The criteria laiddown by the Government of India for growth in SME advances is 20%.3) Agricultural BankingThis SBU is accountable for agricultural credit both traditional and new thrust areas like contractfarming, farmers financed through Agri Export Zones (AEZs) and value chain financing.Increase in disbursements during FY06 was 83% against the Govt. of India target of 30%.Agricultural advances grew from a level of Rs.205.26bn in FY05 to Rs.305.16bn as at the end ofMarch 06. As on November 2006, agriculture loans contribute 11% of the total loan book.4) Government BankingWith the establishment of the government business unit and the consequent focus on marketing,business turnover of this segment has grown substantially over the years. Bank’s businessturnover from the government business segment during 2004-05 was Rs.8,843.81bn. Theturnover increased by 10.52 % to Rs.9,773.90bn during FY06.c) INTERNATIONAL BANKINGSBI has a network of 73 overseas offices in 30 countries in all time zones and correspondentrelationship with 520 international banks in 123 countries. The bank is keen to implement corebanking solution to its international branches also. During FY06, 25 foreign offices weresuccessfully switched over to Finacle software. SBI has installed ATMs at Male, Muscat andColombo Offices. In recent years, SBI acquired 76% shareholding in Giro Commercial BankLimited in Kenya and PT Indomonex Bank Ltd. in Indonesia. The bank incorporated a company BSPATIL
  15. 15. CREDIT APPRAISAL IN BANKING SECTORSBI Botswana Ltd. at Gaborone.d) TREASURYThe bank manages an integrated treasury covering both domestic and foreign exchange markets.In recent years, the treasury operation of the bank has become more active amidst rising interestrate scenario, robust credit growth and liquidity constraints. The bank diversified its operationsmore actively into alternative assets classes with a view to diversify the portfolio and buildalternative revenue streams in order to offset the losses in fixed income portfolio. Reorganizationof the treasury processes at domestic and global levels is also being undertaken to leverage onthe operational synergy between business units and network. The reorganization seeks toenhance the efficiencies in use of manpower resources and increase maneuverability of banksoperations in the markets both domestic as well as internationale) ASSOCIATES & SUBSIDIARIESThe State Bank Group with a network of 14,061 branches including 4,755 branches of its sevenAssociate Banks dominates the banking industry in India. In addition to banking, the Group,through its various subsidiaries, provides a whole range of financial services which includes LifeInsurance, Merchant Banking, Mutual Funds, Credit Card, Factoring, Security trading andprimary dealership in the Money Market.1) Associates Banks:SBI has seven associate banks namely• State Bank of Indore BSPATIL
  16. 16. CREDIT APPRAISAL IN BANKING SECTOR• State Bank of Travancore• State Bank of Bikaner and Jaipur• State Bank of Mysore• State Bank of Patiala• State Bank of Hyderabad• State Bank of SaurashtraAll associate banks have migrated to Core Banking (CBS) platform. Single window deliverysystem has been introduced in all associate banks. SBI’s seven associate banks are the firstamongst the public sector banks in India to get fully networked through CBS, providing anytime-anywhere banking to its customers to facilitate a bouquet of innovative customer offerings.2) Non-Banking Subsidiaries/Joint Venturesi) SBI Life:SBI Life is the third largest private insure with the market share of 10.21% among the privateplayers and number one in terms of number of lives insured amongst private players (no. of livesinsured and policies is 25mn). In H1FY07 gross premium was Rs.7.68bn.ii) SBI Capital Markets Limited (SBICAP)SBI Caps forged ahead in issue management, project advisory and structured finance, sales anddistribution. To capitalize on the emerging opportunities, SBI Caps has promoted four whollyowned subsidiaries viz. SBICAP Securities Ltd. for undertaking stock broking activities,SBICAPS Ventures Limited, SBICAP Trustee Company Limited for undertaking venture capitalbusiness and SBI CAP (UK) LTD., for carrying on the Financial Services Authority (FSA)regulated activities. On the international front, the expertise of SBI Caps in the infrastructure and BSPATIL
  17. 17. CREDIT APPRAISAL IN BANKING SECTORproject advisory has received international acclaim. In addition, the company has been placed11th globally in the Mandated Project Advisor league tables by Thompson’s, and one of theprojects handled by the company has been selected as the Asia Pacific Infrastructure deal of theyear for FY06. SBI Caps booked gross income amounting to Rs.1.79bn in FY06 as againstRs.1.75bn in the previous year, while PAT of the company was at Rs.906.2mn in FY06 asagainst Rs.881.2mn in the last year.iii) SBI DFHI LTDSBI group holds 67.01% of the company’s paid up capital, while other nationalized banks hold22.46%. All India financial institutions and private sector banks hold 5.84% and the AsianDevelopment Bank holds 4.69% as on March 31, 2006. For the year ended 31st March, 2006, thecompany has earned a PAT of Rs.24.4mn. Total secondary market turnover of the company wasRs.285.39bn which amounted to a market share of 12.89% among all primary dealers.iv) SBI Cards & Payments Services Pvt. Ltd. (SBICSPL)SBICSPL is ranked 2nd in industry with cards in force over 3mn as on September 06. DuringFY06, the aggregate revenue generated by the SBICSPL was Rs.5.27bn while pre-tax profit wasRs.558.6mn.v) SBI Funds Management (P) Ltd. (SBIFMPL)SBI Mutual Fund is the mutual funds arm of the bank. SBIFMPL reported a total inflow ofRs.481.67bn in the various schemes during the year. The total assets under management areRs.132.49bn. The company reported a net profit of Rs.186.4mn as at the end of March, 2006.f) Human ResourcesThe bank had total staff strength of 198,774 on the 31st March, 2006. Of this, 29.51% areofficers, 45.19% clerical staff and the remaining 25.30% were sub-staff. SBI had launched VRS BSPATIL
  18. 18. CREDIT APPRAISAL IN BANKING SECTORscheme for its employees in FY01 in which it has reduced it staff by approximately 5,000 andestimates natural retirement of another 5,000 employees in next 4-5 year.NON BANKING SUBSIDIARIES:The Bank has the following Non-Banking Subsidiaries in India :SBI Capital Markets LtdSBI Funds Management Pvt LtdSBI Factors & Commercial Services Pvt LtdSBI DFHI LtdState Bank of Travancore (SBT)INVESTOR RELATIONS:State Bank of India, the country’s largest commercial Bank in terms of profits, assets, deposits,branches and employees, welcomes you to its ‘Investors Relations’ Section. SBI, with itsheritage dating back to the year 1806, strives to continuously provide latest and upto dateinformation on its financial performance. It is our endeavor to walk on the path of transparencyand allow complete access to all the stakeholders enabling total awareness about the Bank. TheBank communicates with the stakeholders through a variety of channels, such as through e-mail,website, conference call, one-on-one meeting, analysts’ meet and attendance at InvestorConference throughout the world.Please find below Bank’s financial results, analysis of performance and other highlights whichwill be of interest to Investors, Fund Managers and Analysts. SBI has always been fundamentallystrong in its core business which is mirrored in its results – year after year. BSPATIL
  19. 19. CREDIT APPRAISAL IN BANKING SECTORState Bank of India has an extensive administrative structure to oversee the large network ofbranches in India and abroad. The Corporate Centre is in Mumbai and 14 Local Head Officesand 57 Zonal Offices are located at important cities spread throughout the country. TheCorporate Centre has several other establishments in and outside Mumbai, designated to cater tovarious functions. Our Colleges/Institutes/Training Centres are the seats of learning and researchand development to spread the wings of knowledge not only to our employees but also otherbanks/establishments in India and abroad.The Corporate Accounts Group is a Strategic Business Unit of the Bank set up exclusively tofulfil the specialised banking needs of top corporates in the country.State Bank of India has 52 foreign offices in 34 countries across the globe.State Bank of India invites you to take a journey to understand the potential of not just a largebut truly global organisation. CHAPTER-2 BRIEF OVERVIEW OF CREDIT APPRAISALCredit appraisal means an investigation/assessment done by the bank prior before providing anyloans & advances/project finance & also checks the commercial, financial & technical viabilityof the project proposed its funding pattern & further checks the primary & collateral securitycover available for recovery of such funds.Brief overview of credit:Credit Appraisal is a process to ascertain the risks associated with the extension of the creditfacility. It is generally carried by the financial institutions which are involved in providing BSPATIL
  20. 20. CREDIT APPRAISAL IN BANKING SECTORfinancial funding to its customers. Credit risk is a risk related to non repayment of the creditobtained by the customer of a bank. Thus it is necessary to appraise the credibility of thecustomer in order to mitigate the credit risk. Proper evaluation of the customer is performedwhich measures the financial condition and the ability of the customer to repay back the loan infuture. Generally the credit facilities are extended against the security know as collateral. Buteven though the loans are backed by the collateral, banks are normally interested in the actualloan amount to be repaid along with the interest. Thus, the customers cash flows are ascertainedto ensure the timely payment of principal and the interest.It is the process of appraising the credit worthiness of a loan applicant. Factors like age, income,number of dependents, nature of employment, continuity of employment, repayment capacity,previous loans, credit cards, etc. are taken into account while appraising the credit worthiness ofa person. Every bank or lending institution has its own panel of officials for this purpose.However the 3 ‘C’ of credit are crucial & relevant to all borrowers/ lending which must be keptin mind at all times. • Character • Capacity • CollateralIf any one of these are missing in the equation then the lending officer must question the viabilityof credit.There is no guarantee to ensure a loan does not run into problems; however if proper creditevaluation techniques and monitoring are implemented 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 another party wherethat second party does not reimburse the first party immediately, thereby generating a debt, andinstead arranges either to repay or return those resources (or material(s) of equal value) at a laterdate. The first party is called a creditor, also known as a lender, while the second party is called adebtor, also known as a borrower. BSPATIL
  21. 21. CREDIT APPRAISAL IN BANKING SECTORCredit allows you to buy goods or commodities now, and pay for them later. We use credit to buy thingswith an agreement to repay the loans over a period of time. The most common way to avail credit is bythe use of credit cards. Other credit plans include personal 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 another party andpromises to repay him on a future date along with interest. In simple terms, a credit is anagreement of postponed payments of goods bought or loan. With the issuance of a credit, a debtis formed.BASIC TYPES OF CREDITThere are four basic types of credit. By understanding how each works, you will be able to getthe 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 orseveral years. Money can be repaid in one lump sum or in several regular payments until theamount you borrowed and the finance charges are paid in full. Loans can be secured orunsecured.Installment credit may be described as buying on time, financing through the store or the easypayment 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 adown payment, and agree to pay the balance with a specified number of equal payments calledinstallments. 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 a credit card canbe the equivalent of an interest-free loan--if you pay for the use of it in full at the end of eachmonth. BSPATIL
  22. 22. CREDIT APPRAISAL IN BANKING SECTORBRIEF OVERVIEW OF LOANSCredit can be of two types fund base & non-fund base:FUND BASED includes: • Working Capital • Term LoanNON-FUND BASED includes: • Letter of Credit • Bank GuaranteeFUND BASED:-WORKING CAPITAL:-1. GENERALThe objective of running any industry is earning profits. An industry will require funds to acquire“Fixed assets” like land, building, plant, machinery, equipments, vehicles, tools etc., & also torun the business i.e. its day to day operations. BSPATIL
  23. 23. CREDIT APPRAISAL IN BANKING SECTORFunds required for day to-day working will be to finance production & sales. For production,funds are needed for purchase of raw materials/ stores/ fuel, for employment of labour, for powercharges etc., for storing finishing goods till they are sold out & for financing the sales by way ofsundry debtors/ receivables.Capital or funds required for an industry can therefore be bifurcated as fixed capital & workingcapital. Working capital in this context is the excess of current assets over current liabilities. Theexcess of current assets over current liabilities is treated as net working capital or liquid surplus& represents that portion of the working capital which has been provided from the long termsource.2. DefinitionWorking capital is defined as the funds required to carry the required levels of current assets toenable the unit to carry on its operations at the expected levels uninterruptedly.Thus Working Capital Required is dependent on (a) The volume of activity (viz. level of operations i.e. Production & sales) (b) The activity carried on viz. mfg process, product, production programme, the materials & marketing mix.3. METHODS & APPLICATION SEGMENT LIMITS METHODSSI Upto Rs 5 cr Traditional Method & Nayak Committee method Above Rs 5 cr Projected Balance Sheet MethodSBF All loans Traditional / Turnover MethodC&I Trade & Upto Rs 1 cr Traditional Method for Trade &Services Projected Turnover Method Above Rs 1 cr Projected Balance Sheet Method & & upto Rs 5 cr Projected Turnover Method Above Rs 5 cr Projected Balance Sheet MethodC&I Industrial Below Traditional MethodUnits Rs 25 lacs Rs 25 lacs & Projected Balance Sheet Method & Over but upto Projected Turnover Method Rs 5 cr BSPATIL
  24. 24. CREDIT APPRAISAL IN BANKING SECTOR Above Rs 5 cr Projected Balance Sheet Method4. OPERATING CYCLE METHODa) Any manufacturing activity is characterized by a cycle of operations consisting of purchase of purchase of raw materials for cash, converting these into finished goods & realizing cash by sale of these finished goods.b) Diagrammatically, the OPERATING CYCLE is represented as under BSPATIL
  25. 25. CREDIT APPRAISAL IN BANKING SECTOR Raw Stock in Materials Process Finished Cash Goods Billsc) The time that lapses between cash outlay & cash realization by sale of finished goods & realization of sundry debtors is known as the length of the operating cycle.d) That is, the operating cycle consists of: • Time taken to acquire raw materials & average period for which they are in store. • Conversion process time BSPATIL
  26. 26. CREDIT APPRAISAL IN BANKING SECTOR • Average period for which finished goods are in store & • Average collection period of receivables (Sundry Debtors) Operating cycle is also called the cash-to-cash cycle & indicates how cash is converted into raw material, stocks in process, finished goods, bills (receivables) & finally back to cash. Working capital is the total cash that is circulating in this cycle. Therefore, working capital can be turned over or redeployed after completing the cycle.e) The length of the operating cycle = a+b+c+d (as in 4.4) If a = 60 days b = 10 days c = 20 days d = 30 days The operating cycle is 120 days (nearly 4 months). This means there are 365/120 = 3 cycles of operations in a year. Sales = Rs. 1,00,000 per annum Operating expenses = Rs. 72,000 per annum But the working capital requirement, as you know, is not Rs. 72,000. In these cases, there are 3 operating cycles in a year. That means each rupee of working deployed in the unit is turned over 3 times in a year. (This is also known as working capital turnover ratio). Therefore WCR = Operating Expenses = Rs. 72,000/- = Rs. 24,000/- No. of cycles per annum 3 WCR is therefore not Rs. 72,000/- but only Rs. 24,000/- Assessment of Working Capital Requirement & Permissible Bank Finance usingOperating Cycle Concept Let us consider a case of a unit where: Sales = Rs. 20,000 p.m. (A) Raw Materials = Rs. 14,000 p.m. BSPATIL
  27. 27. CREDIT APPRAISAL IN BANKING SECTOR Wages = Rs. 2,000 p.m. Other manufacturing Expenses = Rs. 3,000 p.m. Total expenses = Rs. 19,000 p.m. (B) Profit = Rs. 1,000 P.m. (C) The operating cycle is Raw Materials = 15 days Stock in Process = 2 days FG = 3 days Sundry Debtors = 15 days The total length of Operating cycle = 35 days (D) WCR = B * D = 19,000 * 35 = Rs. 22,167/- (approx.) 30 30 Where B = Operating Expenses; & D = Length of Operating cycleTERM LOAN 1. A term loan is granted for a fixed term of not less than 3 years intended normally for financing fixed assets acquired with a repayment schedule normally not exceeding 8 years. 2. A term loan is a loan granted for the purpose of capital assets, such as purchase of land, construction of, buildings, purchase of machinery, modernization, renovation or rationalization of plant, & repayable from out of the future earning of the enterprise, in BSPATIL
  28. 28. CREDIT APPRAISAL IN BANKING SECTOR installments, as per a prearranged schedule. From the above definition, the following differences between a term loan & the working capital credit afforded by the Bank are apparent: • The purpose of the term loan is for acquisition of capital assets. • The term loan is an advance not repayable on demand but only in installments ranging over a period of years. • 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. • The security is not the readily saleable goods & commodities but the fixed assets of the units.3. It may thus be observed that the scope & operation of the term loans are entirely different from those of the conventional working capital advances. The Bank’s commitment is for a long period & the risk involved is greater. An element of risk is inherent in any type of loan because of the uncertainty of the repayment. Longer the duration of the credit, greater is the attendant uncertainty of repayment & consequently the risk involved also becomes greater.4. However, it may be observed that term loans are not so lacking in liquidity as they appear to be. These loans are subject to a definite repayment programme unlike short term loans for working capital (especially the cash credits) which are being renewed year after year. Term loans would be repaid in a regular way from the anticipated income of the industry/ trade.5. These distinctive characteristics of term loans distinguish them from the short term credit granted by the banks & it becomes necessary therefore, to adopt a different approach in examining the applications of borrowers for such credit & for appraising such proposals.6. 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 the anticipated income from the unit would provide the necessary amount for the repayment of the loan. This will involve a detailed scrutiny of the scheme, its financial aspects, economic aspects, technical aspects, a projection of future trends of outputs & sales & estimates of cost, returns, flow of funds & profits.7. Appraisal of Term Loans BSPATIL
  29. 29. CREDIT APPRAISAL IN BANKING SECTOR Appraisal of term loan for, say, an industrial unit is a process comprising several steps. There are four broad aspects of appraisal, namely • Technical Feasibility - To determine the suitability of the technology selected & the adequacy of the technical investigation & design; • Economic Feasibility - To ascertain the extent of profitability of the project & its sufficiency in relation to the repayment obligations pertaining to term assistance; • Financial Feasibility - To determine the accuracy of cost estimates, suitability of the envisaged pattern of financing & general soundness of the capital structure; & • Managerial Competency – To ascertain that competent men are behind the project to ensure its successful implementation & efficient management after commencement of commercial production.7.1 Technical FeasibilityThe examination of this item consists of an assessment of the various requirement of theactual production process. It is in short a study of the availability, costs, quality &accessibility of all the goods & services needed. a) The location of the project is highly relevant to its technical feasibility & hence special attention will have to be paid to this feature. Projects whose technical requirements could have been taken care of in one location sometimes fail because they are established in another place where conditions are less favorable. One project was located near a river to facilitate easy transportation by barge but lower water level in certain seasons made essential transportation almost impossible. Too many projects have become uneconomical because sufficient care has not been taken in the location of the project, e.g. a woolen scouring & spinning mill needed large quantities of good water but was located in a place which lacked ordinary supply of water & the limited water supply available also required efficient softening treatment. The accessibility to the various resources has meaning only with reference to location. Inadequate transport facilities or lack of sufficient power or water for instance, can adversely affect an otherwise sound industrial project. b) Size of the plant – One of the most important considerations affecting the feasibility of a new industrial enterprise is the right size of the plant. The size of the plant will be such that it will give an economic product which will be competitive when compared to the alternative product available in the market. A smaller plant than the optimum BSPATIL
  30. 30. CREDIT APPRAISAL IN BANKING SECTOR size may result in increased production costs & may not be able to sell its products at competitive prices. c) Type of technology – An important feature of the feasibility relates to the type of technology to be adopted for a project. A new technology will have to be fully examined & tired before it is adopted. It is equally important to avoid adopting equipment or processes which are absolute or likely to become outdated soon. The principle underlying the technological selection is that “a developing country cannot afford to be the first to adopt the new nor yet the last to cast the old aside”. d) Labour – The labour requirements of a project, need to be assessed with special care. Though labour in terms of unemployed persons is abundant in the country, there is shortage of trained personnel. The quality of labour required & the training facilities made available to the unit will have to be taken into account e) Technical Report – A technical report using the Bank’s Consultancy Cell, external consultants, etc., should be obtained with specific comments on the feasibility of scheme, its profitability, whether machinery proposed to be acquired by the unit under the scheme will be sufficient for all stages of production, the extent of competition prevailing, marketability of the products etc., wherever necessary. 7.2 Economic FeasibilityAn economic feasibility appraisal has reference to the earning capacity of the project. Sinceearnings depend on the volume of sales, it is necessary to determine how much output or theadditional production from an established unit the market is likely to absorb at given prices. a) A thorough market analysis is one of the most essential parts of project investigation. This involves getting answers to three questions. a) How big is the market? b) How much it is likely to grow? c) How much of it can the project capture?The first step in this direction is to consider the current situation, taking account of the total BSPATIL
  31. 31. CREDIT APPRAISAL IN BANKING SECTORoutput of the product concerned & the existing demand for it with a view to establishing whetherthere is unsatisfied demand for the product. Care should be taken to see that there is no idlecapacity in the existing industries.ii) Future – possible future changes in the volume & patterns of supply & demand will have tobe estimated in order to assess the long term prospects of the industry. Forecasting of demand isa complicated matter but one of the vital importance. It is complicated because a variety offactors affect the demand for product e.g. technological advances could bring substitutes intomarket while changes in tastes & consumer preference might cause sizable shifts in demand.iii) Intermediate product – The demand for “Intermediate product” will depend upon the demand& supply of the ultimate product (e.g. jute bags, paper for printing, parts for machines, tyres forautomobiles). The market analysis in this case should cover the market for the ultimate product. 7.3 Financial FeasibilityThe basis data required for the financial feasibility appraisal can be broadly grouped under thefollowing heads i) Cost of the project including working capital ii) Cost of production & estimates of profitability iii) Cash flow estimates & sources of finance.The cash flow estimates will help to decide the disbursal of the term loan. The estimate ofprofitability & the breakeven point will enable the banker to draw up the repayment programme,start-up time etc. The profitability estimates will also give the estimate of the Debt ServiceCoverage which is the most important single factor in all the term credit analysis.A study of the projected balance sheet of the concern is essential as it is necessary for theappraisal of a term loan to ensure that the implementation of the proposed scheme.Break-even point:In a manufacturing unit, if at a particular level of production, the total manufacturing cost equalsthe sales revenue, this point of no profit/ no loss is known as the break-even point. Break-evenpoint is expressed as a percentage of full capacity. A good project will have reasonably lowbreak-even point which not be encountered in the projections of future profitability of the unit. BSPATIL
  32. 32. CREDIT APPRAISAL IN BANKING SECTORDebt/ Service Coverage:The debt service coverage ratio serves as a guide to determining the period of repayment of aloan. This is calculated by dividing cash accruals in a year by amount of annual obligationstowards term debt. The cash accruals for this purpose should comprise net profit after taxes withinterest, depreciation provision & other non cash expenses added back to it. Debt Service = Cash accruals Coverage Ratio Maturing annual obligationsThis ratio is valuable, in that it serves as a measure of the repayment capacity of the project/ unit& is, therefore, appropriately included in the cash flow statements. The ratio may vary fromindustry to industry but one has to view it with circumspection when it is lower than thebenchmark of 1.75. The repayment programme should be so stipulated that the ratio iscomfortable. 7.4 Managerial CompetenceIn a dynamic environment, the capacity of an enterprise to forge ahead of its competitorsdepends to a large extent, on the relative strength of its management. Hence, an appraisal ofmanagement is the touchstone of term credit analysis.If there is a change in the administration & managerial set up, the success of the project may beput to test. The integrity & credit worthiness of the personnel in charge of the management of theindustry as well as their experience in management of industrial concerns should be examined. Inhigh cost schemes, an idea of the unit’s key personnel may also be necessary.NON-FUND BASED:-LETTER OF CREDIT BSPATIL
  33. 33. CREDIT APPRAISAL IN BANKING SECTORIntroductionThe expectation of the seller of any goods or services is that he should get the paymentimmediately on delivery of the same. This may not materialize if the seller & the buyer are atdifferent places (either within the same country or in different countries). The seller desires tohave an assurance for payment by the purchaser. At the same time the purchaser desires that theamount should be paid only when the goods are actually received. Here arises the need of Letterof Credit (LCs). The objective of LC is to provide a means of payment to the seller & thedelivery of goods & services to the buyer at the same time.DefinitionA Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at therequest & on the instructions of the customer (the applicant) or on its own behalf, i. 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); or ii. authorizes another bank to effect such payment, or to accept & pay such bills of exchanges (drafts); or iii. authorizes another bank to negotiate against stipulated document(s), provided that the terms & conditions of the credit are complied with.Basic Principle:The basic principle behind an LC is to facilitate orderly movement of trade; it is thereforenecessary that the evidence of movement of goods is present. Hence documentary LCs is thosewhich contains documents of title to goods as part of the LC documents. Clean bills which do nothave document of title to goods are not normally established by banks. Bankers and allconcerned deal only in documents & not in goods. If documents are in order issuing bank willpay irrespective of whether the goods are of expected quality or not. Banks are also notresponsible for the genuineness of the documents & quantity/quality of goods. If importer is yourborrower, the bank has to advice him to convert all his requirements in the form of documents toensure quantity & quality of goods.Parties to the LC 1) Applicant – The buyer who applies for opening LC 2) Beneficiary – The seller who supplies goods 3) Issuing Bank – The Bank which opens the LC BSPATIL
  34. 34. CREDIT APPRAISAL IN BANKING SECTOR 4) Advising Bank – The Bank which advises the LC after confirming authenticity 5) Negotiating Bank – The Bank which negotiates the documents 6) Confirming Bank – The Bank which adds its confirmation to the LC 7) Reimbursing Bank – The Bank which reimburses the LC amount to negotiating bank 8) Second beneficiary – The additional beneficiary in case of transferable LCsConfirming bank may not be there in a transaction unless the beneficiary demand confirmationby his own bankers & such a request is made part of LC terms. A bank will confirm an LC forhis beneficiary if opening bank requests this as part of LC terms. Reimbursing bank is used in anLC transaction by an opening bank when the bank does not have a direct correspondent/branchthrough whom the negotiating bank can be reimbursed. Here, the opening bank will direct thereimbursing bank to reimburse the negotiating bank with the payment made to the beneficiary. Inthe case of transferable LC, the LC may be transferred to the second beneficiary & if provided inthe LC it can be transferred even more than once.Types of Letter of Credit:- a) Revocable & Irrevocable: As the name suggests, revocable LCs are those that can be revoked by the issuing bank & hence are not in commercial use. Irrevocable LCs cannot be revoked/ cancelled/ amended without the prior concern of all the parties to the LC. b) Confirmed LC: The seller may ask for the confirmation of the LC by a bank in his own country if he is not satisfied about the issuing bank’s credentials. c) Sight/ Usance LCs: In case of the sight LCs beneficiary gets immediate payment upon presentation of the documents while in the case of usance, the payment is made after a certain period as per the LC terms. Sight LCs have to be paid by the drawee (buyer) immediately whereas he gets credit as per LC terms under Usance LCs. d) LC with advance payment to the seller: BSPATIL
  35. 35. CREDIT APPRAISAL IN BANKING SECTOR The LC which authorizes the advising bank to advance a part of LC amount to the seller to meet pre-shipment expenses is known as Red Clause Letter of Credit. The seller gives the receipt & an undertaking to present the documents before the LC expires. Advance amount would be adjusted from the proceeds of the export documents. However, the risk is assumed by the buyer. When the Red Clause LC provides for the cost of shortage facilities at the port of shipment in addition to the pre-shipment advance to the beneficiary it is called Green Clause LC. The goods are stored in the name of the issuing bank.e) Revolving LC: Under this, the issuing bank undertakes to restore the credit to the original amount after it has been utilized. Number of such utilization & the period of time by which this should take place are stipulated in the LC. On receipt of bill payment advise the LC amount gets reinstated.f) Transferable LCs: Transferable LC are transferable in whole or in part to one or more beneficiaries depending on the terms of LC. As per UCPDC stipulated in the LC, all LC are not transferable.g) Back to back LCs: When the bank opens new LCs against the backing of an LC received by a beneficiary having the first LC as security for the new LCs opened, the transaction is referred to as Back to Back. For example let us assume a customer A, who exports marine products by buying them from a number of suppliers. If A receives an LC for USD 100000 for shipment of marine products & he approaches the Bank for opening LCs in favour of his suppliers of marine products within the original value & in keeping with the terms of the original LC these new LCs are opened against the backing of the original LC. This is the back to back transaction. However, it may be noted that this arrangement is not under the provisions of UCPDC though the individual LCs are governed by it. BSPATIL
  36. 36. CREDIT APPRAISAL IN BANKING SECTOR Illustration for computation of LC limit M/S XYZ Co Ltd Letter of credit limit of Rs. 20 crore (Rs. in crores)Total purchase of raw material 172.64Purchase of raw materials under LC 69.41Average monthly purchase of raw material under LC (A) 5.78Average holding of imported raw materials (2.2 months’ consumption) 11.30Average usance period (B) 3 monthsLead time & transit period (C) 1 monthTotal of (B) & (C) (D) 4 monthsThe requirement of LC limit (A) * (D) 23.12Limit recommended say 23.00Explanatory notes: 1) While calculating the amount of raw materials purchases on LC basis, the following points need to be noted. (Amount in rupees) a) Raw material consumption BSPATIL
  37. 37. CREDIT APPRAISAL IN BANKING SECTOR b) Add: Closing stock of raw material c) Less: Opening stock of raw material d) Total Purchases during the period e) Purchases on LC basis as % of total purchases f) Purchases on LC basis in rupees g) Import duty payable, if any h) Purchases on LC basis net on import duty (CIF value) (f-g) 2) Transit time should be treated as ‘nil’ if usance period starts from shipment date.BANK GUARANTEESA contract of guarantee is defined as ‘a contract to perform the promise or discharge the liabilityof 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 executed b) 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 contract between the applicant & the beneficiary.Purpose of Bank GuaranteesBank Guarantees are used to for both both preventive & remedial purposes. The guaranteesexecuted by banks comprises 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 BSPATIL
  38. 38. CREDIT APPRAISAL IN BANKING SECTOR 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 realize the proceeds without waiting for warranty period to be over; f) To allow units to draw funds from time to time from the concerned indenters against part execution of contracts, etc. g) Bid bonds on behalf of exporters h) Export performance guarantees on behalf of exporters favouring the Customs Department under EPCG scheme.Guidelines on conduct of Bank Guarantee businessBranches, as a general rule, should limit themselves to the provision of financial guarantees &exercise due caution with regards to performance guarantee business. The subtle differencebetween the two types of guarantees is that under a financial guarantee, a bank guarantee’s acustomer financial worth, creditworthiness & his capacity to take up financial risks. In aperformance guarantee, the bank’s guarantee obligations relate to the performance relatedobligations of the applicant (customer).While issuing financial guarantees, it should be ensured that customers should be in a position toreimburse the Bank in case the Bank is required to make the payment under the guarantee. Incase of performance guarantee, branches should exercise due caution & have sufficientexperience with the customer to satisfy themselves that the customer has the necessaryexperience, capacity, expertise, & means to perform the obligations under the contract & anydefault is not likely to occur.Branches should not issue guarantees for a period more than 18 months without prior referenceto the controlling authority. Extant instructions stipulate an Administrative Clearance for issue ofBGs for a period in excess of 18 months. However, in cases where requests are received forextension of the period of BGs as long as the fresh period of extension is within 18 months. Nobank guarantee should normally have a maturity of more than 10 years. Bank guarantee beyondmaturity of 10 years may be considered against 100% cash margin with prior approval of thecontrolling authority.More than ordinary care is required to be executed while issuing guarantees on behalf ofcustomers who enjoy credit facilities with other banks. Unsecured guarantees, where furnished BSPATIL
  39. 39. CREDIT APPRAISAL IN BANKING SECTORby exception, should be for a short period & for relatively small amounts. All deferred paymentguarantee should ordinarily be secured.Appraisal of Bank Guarantee LimitProposals for guarantees shall be appraised with the same diligence as in the case of fund-baselimits. Branches may obtain adequate cover by way of margin & security so as to prevent defaulton payments when guarantees are invoked. Whenever an application for the issue of bankguarantee is received, branches should examine & satisfy themselves about the followingaspects: a) The need of the bank guarantee & whether it is related to the applicant’s normal trade/business. b) Whether the requirement is one time or on the regular basis c) The nature of bank guarantee i.e., financial or performance d) Applicant’s financial strength/ capacity to meet the liability/ obligation under the bank guarantee in case of invocation. e) Past record of the applicant in respect of bank guarantees issued earlier; e.g., instances of invocation of bank guarantees, the reasons thereof, the customer’s response to the invocation, etc. f) Present o/s on account of bank guarantees already issued g) Margin h) Collateral security offeredFormat of Bank GuaranteesBank guarantees should normally be issued on the format standardized by Indian BanksAssociation (IBA). When it is required to be issued on a format different from the IBA format, as BSPATIL
  40. 40. CREDIT APPRAISAL IN BANKING SECTORmay be demanded by some of the beneficiary Government departments, it should be ensured thatthe bank guarantee is a) for a definite period, b) for a definite objective enforceable on the happening of a definite event, c) for a specific amount d) in respect of bona fide trade/ commercial transactions, e) contains the Bank’s standard limitation clause f) not stipulating any onerous clause, & g) not containing any clause for automatic renewal of the bank guarantee on its expirySpecimen of the First Page of Bank Guarantee(To be stamped as an agreement in accordance with the Stamp Act in force) STATE BANK OF INDIA …………………….Branch (Stamp)Form No. ……….………………………………………………………….…………………………….…………………………….Dear Sir,Guarantee No.Amount of Guarantee Rs……………….Guarantee cover from 1.1.20*0 to 31.3.20*1Last date for lodgement of claim – 31.3.20*1This Deed of guarantee executed by the State Bank Of India constituted under the State Bank ofIndia Act, 1955 having its Central Office at Nariman Point, Mumbai & amongst other places, abranch at……………………………….(hereinafter referred to as ‘the Bank’) in favourof…………………………(hereinafter referred to as ‘the Beneficiary’) for an amount notexceeding Rs……………..(Rupees ……………………………………………………..only) atthe request of…………………….(hereinafter referred to as ‘the Contractor/(s)).This guarantee is issued subject to the condition that the liability of the bank under thisGuarantee is limited to a maximum of Rs. …………… (Rupees………………………..only) &the Guarantee shall remain in full force up to 31.3.20*1 (date of expiry) & cannot be invokedotherwise than by a written demand or claim under this Guarantee served on the Bank on or BSPATIL
  41. 41. CREDIT APPRAISAL IN BANKING SECTORbefore the 31.3.20*1, last date of claim).SUBJECT TO AS AFORESAID(Main Guarantee matter may be typed hereafter) 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 officers | Check for RBI defaulters list, willful defaulters list, CIBIL data, ECGC caution list, etc. |Title clearance reports of the properties to be obtained from empanelled advocates | Valuation 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 BSPATIL
  42. 42. CREDIT APPRAISAL IN BANKING SECTOR | Disbursement of loan | Post sanction activities such as receiving stock statements, review of accounts, renew of accounts, etc (on regular basis) CHAPTER-3 RESEARCH METHODOLOGYINTRODUCTION TO CREDIT APPRAISAL:Credit appraisal means an investigation/assessment done by the bank prior before providing anyloans & advances/project finance & also checks the commercial, financial & technical viabilityof the project proposed its funding pattern & further checks the primary & collateral securitycover available for recovery of such funds.PROBLEM STATEMENT:To study the Credit Appraisal System in SME sector, at State Bank of India (SBI), Ahmedabad.OBJECTIVES • To study the Credit Risk Assessment Models. • To observe the movements to reduce various risk parameters which are broadly BSPATIL
  43. 43. CREDIT APPRAISAL IN BANKING SECTOR categorized into financial risk, business risk, industrial risk & management risk. • To check the commercial, financial & technical viability of the project proposed & its funding pattern. • To check the primary & collateral security cover available for recovery of such funds.RESEARCH DESIGN - Analytical in natureCOVERAGEStudy of credit appraisal in banking sector at State Bank of India, AhmedabadDATA COLLECTION Secondary Data • Books & magazines • Database at SBI • Library research • Websites • E-circulars of SBILIMITATION OF STUDY • Due to the constraint limited study on the project has been done • Access to data ( Credit Appraisal data in detail is not available) BSPATIL
  44. 44. CREDIT APPRAISAL IN BANKING SECTOREXPECTED CONTRIBUTION OF THE STUDY:This study will help in understanding the credit appraisal system in banks & to reduce variousrisk parameters, which are broadly categorized into financial risk, business risk, industrial risk &management risk associated in providing any loans or advances or project finance. CHAPTER-4 INTRODUCTION OF SMESME BSPATIL
  45. 45. CREDIT APPRAISAL IN BANKING SECTOR4.1 Concept:The small-scale industries (SSI) produce about 8000 products, contribute 40% of the industrialoutput and offer the largest employment after agriculture. The sector, therefore, presents anopportunity to the nation to harness local competitive advantages for achieving globaldominance.4.2 From SSI to SME:Defining the New Paradigm2.1 Government policy as well as credit policy has so farconcentrated on manufacturing units in the small-scale sector. The lowering of trade barriersacross the globe has increased the minimum viable scale of enterprises. The size of the unit andtechnology employed for firms to be globally competitive is now of a higher order. Thedefinition of small-scale sector needs to be revisited and the policy should consider inclusion ofservices and trade sectors within its ambit. In keeping with global practice, there is also a need tobroaden the current concept of the sector and include the medium enterprises in a compositesector of Small and Medium Enterprises (SMEs). A comprehensive legislation, which wouldenable the paradigm shift from small-scale industry to small and medium enterprises underconsideration of Parliament. The Reserve Bank of India had meanwhile set up an Internal Groupwhich has recommended:” Current SSI/tiny industries definition may continue. Units withinvestment in plant and machinery in excess of SSI limit and up to Rs.10 crore may be treated asMedium Enterprises (ME). The definition may be reviewed after enactment of the Small andMedium Enterprises Development Bill.4.3 Definition of SMEs-“ At present, a small scale industrial unit is an undertaking in which investment in plant andmachinery, does not exceed Rs.1 crore, except in respect of certain specified items under hosiery, BSPATIL
  46. 46. CREDIT APPRAISAL IN BANKING SECTORhand tools, drugs and pharmaceuticals, stationery items and sports goods, where this investmentlimit has been enhanced to Rs 5 crore. Units with investment in plant and machinery in excessof SSI limit and up to Rs. 10 crore may be treated as Medium Enterprises (ME). “The Government of India has enacted the Micro, Small and Medium Enterprises Development(MSMED) Act 2006 which was notified on October 2, 2006. The definition of the small andmedium enterprises as provided in the Act (Annex VII) will have immediate effect.4.4 Eligibility criteria(i) These guidelines would be applicable to the following entities, which are viable orpotentially viable:a) All non-corporate SMEs irrespective of the level of dues to banks.b) All corporate SMEs, which are enjoying banking facilities from a single bank, irrespective ofthe level of dues to the bank.c) All corporate SMEs, which have funded and non-funded outstanding up to Rs.10 crore undermultiple/ consortium banking arrangement.(ii) Accounts involving willful default, fraud and malfeasance will not be eligible forrestructuring under these guidelines.(iii) Accounts classified by banks as “Loss Assets” will not be eligible for restructuring.(iv) In respect of BIFR cases banks should ensure completion of all formalities in seekingapproval from BIFR before implementing the package.SME: At present, a small scale industrial unit is an industrial undertaking in which investment inplant and machinery, does not exceed Rs.1 crore except in respect of certain specified itemsunder hosiery, hand tools, drugs and pharmaceuticals, stationery items and sports goods wherethis investment limit has been enhanced to Rs.5 crore. A comprehensive legislation which wouldenable the paradigm shift from small scale industry to small and medium enterprises is underconsideration of Parliament. Pending enactment of the above legislation, current SSI/tinyindustries definition may continue. Units with investment in plant and machinery in excess ofSSI limit and up to Rs.10 crore may be treated as Medium Enterprises (ME). Only SSI financingwill be included in Priority Sector.All banks may fix self-targets for financing to SME sector so as to reflect a higher disbursement BSPATIL
  47. 47. CREDIT APPRAISAL IN BANKING SECTORover the immediately preceding year, while the sub-targets for financing tiny units and smallerunits to the extent of 40% and 20% respectively may continue. Banks may arrange to compiledata on outstanding credit to SME sector as on March 31, 2005 as per new definition and alsoshowing the break up separately for tiny, small and medium enterprises.Banks may initiate necessary steps to rationalize the cost of loans to SME sector by adopting atransparent rating system with cost of credit being linked to the credit rating of enterprise.SIDBI has developed a Credit Appraisal & Rating Tool (CART) as well as a Risk AssessmentModel (RAM) and a comprehensive rating model for risk assessment of proposals for SMEs.The banks may consider to take advantage of these models as appropriate and reduce theirtransaction costs.In order to increase the outreach of formal credit to the SME sector, all banks, includingRegional Rural Banks may make concerted efforts to provide credit cover on an average to atleast 5 new small/medium enterprises at each of their semi urban/urban branches per year.A debt restructuring mechanism for nursing of sick units in SME sector and a One TimeSettlement (OTS) Scheme for small scale NPA accounts in the books of the banks as on March31, 2004 are being introduced.4.5 CHALLENGES FACED BY SME:The challenges being faced by the small and medium sector may be briefly set out as follows-a) Small and Medium Enterprises (SME), particularly the tiny segment of the small enterpriseshave inadequate access to finance due to lack of financial information and non-formal businesspractices. SMEs also lack access to private equity and venture capital and have a very limitedaccess to secondary market instruments.b) SMEs face fragmented markets in respect of their inputs as well as products and arevulnerable to market fluctuations.c) SMEs lack easy access to inter-state and international markets.d) The access of SMEs to technology and product innovations is also limited. There is lack ofawareness of global best practices.e) SMEs face considerable delays in the settlement of dues/payment of bills by the large scalebuyers. With the deregulation of the financial sector, the ability of the banks to service the creditrequirements of the SME sector depends on the underlying transaction costs, efficient recovery BSPATIL
  48. 48. CREDIT APPRAISAL IN BANKING SECTORprocesses and available security. There is an immediate need for the banking sector to focus oncredit and SMEs. CHAPTER-5 CREDIT RISK ASSESSMENTFOR A BANK, WHAT IS RISK? • Risk is inability or unwillingness of borrower-customer or counter-party to meet their repayment obligations/ honor their commitments, as per the stipulated terms.LENDER’ TASK • Identify the risk factors, and • Mitigate the riskHOW DOES RISK ARISE IN CREDIT?In the business world, Risk arises out of • Deficiencies / lapses on the part of the management (Internal factor) • Uncertainties in the business environment (External factor) • Uncertainties in the industrial environment (External factor) • Weakness in the financial position (Internal factor)To put in another way, success factors behind a business are: - • Managerial ability • Favorable business environment • Favorable industrial environment BSPATIL
  49. 49. CREDIT APPRAISAL IN BANKING SECTOR • Adequate financial strengthAs such, these are the broad risk categories or risk factors built into our CRA models. CRA takesinto account the above types of risks associated with the borrowal unit. The eventual CRA ratingawarded to a unit (based on a score of 100) is a single-point risk indicator of an individual creditexposure, & is used to indentify, to measure & to monitor the credit risk of an individualproposal. At the corporate level, CRA is also used to track the quality of Bank’s credit portfolio.CREDIT & RISK • Go hand in hand. • They are like twin brothers. • They can be compared to two sides of the same coin. • All credit proposals have some inherent risks, excepting the almost negligible volume of lending against liquid collaterals with adequate margin.LENDING DESPITE RISKS: • So, risk should not deter a Banker from lending. • A banker’s task is to identify/ assess the risk factors/ parameters & manage / mitigate them on a continuous basis. • But it’s always prudent to have some idea about the degree of risk associated with any credit proposal. • The banker has to take a calculated risk, based on risk-absorption/ risk-hedging capacity & risk-mitigation techniques of the Bank. BSPATIL
  50. 50. CREDIT APPRAISAL IN BANKING SECTORIMPORTANCE OF CREDIT RISK ASSESSMENTCredit is a core activity of banks & an important source of their earnings, which go to payinterest to depositors, salaries to employees & dividend to shareholdersIn credit, it is not enough that we have sizable growth in quantity/ volume, it is also necessary toensure that we have only good quality growth.To ensure asset quality, proper risk assessment right at the beginning, that is, at the time oftaking an exposure, is extremely important.Moreover, with the implementation of Basle-II accord4, capital has to be allocated for loan assetsdepending on the risk perception/ rating of respective assets. It is, therefore, extremely importantfor every bank to have a clear assessment of risks of the loan assets it creates, to become Basle-IIcompliant.That is why Credit Risk Assessment (CRA) system is an essential ingredient of the CreditAppraisal exercise.INDIAN SCENARIO: • In Indian banks, there was no systematic method of Credit Risk Assessment till late 1980’s/ early 1990’s. • Health Code System (1985) / IRAC norms (1993) are Asset (loan) classification systems, not CRA systems. • RBI came out with its guidelines on Risk Management Systems in Banks in 1999 & Guidance Note on Management of Credit in October, 2002.SBI SCENARIO:However, like in many other fields, in the field of Credit Risk Assessment too, our Bank played aproactive & pioneering role. We had our Credit Rating System (CRA) in 1988. Then, the CRAsystem was introduced in the Bank in 1996. The first CRA model was rolled out in 1996 to takecare of exposures to the C & I (Manufacturing) segment. Thereafter, separate models for SSI &AGL segments were introduced in 1998, when the C&I (Mfg) CRA model was developed forNon Banking Finance Companies (NBFCs). BSPATIL
  51. 51. CREDIT APPRAISAL IN BANKING SECTORAs of now, in SBI, CRA is the most important component of the Credit Appraisal exercise for allexposures > 25 lacs & a very important tool in decision-making (a Decision Support System) aswell as in pricing. The review of the existing CRA Model for NBFCs is under process.CREDIT RISK ASSESSMENT (CRA) – MINIMUM SCORES / HURDLE RATES 1. The CRA models adopted by the Bank take into account all possible factors which go into appraising the risks associated with a loan. These have been categorized broadly into financial, business, industrial & management risks and are rated separately. To arrive at the overall risk rating, the factors duly weighted are aggregated & calibrated to arrive at a single point indicator of risk associated with the credit decision. 2. Financial parameters: The assessment of financial risk involves appraisal of the financial strength of the borrower based on performance & financial indicators. The overall financial risk is assessed in terms of static ratios, future prospects & risk mitigation (collateral security / financial standing). 3. Industry parameters: The following characteristics of an industry which pose varying degrees of risk are built into Bank’s CRA model: • Competition • Industry outlook • Regulatory risk • Contemporary issues like WTO etc. 4. Management parameters: The management of an enterprise / group is rated on the following parameters: • Integrity (corporate governance) • Track record • Managerial competence / commitment • Expertise • Structure & systems BSPATIL
  52. 52. CREDIT APPRAISAL IN BANKING SECTOR • Experience in the industry • Credibility : ability to meet sales projections • Credibility : ability to meet profit (PAT) projections • Payment record • Strategic initiatives • Length of relationship with the Bank 5. The risk parameters as mentioned above are individually scored to arrive at an aggregate score of 100 (subject to qualitative factors – negative parameters). The overall score thus obtained (out of a max. of 100) is rated on a 8 point scale from SB1/SBTL1 to SB 8 /SBTL8.SALIENT FEATURES OF CRA MODELS:(a) Type of Models S. Exposure Level (FB + NFB Non – Trading Sector Trading SectorNo. Limits ) (C&I , SSI , AGL) ( Trade & Services)(i) Over Rs. 5.00 crore Regular Model Regular Model(ii) Rs 0.25 crore to Rs. 5.00 crore Simplified Model Simplified Model(b) Type of RatingsS. No. Model Type of Rating(i) Regular Model Borrower Rating Facility Rating(ii) Simplified Model Borrower Rating BSPATIL
  53. 53. CREDIT APPRAISAL IN BANKING SECTORNew Rating Scales – Borrower Rating: 16 Rating Grades There are different rating given to the different banks. For exampleS. Borrower Range of Risk level Comfort LevelNo. Rating scores 1 SB1 94-100 Virtually Zero risk Virtually Absolute safety 2 SB2 90-93 Lowest Risk Highest safety 3 SB3 86-89 Lower Risk Higher safety 4 SB4 81-85 Low Risk High safety 5 SB5 76-80 Moderate Risk with Adequate safety Adequate Cushion 6 SB6 70-75 Moderate Risk Moderate Safety 7 SB7 64-69 8 SB8 57-63 Average risk Above Safety Threshold 9 SB9 50-56 10 SB10 45-49 Acceptable Risk Safety Threshold (Risk Tolerance Threshold) 11 SB11 40-44 Borderline risk Inadequate safety 12 SB12 35-39 High Risk Low safety 13 SB13 30-34 Higher risk Lower safety 14 SB14 25-29 Substantial risk Lowest safety 15 SB15 <24 Pre-Default Risk (extremely Nil Vulnerable to default) 16 SB16 - Default GradeBank has introduced New Rating Scales for borrower for giving loans. Rating is given on thebasis of scores out of 100. Bank gives loans to the borrower as per their rating like SBI givesloans to the borrower up to SB8 rating as it has average risk till SB8 rating. From SB9 rating therisk increases. So banks does not give loans after SB8 rating.New Rating Scales - Facility Rating : 16 Rating Grades BSPATIL

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