CBCHPP07- Funded Services

8/13/2019 CBCHPP07- Funded Services

1/40

CORPORATE BANKING

FUNDED SERVICES

Lending/AdvancesCB-CHPP07


2/40

Business of Lending/Advances

Banking is

the acceptance for the purpose of lending or investment, of depositsf rom publi c, repayable on demand or otherwise, and withdrawal by

cheque, draft, order or otherwise.

Banking is accepting deposits to lend.

Lending money can be profitable but is risky.

As return on loans is usually better than the return banks receive oninvestments, a large portion of the deposits of a bank is given out asadvances or loans to its customers.

Credit risk is the risk of repayment and adversely affect earnings andcapital.

Credit risk applies to loans, derivatives, foreign exchange transactions, theinvestment portfolio and other financial activities.

There is increasing competition in lending, due to expectation of highreturns, also from non-bank financial firms.


3/40

Schedule Commercial Banks Portfolio% share by credit-type

Credit Type

For Year

Annual Average

FY 1991-2001

Annual Average

FY 2002-2008 Yr. 2007-2008Cash Credit 35.07% 21.03% 16.80%

Overdraft 7.33% 5.25% 4.87%

Demand Loan 8.99% 10.80% 10.06%

Medium Term Loan 8.16% 12.00% 15.85%

Long Term Loan 22.13% 40.20% 44.40%

Inland Bills 6.18% 2.98% 2.25%

Others 12.14% 7.74% 5.77%


4/40

Corporate Credit Deleveraging

Heightened concern about default/delay by trade debtors and inordinately

high cash discount rates bolster strong preference for B2B transactions andshorter credit period in recent years.

These contributed to reduced level working capital requirement of

corporate from banks, resulting into under utilization of bank credit.

Further, the gap in level of credit limit utilization vis--vis credit limit

available in respect of credit limits of Rs. 25 crores have widenedconsiderably in recent years.

There are structural changes of systemic importance in the fund flow

matrix of large companies. Deposits/advances from customers and

security/trade/dealer deposits have increased by 14.9 times and 8.2 times

respectively, despite lower increase of 3.9 times in inventories. Small business liquidity is further strained as their purchases from large

corporate are generally on cash/advance payment basis, where as their sales

are generally on credit.


5/40

Ways to make Loans

Seven ways are:

Solicit Loans

Buying Loans

CommitmentsCustomer -request Loan

Loan Brokers

Overdrafts

Refinancing

Collecting Loans


6/40

Principal Lending Activities

The principal lending activities include loans and leases.

The types of loans are classified as;

Line of Credit

Revolving Loan

Term Loan

Bridge Loan

Asset-Based Lending

Characteristics of Good Collateral (a secondary source of repayment)

Durability, Identification, Marketability, Stability of value & Standardizationdetermine the suitability for use as collateral.

Types of CollateralAccounts receivable (* Pledging * Factoring * Bankers acceptance)

Inventory -- Marketable Securities

Real Property & Equipment -- Guarantees


7/40

Lending Process

Evaluating a Loan request involves 6 Cs of credit:-

Character

Capacity

CapitalCollateral

Conditions

Apply to borrower

Compliance

Applies to lender


8/40

Case relating to Compliance

A bank made a one-year $800,000 first mortgage loan to Panamanian

corporation.

The loan was collateralized with a $1.1 million home owned by the

corporation.

After the loan was made, the Government seized the property, on basis of a

investigation discovery that the Corporation was owned by a drug trafficker,

claiming that there is all probability that the house was purchased with the

proceeds from illegal drug sales.

Under Federal Laws, property that has been purchased with laundered

money is subject to government seizure and forfeiture, even if it is collateral

to a bank loan.

In a reference to judiciary, the court ruled that that the bank was willfullyblind to a number of obvious facts that should have been taken into account

in making the loan.

Sole asset of the corporation was the property, which was vacant and up for

sale.Purpose of loan and how it was going to be repaid are not known.

Bank lost the amount along with attorney fees.


9/40

Structuring

Loans that are made are either:

# Secured# Unsecured

# Partly Secured

All commercial Loans have following elements:

a) The type of credit facility and amount to be borrowed

b) The term of the loan

c) The method and timing of repayment

d) Interest rates (fixed/floating) and fees

e) Collateral if required

f) Covenants or promises


10/40

Pricing

One key element in the process of commercial lending is loan pricing.

There arenominal interest ratesthe interest rate that is stated in loan agreement.

effective yield which takes into account the payment accrual

basis and the payment frequency basis.

Loan Pricing: When profit margins are wafer thin, precise estimates of cost

are necessary to price loans correctly, taking into account risk, costs andreturns.

Return on net funds employed:

Marginal cost of funds + Profit Goal =

(Loan incomeLoan expense) / Net Bank Funds employed

Requir ed rate of return: Weighted average cost of capital of new funds =

cost of interest bearing liabilities (1--corporate tax rate)x ratio of liabilities

to assets + cost of equity (1ratio of liabilities to assets)

Marginal cost of funds is the rate of return required by debt and equity

investors on newly issued funds. Marginal cost of capital is WACC.


11/40

Profit Goal The cost of capital takes into account the average risk of bank.

The profit goal must consider the specific risk of each loan.

Liquidity, measured in terms of years, must also be considered when

evaluating the profit goal.

Profit goal increases with the risk and the maturity of the loan.

Loan Expense includes all direct and indirect costs associated with making,

servicing, and collecting loan.(using cost accounting data) Net Bank Funds Employed is the average amount of the loan over its life,

less funds provided by the borrower, net of Central Bank Reserve System

reserve requirements.

Relationship Pricing Under this, the rate charged on a loan may differ from

rate indicated by loan pricing model, since the projected cash flow from eachservice, including loan, should be adjusted to take risks into account.

Minimum SpreadSome banks price loans by deterring the minimum spread

they will accept between their lending rate and their cost plus profit margin.


12/40

Other Pricings

Average cost versus Marginal Cost

The costs include the cost of funds and operating costs.As regards cost of funds, bank has to decide whether to use average cost of

funds or marginal cost of funds. These two costs appear same but not

necessarily.

When market rates of interest are rising, the bank is better off using the

marginal cost of funds, because it is higher than average cost of funds.When market rates of interest are falling, it is better using average cost of

funds, which is higher than the marginal cost.

If the bank views of the deposits as a pool of funds used to finance loans,

the marginal cost of funds including cost of equity should be considered.

* Performance Pricing: The price of the loan reflects the riskiness of theborrower. The price can be tied to specific financial ratios, the amount of

the loan outstanding or other criteria.


13/40

Charge

It is a legal right on the assets that have been given by borrower as security

for a loan/advance/facility. Kinds of Charge are:

1. Lien - a right to retain property pledged till payment is made. Banks also

obtain a negative lien.

2. Pledge- bailment of goods (movable property) as security for payment of a

debt or performance of a promise. Ownership continues with pledger.3. Hypothecationis a charge against movable property for an amount of

debt where neither ownership nor possession is passed on to creditor.

Borrower executes a Letter of Hypothecation

4. MortgageWhen a customer offers immovable property like land and

building as security for a loan charge thereon is created by means of amortgage. Ownership is not transferred. Types of mortgages are:

Simple Mortgage, Mortgage by conditional sale , Usufructuary mortgage,

English Mortgage, By deposit of title deeds or equitable mortgage,

Anomalous mortgage, sub-mortgage.


14/40

Charge-2

Assignmenttransfer of a right, property or debtpresent or future.

Borrowers normally assign [Book-debts ; Money due from Government or

[semi-government organizations.

Types of Assignments are: Legal or Equitable

Trust ReceiptCustomer holds goods (separately) in trust for the bank.

Charge is classified as {First Charge, Second Charge,{Pari-passu and Floating charge

Factors to be checked by banker while taking charge are:

Ready conversion Return or YieldNo Encumbrance Margin

Stable Price Valuation

Safety Other aspects


15/40


16/40

Stipulations of RBI

There are certain stipulations of the Reserve Bank of India regarding

lending, in respect of following:

1. Priority sector lending

2. Export Credit

3. Exposure norms

4. Restrictions on advances

5. Income recognition

These are extremely important for a banker.


17/40

Cash Credit

Finance given to purchase goods/manufacture goods for sale and finance

debtors is known as cash credit.

Banker fixes the cash credit limit after taking into account several features

of working of borrowing concern such as:

Production -- Sales -- Inventory -- past utilization etc.

The limits are sanctioned on a year-to-year basis and reviewed periodically.

Drawing power against inventory/ debtors, which are current , is fixed andcustomer is expected to finance remaining amount.

There are three methods used.

MPBF method --- Tandon Committee --- with three alternatives.

Turnover methodNayak Committee recommendations.

Client prepares a projected cash budget and bank assesses quantum of

working capital required and monitors disbursements.Kannan Committee

recommended this method for W.C. up to Rs.5 Crores


18/40

Cash Credit -2

Drawing Power : In order to ensure that clients have adequate finance, but

not more than they need, banks call for statements periodically, giving

position of stocks and debtors, on basis of which drawing power is arrived

at, after providing for the stipulated margin.

Interest is charged on actual amount utilized by the customer.

The loan is technically repayable on demand and there is therefore no

defined date of payment.

Raneegunj Coal Association and another vs Union Bank of India and

others.

In this case, Supreme Court has described Cash Credit as

Cash Credit is a drawing account against credit granted by a bank and is

operated in exactly the same way as a current account on which anoverdraft has been sanctioned. Since it is in the nature of a current account,

no interest is payable in this account

Such accounts are opened only by traders, industrial units and other

business units.


19/40

Cash Credit -3

Hypothecation:

As cash credit is financed against stocks and debtors, these are usually

hypothecated to the bank. If the customer defaults, the bank can seize the

assets hypothecated and sell them to third parties to realize the amounts

due. The margin stipulated becomes cushion in case the bank does not

realize real value due to distress sale.

Commitment charge:

This existed for two purposes: to encourage proper management of funds

by banks and bring about better discipline in availing finance by

borrowers.

W.e.f. 01-07-1996, RBI has advised banks to evolve their own guidelines

to ensure credit discipline. Levying of a commitment charge now dependson the individual banks.

There are both Advantages & Disadvantages in extending/availing this

facility.


20/40

Overdrafts

When a financial accommodation is extended to a customer and he is

allowed to withdraw more than the balance in his current account, resulting

in indebtedness to bank, such indebtedness or advance is known asOverdraft.

Overdraft can be temporary or a regular arrangement and can be secured or

unsecured.

Customer is required to pay interest only on the amount actually overdrawn

in the account and they are running accounts like cash-credit.

Overdrafts are repayable on demand.

Bank of Maharashtra vs. M/s United Construction Co. and others:

Bombay High Court concluded in this case that there is an implied

agreement by stating where a customer is having a current account in abank, even without any express grant of overdraft facility, overdraws on his

account and the cheques issued by him are honoured, without there being

sufficient balance in the account, the transaction amounts to loan and the

customer is bound to make good the loan to bank with reasonable interest.


21/40

Overdraft- 2Indian Overseas Bank, Madras and Another vs. M/s Naranprasad

Govindlal Patel

It was held in this case that an overdraft arrangement between bank and its

customer, although called facility, is nothing but a contract and cannot be

terminated by the bank unilaterally even though it is temporary one.

The court held that bank is liable for damages. Any cheque issued prior to

receipt of information from bank must be honored.

Interest

Interest is charged on the amount overdrawn for the period overdraft exists.

Interest is charged monthly. Bank can charge compound interest at a monthly

rate on overdraft amount, even without an agreement.

SecurityAn overdraft facil ity is sanctioned against paper secur ities.( shares,

l .I .C.policies, bonds and other government secur ities), whereas cash credit

is sanctioned against stocks and debtors.

Overdrafts may be Secured and Unsecured.

LOANS


22/40

LOANS

purchase of premises,capital assets, setting

expansion of factory

etc.

no cheque book issued

no debits allowed

except interest,

charges, insurance premium etc.

Loans are advances

For a specific period

For a definite purpose

Repayable in installments

or balloon payments

Not a running account

Interest charged on

actual balance

Operating

costs low


23/40

Types of LoansLoans can be classified as:

Short Term Loan #Loans for a period of less than a year

to meet working capital needsagainst tangible security goods, shares etc. Medium and Long Term Loan #For a period in excess of one year

extended for purchase of capital goods/ for capital expendituresecured by

asset purchasedlarge amounts financed jointly with other financial

institutions.

Bridge Loan #Short term loanssanctioned to bridgecash flowsgranted to industrial undertakings to meet urgent & essential

needsRBI stipulates certain conditions for these loans.

Composite Loan #Granted for buying both for capital

assets and for working capital purposes usually granted to small borrowers

Consumption Loan #provided for personal needs such asmedical expenses, marriage expenses, education loans, car loans,

professional loans etc and also for consumer durable goods.

Demand Loan #repayable on demandbanks own

time deposits, NSCs, and other securities. Bank has a right to recall loan any

time and in case of default can dispose of securities pledged.


24/40

Other aspects of Loans

Interest: Interest is charged at monthly rests.

Term Loans and working capital advances are to be clubbed to

determine size of Loan and rate of interest.

BPLR (benchmark prime lending rate) is determined by

Actual cost of funds,

Operating expenses &

Minimum margin for provision/capital charge and profit margin.Banks are free to charge a rate of interest based on customers

credit worthiness and BPLR, except in cases of loans up to Rs.2

lakhs (BPLR) and on export credit (not exceeding BPLR minus

2.5%).

Advantages:- Periodical installments payable on Loans and yearly review ofadvance ensures a discipline on borrower,

Easy to manage and documentation is comprehensive.

Disadvantage:- Bank has no control on end use of Loans.


25/40

RBI notification on 15-11-2010

Banks are required to disclose all in cost involved in processing/sanction

of loan application in a transparent manner.

With a view to bring in fairness and transparency, banks have been told to

disclose to borrowers all information about

Fees/charges payable for processing the loan application

The amount of fees refundable if loan amount is not sanctioned/disbursed

Pre-payment options and charges, if any Penalty for delayed repayments, if any

Conversion charges for switching loan from fixed to floating rates and

vice-versa

Existence of any interest reset clause and

any other matter which affects the interest of the borrower.

All information relating to processing fees/charges should also be displayed

in the Web site of the Banks for all categories of LOANS.


26/40

Bill Discounting This type of advances (discounting bills of exchange) are short-term and self

liquidating by nature.

A bill of exchange is:

an instrument in writing containing an unconditional order, signed by the

maker directing a certain person to pay a certain sum of money to or to the

order of certain persons or to bearer of the instrument.

Buyer gets some time to make payment.

Seller can, if he requires, have bill discounted and obtain cash.

Bank or any one who discounts the bill gets good title provided he discounts

/buys the bill in good faith, for consideration and without being aware of

any defect in the title of the personfrom whom the bill was purchased.

Types of Bills of Exchange Classification of B. E.

Sight or Demand Bills Documentary Bills

Usance Bills Clean Bills


27/40

Purchase/discounting of Bills

When a seller (creditor) of the goods draws a bill on the buyer (debtor), the

banker can purchase/discount the bill at the request of the drawer and lend

its own funds before realization of the bill. Banker credits the account withthe amount of the bill after deducting its charges or discount.

In case of demand bills, that are payable on demand (presentation),

discounting is known as purchase of bills.

In case of usance bills (bill that matures after a specified period of time),

where the banker has to hold the bill, after acceptance, until due date, thepractice of funding is called discounting of the bill. The discount includes

interest on the amount lent in addition to other charges/expenses.

Bankers Position

Keshari Chand vs. Shi l long Banking Corporation

Supreme Court held in the above case that:

Under collection arrangement, the banker is bound to act according to

directions given by the customer, since he acts as his agent. In absence of

such directions, banker is bound to use reasonable skill and diligence in his

work and acts in accordance with usage prevailing at the place of business.


28/40

Discounting of bills and advantagesDena Bank vs. M .P. National Texti les Corporation L td.

Madhya Pradesh High Court held in this case that:

In case of the bills and the relevant documents purchased or discounted bybanker, it is the responsibility of the bank to collect the amount of bills from

the drawee and to reimburse itself. If payment is refused by the drawee

banker can present the documents back to the drawer and collect the value

thereof.

Advantages of discounting of bills: Safety of funds of the bankbill being a negotiable legal instrument

considered good.

Certainty of Paymentideal self liquidating asset, i.e. semi-liquid assets.

Facility of refinanceIn case of need for funds, bill can be discounted with

Central Bank or any other bank.

Stability in valueAmount payable on bill is fixed and does not fluctuate in

value like other tangible assets.

ProfitabilityEarns discounting interest and exchange/fees for transaction.

Accommodation Bills:Not to be discounted, as there is no consideration.


29/40

Priority Sector Advances

The different segments of priority sectors are:-

Agr iculture (direct and I ndir ect f inance) :- Finance for agriculture andallied activities for short, medium or long term, directly to individual

farmers, SHGs, JLGs, or to others (corporate, partnership firms or

institutions.)

Indirect finance for agricultural machinery, implements or for construction

of cold storage, warehouse, tractors, well boring equipment etc. Small Enterprises (Di rect & I ndir ect F inance) :- Finance to small

enterprises i.e. loans to micro and small enterprises engaged in

manufacture/production, processing or preservation and rendering of

services. These include small road & water transport operators, small

business, professional and self-employed persons etc.Indirect finance to any person providing inputs to or marketing the output

of artisans etc.


30/40

Priority Sector Advances-2

Retail Trade: Traders dealing in essential commodities, and

consumer co-operative stores. Micro Credit:-Lending small amounts, not exceeding Rs

50,000 per borrower either directly or indirectly, constitute

micro credit.

Education Loans: Granted for studies in India up to 10 lakhsand up to 20 lakhs for studies abroad.

Housing Loans: Loans up to Rs 20 laks for a dwelling

(purchase/ construction) and for repairs up to Rs 1 lakh in

rural and semi urban areas and Rs.2 lakhs ( urban andmetropolitan areas)

Export Finance is not treated as priority sector, in case of

Indian Banks.


31/40

Priority Sector Advances-3

Others: (i) Investments in securitized assets, representing loans to

various categories of priority sector,

(ii) Outright purchases of any loan asset eligible to be categorized

under priority sector and

(iii) Investments by banks in Inter Bank Participation Certificates,

on a risk sharing basis, if underlying assets are eligible under

priority sector

are eligible to be classified under priority sector.

* ANBC: Targets and sub-targets under priority sector are linked to Adjusted

Net Bank Credit, which is arrived at as under:

(a)Net Bank Credit plus Investments made by banks in non-SLR

bonds held in held-to-maturity (HTM) categoryor

(b) Credit equivalent amount of Off-Balance Sheet Exposures

(OBE)

which ever is higher as on March 31 of the previous year.


32/40

Priority Sector Advances-4 Targets fixed for all scheduled commercial banks, excluding foreign banks, in

lending to priority sector is 40% of ANBC, with sub-targets as under:-

18% of ANBC goes to agricultural of which indirect category not toexceed 4.5%.

10% of ANBC goes to weaker sections (or 25% of priority sector

advances)

1% of previous years total advances are to given under DRI scheme

(differential rate of interest) with sub-limit that 40% of DRIamount goes to SC/ST categories and 66- 2/3% through rural and semi-urban

branches.

40% of total credit to SSI goes to cottage industries, tiny industries, artisans etc.

with investment in plant & machinery not exceeding Rs.5 lakhs.

20% of SSI credit goes to SSI units with investment between Rs.5 lakhs to Rs.

25 lakhs.

Remaining 40% goes to SSI units with investment exceeding Rs.25 lakhs.

Targets for Foreign Banks is 32% of ANBC or credit equivalent of Off balance

sheet exposure, whichever is higher. Advances to SSI should not be less than 10%

of ANBC. and to Export Credit should not be less than 12% of ANBC.


33/40

Export Credit

Advances are made by banks both as

pre-shipment expor t credit

and

post shipment expor t credit.

These advances can be either in

rupees

or

in foreign cur rency.


34/40

Export credit-2

Pre-shipment/packing credit means any loan or advance granted or any

other credit provided by a bank to any exporter

--for financing the purchase, processing, manufacturing or

packing of goods prior to shipment

-- for working capital expenses towards rendering of

services

on the basis of L/C opened in his favour or some other person by an

overseas buyer or

on basis of confirmed and irrevocable order for export of goods/services.

Post-shipment credit means any loan or advances granted or any other

credit provided by a bank to an exporter of goods/services,

after shipment of goods/services to date of realization ofexport proceeds and includes

any loan or advance granted to exporter in

consideration of or on security of any Duty Drawback

allowed by the Government from time to time.


35/40

Rupee Export Credit

Pre-shipment Credit/ Packing Credit

Period of Advance -- The period should be sufficient to enable the

exporter to ship the goods/render the services.

-- If pre-shipment advance is not adjusted by

submission of export documents within 360 days

from date of advance, concessional rate of interest

will cease ab initio.

-- RBI would provide refinance only for a period not

exceeding 180 days

Disbursement -- A separate account is maintained to monitor period

of sanction and end-use of funds.

-- Funds are disbursed in one lump sum or in stagesdepending upon need and as per contract or L.C

-- Banks may maintain different accounts at various

stages. Banks should ensure that accounts are

adjusted by transfer of funds from one account to

other until exported. End-use should be for exports.


36/40

Pre-shipment Credit/ Packing Credit

Liquidation of Packing Credit

The advance should be liquidated out of the proceeds of export bills of theproduct/services by purchase or discount.

It can also be repaid/prepaid out of balances in EEFC account or from

rupee resources of exporter to extent exports have actually taken place.

If not so liquidated/repaid banks are free to decide the rate of interest.

Value difference:-If export bills are not of equivalent value for liquidating Packing Credit,

excess packing credit can be adjusted by export of those bye-products.

When larger quantity of raw materials (agro) are purchased for manufacture

non-exportable produce can be sold locally. However, banks will charge

commercial rate of interest on the shortfall. No refinance will be availablefrom RBI.

Banks can grant Packing Credit advance to exporters to extent of value of

raw materials required, even if it exceeds value of export order. Excess is to

be adjusted in 30 days, to become eligible for concession rate of interest.


37/40

Running account facility

Packing Credits are generally granted against L.Cs or firm export orders.

In anticipation of receipt of LCs or firm export orders, banks have beenauthorised to extend pre-shipment credit running account facility in respect

of any commodity. However, Running account facility should not be granted

to granted

Proceeds of cheques, drafts etc, representing advance payment for exports can

also be utilized. Banks can extend credit to manufacturers of specific sectors/segments, who

do not have any L.Cs/export orders, if goods are exported through

STC/MMTC or other export houses.

P.C. can be shared between Export Order Holder and sub-supplier of raw

materials etc as in case of EOH and manufacturer supplier. P.Cs. May be given to construction contractors to meet initial working capital

requirements, to meet preliminary expenses.

Pre-shipment credit facilities are also granted against consultancy agreements

for meeting expenses.


38/40


39/40


40/40

Other Matters

ECGC post-shipment guarantee scheme

Deemed Exports

Gold Card Scheme

Interest:

A ceiling has been prescribed for rupee export credit linked to BPLRs and

banks decide actual rates within this ceiling.

In case of ECNOS, banks can decide rate of interest keeping in view BPLR

and spread guidelines.

Banks should charge interest on pre-shipment credit up to 270 days on basis

of ceiling rate arrived at on basis of BPLR relevant for export credit.

Advances cease to qualify for concession rate beyond 360 days.Export bills &

Overdue Bills

Date post:	04-Jun-2018
Category:	Documents
Upload:	prakash-sharma
View:	218 times
Download:	0 times

CBCHPP07- Funded Services

Documents