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Chapter 07 credit process in banks


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Chapter 07 credit process in banks

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