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RESEARCH METHODOLOGY
Introduction to Credit Appraisal:
Credit appraisal means an investigation/assessment done by the bank prior before providing any loans &
advances/project finance & also checks the commercial, financial & technical viability of the project
proposed its funding pattern & further checks the primary & collateral security cover available for
recovery of such funds.
Problem Statement:
To study the Credit Appraisal System in SME sector, at State Bank of India (SBI), Uttarsanda.
Objectives:
To study the Credit Appraisal Methods.
To understand the commercial, financial & technical viability of the project proposed & its
funding pattern.
To understand the pattern for primary & collateral security cover available for recovery of such
funds.
Research Design:
Analytical in nature
Data Collection:
Primary Data:
Informal interviews with Branch Manager and other staff members at SBI bank.
E-circulars of SBI
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Secondary Data:
Books and magazines
Database at SBI
Internal reports of the banks
Library research
Websites
Expected contribution of the study:
This study will help in understanding the credit appraisal system at SBI & to understand how to reduce
various risk parameters, which are broadly categorized into financial risk, business risk, industrial risk &management risk associated in providing any loans or advances or project finance.
Beneficiaries:
Researcher:
This report will help researcher in improving knowledge about the credit appraisal system and to have
practical exposure of the credit appraisal scenario in SBI .
Management student:
The project will help the management student to know the patterns of credit appraisal in SBI
bank.
SBI Bank:
The project will help bank in reducing the credit risk parameters and to improve its efficiencies.
It will also help to reduce risk associated in providing any loans & advances or project finance in
future and to overcome the loopholes.
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Short write-up on the researcher and reason for taking up the project:
The researcher are MBA 2nd year students, studying in N.R.INSTITUTE OF BUSINESS
MANAGEMENT(GLS),AHMEDABAD.
The reason for taking up the project is to know and understand the credit appraisal system in
banking sector.
Credit appraisal is the major focus of banking industries these days, so the project will help in
understanding and analyzing the situation prevailing currently.
Limitations of the study:
As the credit rating is one of the crucial areas for any bank, some of the technicalities are not
revealed which may have cause destruction to the information and our exploration of the problem.
As some of the information is not revealed, whatever suggestions generated, are based on certain
assumptions.
Credit appraisal system includes various types of detail studies for different areas of analysis, but
due to time constraint, our analysis was of limited areas only.
CHAPTER-1
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INTRODUCTION TO BANKING SECTOR AND SBI
A snapshot of the banking industry:
The Reserve Bank of India (RBI), as the central bank of the country, closely monitors
developments in the whole financial sector.
The banking sector is dominated by Scheduled Commercial Banks (SBCs). As at end-March 2002, there
were 296 Commercial banks operating in India. This included 27 Public Sector Banks (PSBs), 31 Private,
42 Foreign and 196 Regional Rural Banks. Also, there were 67 scheduled co-operative banks consisting
of 51 scheduled urban co-operative banks and 16 scheduled 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 the earlier year.
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 and group 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 of banks to
absorb losses and the ratio has subsequently been raised from 8% to 9%. It is proposed to hike the CAR to
12% by 2004 based on the Basle Committee recommendations.
Retail Banking is the new mantra in the banking sector. The home loans alone account for nearly two-
third of the total retail portfolio of the bank. According to one estimate, the retail segment is expected to
grow at 30-40% in the coming years.
Net banking, phone banking, mobile banking, ATMs and bill payments are the new buzz words that 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 are the promoters of the CIBIL.
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The RBI is now planning to transfer of its stakes in the SBI, NHB and National bank for Agricultural and
Rural Development to the private players. Also, the Government has sought to lower its holding in PSBs
to a minimum of 33% of total capital by allowing them to raise capital from the market.
Banks are free to acquire shares, convertible debentures of corporate and units of equity-oriented mutual
funds, subject to a ceiling of 5% of the total outstanding advances (including commercial paper) as on
March 31 of the previous year.
The finance ministry spelt out structure of the government-sponsored ARC called the Asset
Reconstruction Company (India) Limited (ARCIL), this pilot project of the ministry would pave way 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 resulted
in a shift from Class banking to Mass banking. This in turn resulted in a significant growth in the
geographical coverage of banks. Every bank has to earmark a minimum percentage of their loan portfolio
to sectors identified as priority sectors. The manufacturing sector also grew during the 1970s in
protected environs and the banking sector was a critical source. The next wave of reforms saw the
nationalization of 6 more commercial banks in 1980. Since then the number scheduled commercial banks
increased four-fold and the number of banks branches increased eight-fold.
After the second phase of financial sector reforms and liberalization of the sector in the early nineties, the
Public Sector Banks (PSB) s found it extremely difficult to complete with the new private sector banks
and the foreign banks. The new private sector banks first made their appearance after the guidelines
permitting them were issued in January 1993. Eight new private sector banks are presently in operation.
This 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 better services.
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% of the deposits and
47.5% of credit during the same period. The share of foreign banks ( numbering 42 ), regional rural banks
and other scheduled commercial banks accounted for 5.7%, 3.9% and 12.2% respectively in deposits and
8.41%, 3.14% and 12.85% respectively in credit during the year 2000.
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Classification of banks:
The Indian banking industry, which is governed by the Banking Regulation Act of India, 1949 can be
broadly classified into two major categories, non-scheduled banks and scheduled banks. Scheduled banks
comprise commercial banks and the co-operative banks. In terms of ownership, commercial banks can be
further grouped into nationalized banks, the State Bank of India and its group banks, regional rural banks
and private sector banks (the old / new domestic and foreign). These banks have over 67,000 branches
spread across the country. The Indian banking industry is a mix of the public sector, private sector and
foreign banks. The private sector banks are again spilt into old banks and new banks.
Banking System in India
Reserve bank of India (Controlling Authority)
Development Financial institutions Banks
IFCI IDBI ICICI NABARD NHB IRBI EXIM Bank SIDBI
Commercial Regional Rural Land Development Co-operative
Banks Banks Banks Banks
Public Sector Banks Private Sector Banks
SBI Groups Nationalized Banks Indian Banks Foreign Bank
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ABOUT SBI:
THE PLACE TO SHARE THE NEWS ...
SHARE THE VIEWS
The State Bank of India, the countrys oldest Bank and a premier in terms of balance sheet size, number
of branches, market capitalization and profits is today going through a momentous phase of Change and
Transformation the two hundred year old Public sector behemoth is today stirring out of its Public
Sector legacy and moving with an agility to give the Private and Foreign Banks a run for their money.
The bank is entering into many new businesses with strategic tie ups Pension Funds, General Insurance,
Custodial Services, Private Equity, Mobile Banking, Point of Sale Merchant Acquisition, Advisory
Services, structured products etc each one of these initiatives having a huge potential for growth.
The Bank is forging ahead with cutting edge technology and innovative new banking models, to expand
its Rural Banking base, looking at the vast untapped potential in the hinterland and proposes 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 provide Indias
growing mid / large Corporate with a complete array of products and services. It is consolidating its
global treasury operations and entering into structured products and derivative instruments. Today, the
Bank is the largest provider of infrastructure debt and the largest arranger of external commercial
borrowings in the country. It is the only Indian bank to feature in the Fortune 500 list.
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The Bank is changing outdated front and back end processes to modern customer friendly
processes to help improve the total customer experience. With about 11448 of its own branches
and another 6500+ branches of its Associate Banks already networked, today it offers the largest
banking network to the Indian customer. Banking behemoth State Bank of India is planning to
set up 15,000 ATMs in the country by March 2010 investing more than Rs 1,000 crore.
RP Sinha, deputy managing director (information technology) of the bank, said: "We plan to
have 25,000 ATMs in the country by March 2010. We will add 15,000 ATMs to the existing
ones by end of this fiscal." The bank has almost 10,300 ATMs in the country at present.
According to a senior SBI official, the spot for an ATM counter is taken on lease. It requires Rs
5.2-5.5 lakh to set up the infrastructure and almost Rs 3.5 lakh for an ATM machine. "All put
together, the cost is around Rs 9 lakh per counter," he said. Going by the estimate, SBI would
require a whopping Rs 1,350 crore for setting up 15,000 ATMs.
The Bank is also in the process of providing complete payment solution to its clientele with its ATMs,
and other electronic channels such as Internet banking, debit cards, mobile banking, etc.
With four national level Apex Training Colleges and 54 learning Centres spread all over the country the
Bank is continuously engaged in skill enhancement of its employees. Some of the training 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. It presently
has 82 foreign offices in 32 countries across the globe. It has also 8 Subsidiaries in India SBI Capital
Markets Ltd, SBI Mutual Funds, SBI factor and commercial services Ltd, SBI DFHI Ltd, SBI Cards and
Payment Services Ltd, SBI Life Insurance Company Ltd, SBI Fund Management Pvt. Ltd, SBI Canada -
forming a formidable group in the Indian Banking scenario. It is in the process of raising capital for its
growth and also consolidating its various holdings.
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Background:
State Bank of India is the largest and one of the oldest commercial bank in India, in existence for more
than 200 years. The bank provides a full range of corporate, commercial and retail banking services in
India. Indian central bank namely Reserve Bank of India (RBI) is the major share holder of the bank with
59.7% stake. The bank is capitalized to the extent of Rs.646bn with the public holding (other than
promoters) at 40.3%.
SBI has the largest branch and ATM network spread across every corner of India. Thebank has a branch
network of over 17000 branches (including subsidiaries). Apart fromIndian network it also has a network
of 73 overseas offices in 30 countries in all time zones, correspondent relationship with 520 International
banks in 123 countries. In recent past, SBI has acquired banks in Mauritius, Kenya and Indonesia. The
bank had total staff strength of 198,774 as on 31st March, 2008. Of this, 29.51% are officers, 45.19%clerical staff and the remaining 25.30% were sub-staff. The bank is listed on the Bombay Stock
Exchange, National Stock Exchange, Kolkata Stock Exchange, Chennai Stock Exchange and Ahmedabad
Stock Exchange while its GDRs are listed on the London Stock Exchange.
SBI group accounts for around 25% of the total business of the banking industry while itaccounts for 35%
of the total foreign exchange in India. With this type of strong base, SBI has displayed a continued
performance in the last few years in scaling up its efficiency levels. Net Interest Income of the bank has
witnessed a CAGR of 13.3% during the last five years. During the same period, net interest margin (NIM)
of the bank has gone up from as low as 2.9% in FY02 to 3.40% in FY06 and currently is at 3.32%.
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KEY AREAS OF OPERATION:
The business operations of SBI can be broadly classified into the key income generating areas such as
National Banking, International Banking, Corporate Banking, & Treasury operations. The functioning of
some of the key divisions is enumerated below:
a) Corporate banking
The corporate banking segment of the bank has total business of around Rs1,193bn. SBI has created
various Strategic Business Units (SBU) in order to streamline its operations.
These SBUs are as follows:
a.1) Corporate Accounts
a.2) Leasing
a.3) Project Finance
a.4) Mid Corporate Group
a.5) Stressed Assets Management
b) National banking
The national banking group has 14 administrative circles encompassing a vast network of 9,177 branches,
4 sub-offices, 12 exchange bureaus, 104 satellite offices and 679 extension counters, to reach 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 enumerated below:
b.1) Personal Banking SBU
b.2) Small & Medium Enterprises
b.3) Agricultural Banking
b.4) Government Banking
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c) International banking
SBI has a network of 73 overseas offices in 30 countries in all time zones and correspondent relationship
with 520 international banks in 123 countries. The bank is keen to implement core banking solution to its
international branches also. During FY06, 25 foreign offices were successfully switched over to Finacle
software. SBI has installed ATMs at Male, Muscat and Colombo Offices. In recent years, SBI acquired
76% shareholding in Giro Commercial Bank Limited in Kenya and PT Indomonex Bank Ltd. in
Indonesia. The bank incorporated a company SBI Botswana Ltd. at Gaborone.
d) Treasury
The 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 interest rate scenario,
robust credit growth and liquidity constraints. The bank diversified its operations more actively into
alternative assets classes with a view to diversify the portfolio and build alternative revenue streams in
order to offset the losses in fixed income portfolio. Reorganization of the treasury processes at domestic
and global levels is also being undertaken to leverage on the operational synergy between business units
and network. The reorganization seeks to enhance the efficiencies in use of manpower resources and
increase maneuverability of banks operations in the markets both domestic as well as international.
e) Associates & Subsidiaries
The State Bank Group with a network of 14,061 branches including 4,755 branches of its seven Associate
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 Life Insurance, Merchant
Banking, Mutual Funds, Credit Card, Factoring, Security trading and primary dealership in the Money
Market.
e.1) Associates Banks:
SBI has six associate banks namely
State Bank of Indore
State Bank of Travancore
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State Bank of Bikaner and Jaipur
State Bank of Mysore
State Bank of Patiala
State Bank of Hyderabad
e.2) Non-Banking Subsidiaries/Joint Ventures
i) SBI Capital Markets Ltd,
ii) SBI Mutual Funds,
iii) SBI factor and commercial services Ltd,
iv) SBI DFHI Ltd,
v) SBI Cards and Payment Services Ltd,
vi) SBI Life Insurance Company Ltd,
vii) SBI Fund Management Pvt. Ltd, SBI
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CHAPTER 2
INDUSTRY ANALYSIS
Competitive forces model in the banking industry
(PORTERS FIVE-FORCE MODEL)
Prof. Michael Porters competitive forces Model applies to each and every company
as well as industry. This model with regards to the Banking Industry is presented
below.
13
(2)
Potential Entrants is
high as development
financial institutions as
well as private and
foreign banks have
entered in a big way.
(5)
Organizing powerof the supplier is
high. With the new
financial instruments
they are asking higher
return on the
investments.
(1)
Rivalry amongexisting firms has
increased with
liberalization. New
products and improved
customer services is the
focus.
(4)
Bargaining power ofbuyers is high as
corporate can raise
funds easily due to
high competition.
(3)
Threat from
substitute is high due
to competition from
NBFCs and insurance
companies as they offer
a high rate of interest
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1. Rivalry among existing firms
With the process of liberalization, competition among the existing banks has increased. Each bank is
coming up with new products to attract the customers and tailor made loans are provided. The quality of
services provided by banks has improved drastically.
2. Potential Entrants
Previously the Development Financial Institutions mainly provided project finance and development
activities. But they now entered into retail banking which has resulted into stiff competition among the
exiting players.
3. Threats from Substitutes
Banks face threats from Non-Banking Financial Companies. NBFCs offer a higher rate of interest.
4. Bargaining Power of Buyers
Corporate can raise their funds through primary market or by issue of GDRs, FCCBs. As a result they
have a higher bargaining power. Even in the case of personal finance, the buyers have a high bargaining
power. This is mainly because of competition.
5. Bargaining Power of Suppliers
With the advent of new financial instruments providing a higher rate of returns to the investors, the
investments in deposits is not growing in a phased manner. The suppliers demand a higher return for the
investments.
6. Overall Analysis
The key issue is how can banks leverage their strengths to have a better future. Since the availability of
funds is more and deployment of funds is less, banks should evolve new products and services to the
customers. There should be a rational thinking in sanctioning loans, which will bring down the NPAs. As
there is a expected revival in the Indian economy Banks have a major role to play. Funding corporate at a
low cost of capital is a special requisite.
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SWOT ANALYSIS
The banking sector is also taken as a proxy for the economy as a whole. The performance of bank should
therefore, reflect Trends in the Indian Economy. Due to the reforms in the financial sector, banking
industry has changed drastically with the opportunities to the work with, new accounting standards newentrants and information technology. The deregulation of the interest rate, participation of banks in project
financing has changed in the environment of banks.
The performance of banking industry is done through SWOT Analysis. It mainly helps to know the
strengths and Weakness of the industry and to improve will be known through converting the
opportunities into strengths. It also helps for the competitive environment among the banks.
a) STRENGTHS
1. Availability of Funds
There are seven lakh crore wroth of deposits available in the banking system. Because of the recession in
the economy and volatility in capital markets, consumers prefer to deposit their money in banks. This is
mainly because of liquidity for investors.
2. Banking network
After nationalization, banks have expanded their branches in the country, which has helped banks build
large networks in the rural and urban areas. Private banks allowed to operate but they mainly concentrate
in metropolis.
3. Large Customer Base
This is mainly attributed to the large network of the banking sector. Depositers in rural areas prefer banks
because of the failure of the NBFCs.
4. Low Cost of Capital
Corporate prefers borrowing money from banks because of low cost of capital. Middle income people
who want money for personal financing can look to banks as they offer at very low rates of interests.
Consumer credit forms the major source of financing bybanks.
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b) WEAKNESS
1. Loan Deployment
Because of the recession in the economy the banks have idle resources to the tune of 3.3 lakh crores.
Corporate lending has reduced drastically
2. Powerful Unions
Nationalization of banks had a positive outcome in helping the Indian Economy as a whole. But this had
also proved detrimental in the form of strong unions, which have a major influence in decision-making.
They are against automation.
3. Priority Sector Lending
To uplift the society, priority sector lending was brought in during nationalization. This is good for the
economy but banks have failed to manage the asset quality and their intensions were more towards
fulfilling government norms. As a result lending was done for non-productive purposes.
4. High Non-Performing Assets
Non-Performing Assets (NPAs) have become a matter of concern in the banking industry. This is because
of change in the total outstanding advances, which has to be reduced to meet the international standards.
c) OPPORTUNITIES
1. Universal Banking
Banks have moved along the valve chain to provide their customers more products and services. For
example: - SBI is into SBI home finance, SBI Capital Markets, SBI Bonds etc.
2. Differential Interest Rates
As RBI control over bank reduces, they will have greater flexibility to fix their own
interest rates which depends on the profitability of the banks.
3. High Household Savings
Household savings has been increasing drastically. Investment in financial assets has also increased.
Banks should use this opportunity for raising funds.
4. Overseas Markets
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CHAPTER 3
INTRODUCTION TO SME
SME
1 Concept:
The small-scale industries (SSI) produce about 8000 products, contribute 40% of the industrial output and
offer the largest employment after agriculture. The sector, therefore, presents an opportunity to the nation
to harness local competitive advantages for achieving global dominance.
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2 From SSI to SME:
Defining the New Paradigm2.1 Government policy as well as credit policy has so far concentrated on
manufacturing units in the small-scale sector. The lowering of trade barriers across the globe has
increased the minimum viable scale of enterprises. The size of the unit and technology employed for firms
to be globally competitive is now of a higher order. The definition of small-scale sector needs to be
revisited and the policy should consider inclusion of services and trade sectors within its ambit. In
keeping with global practice, there is also a need to broaden the current concept of the sector and include
the medium enterprises in a composite sector of Small and Medium Enterprises (SMEs). A
comprehensive legislation, which would enable the paradigm shift from small-scale industry to small and
medium enterprises under consideration of Parliament. The Reserve Bank of India had meanwhile set up
an Internal Group which has recommended: Current SSI/tiny industries definition may continue. Units
with investment in plant and machinery in excess of SSI limit and up to Rs.10 crore may be treated as
Medium Enterprises (ME). The definition may be reviewed after enactment of the Small and Medium
Enterprises Development Bill.
3Definition of SMEs-
At present, a small scale industrial unit is an undertaking in which investment in plant and machinery,
does not exceed Rs.1 crore, except in respect of certain specified items under hosiery, hand tools, drugs
and pharmaceuticals, stationery items and sports goods, where this investment limit has been enhanced to
Rs 5 crore. Units with investment in plant and machinery in excess of SSI limit and up to Rs. 25 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 and medium enterprises as
provided in the Act (Annex VII) will have immediate effect.
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4 Eligibility criteria
(i) These guidelines would be applicable to the following entities, which are viable or potentially 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 of the level
of dues to the bank.
c) All corporate SMEs, which have funded and non-funded outstanding up to Rs.10 crore under multiple/
consortium banking arrangement.
(ii) Accounts involving willful default, fraud and malfeasance will not be eligible for restructuring 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 seeking approval from
BIFR before implementing the package.
SME: At present, a small scale industrial unit is an industrial undertaking in which investment in plant
and machinery, does not exceed Rs.1 crore except in respect of certain specified items under hosiery,
hand tools, drugs and pharmaceuticals, stationery items and sports goods where this investment limit has
been enhanced to Rs.5 crore. A comprehensive legislation which would enable the paradigm shift from
small scale industry to small and medium enterprises is under consideration of Parliament. Pending
enactment of the above legislation, current SSI/tiny industries definition may continue. Units with
investment in plant and machinery in excess of SSI limit and up to Rs.10 crore may be treated as Medium
Enterprises (ME). Only SSI financing will be included in Priority Sector.
All banks may fix self-targets for financing to SME sector so as to reflect a higher disbursement over the
immediately preceding year, while the sub-targets for financing tiny units and smaller units to the extent
of 40% and 20% respectively may continue. Banks may arrange to compile data on outstanding credit to
SME sector as on March 31, 2005 as per new definition and also showing the break up separately for tiny,
small and medium enterprises.
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Banks may initiate necessary steps to rationalize the cost of loans to SME sector by
adopting a transparent 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
Assessment Model (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 their transaction costs.
In order to increase the outreach of formal credit to the SME sector, all banks, including
Regional Rural Banks may make concerted efforts to provide credit cover on an average to at
least 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 Time Settlement
(OTS) Scheme for small scale NPA accounts in the books of the banks as on March 31, 2004 are being
introduced.
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 business
practices. SMEs also lack access to private equity and venture capital and have a very limited
access to secondary market instruments.
b) SMEs face fragmented markets in respect of their inputs as well as products and are
vulnerable 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 of
awareness of global best practices.
e) SMEs face considerable delays in the settlement of dues/payment of bills by the large scale buyers.
With the deregulation of the financial sector, the ability of the banks to service the credit requirements of
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the SME sector depends on the underlying transaction costs, efficient recovery processes and available
security. There is an immediate need for the banking sector to focus on credit and SMEs.
CHAPTER 4
OVERVIEW OF CREDIT APPRAISAL
Credit appraisal means an investigation/assessment done by the bank prior before providing any loans &
advances/project finance & also checks the commercial, financial & technical viability of the project
proposed its funding pattern & further checks the primary & collateral security cover 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 credit facility. It is
generally carried by the financial institutions which are involved in providing financial funding to its
customers. Credit risk is a risk related to non repayment of the credit obtained by the customer of a bank.
Thus it is necessary to appraise the credibility of the customer in order to mitigate the credit risk. Proper
evaluation of the customer is performed which measures the financial condition and the ability of the
customer to repay back the loan in future. Generally the credit facilities are extended against the security
know as collateral. But even though the loans are backed by the collateral, banks are normally interested
in the actual loan amount to be repaid along with the interest. Thus, the customer's cash flows are
ascertained to 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 of a 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 kept in mind at
all times.
Character
Capacity
Collateral
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If any one of these are missing in the equation then the lending officer must question the viability of
credit.
There is no guarantee to ensure a loan does not run into problems; however if proper credit evaluation
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 where that
second party does not reimburse the first party immediately, thereby generating a debt, and instead
arranges either to repay or return those resources (or material(s) of equal value) at a later date. The first
party is called a creditor, also known as a lender, while the second party is called a debtor, also known as
a borrower.
Credit allows you to buy goods or commodities now, and pay for them later. We use credit to buy things
with an agreement to repay the loans over a period of time. The most common way to avail credit is by
the 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 and promises
to repay him on a future date along with interest. In simple terms, a credit is an agreement of postponed
payments of goods bought or loan. With the issuance of a credit, a debt is formed.
Basic types of credit
There are four basic types of credit. By understanding how each works, you will be able to get the most
for your money and avoid paying unnecessary charges.
Service credit is monthly payments for utilities such as telephone, gas, electricity, and water. You often
have to pay a deposit, and you may pay a late charge if your payment is not on time.
Loans let you borrow cash. Loans can be for small or large amounts and for a few days or several years.
Money can be repaid in one lump sum or in several regular payments until the amount you borrowed and
the finance charges are paid in full. Loans can be secured or unsecured.
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Installment credit may be described as buying on time, financing through the store or the easy payment
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 a down payment, and agree
to pay the balance with a specified number of equal payments called installments. The finance charges are
included in the payments. The item you purchase may be used as security for the loan.
Credit cards are issued by individual retail stores, banks, or businesses. Using a credit card can be the
equivalent of an interest-free loan--if you pay for the use of it in full at the end of each month.
Brief overview of loans:
Loans can be of two types fund base & non-fund base:
FUND BASE includes:
Working Capital
Term Loan
NON-FUND BASE includes:
Letter of Credit
Bank Guarantee
Bill Discounting
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FUND BASE: -
WORKING CAPITAL: -
1. General
The 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 to run the
business i.e. its day to day operations.
Funds 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 power charges etc., for
storing finishing goods till they are sold out & for financing the sales by way of sundry debtors/
receivables.
Capital or funds required for an industry can therefore be bifurcated as fixed capital & working capital.
Working capital in this context is the excess of current assets over current liabilities. The excess 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-term source.
2. DEFINITION
Working capital is defined as the funds required to carry the required levels of current assets to enable 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.
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3. Methods & Application
SEGMENT LIMITS METHOD
SSI Upto Rs 5 cr Traditional Method & Nayak Committee method
Above Rs 5 cr Projected Balance Sheet Method
SBF All loans Traditional / Turnover Method
C&I Trade &
Services
Upto Rs 1 cr Traditional Method for Trade &
Projected Turnover MethodAbove Rs 1 cr
& upto Rs 5 cr
Projected Balance Sheet Method &
Projected Turnover Method
Above Rs 5 cr Projected Balance Sheet Method
C&I Industrial
Units
Below
Rs 25 lacs
Traditional Method
Rs 25 lacs &
Over but upto
Rs 5 cr
Projected Balance Sheet Method &
Projected Turnover Method
Above Rs 5 cr Projected Balance Sheet Method
4. Operating cycle method
4.1 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.
4.2 Diagrammatically, the OPERATING CYCLE is represented as under
4.3 Thetime 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.
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4.4 That is, the operating cycle consists of:
Time taken to acquire raw materials & average period for which they are in store.
Conversion process time
Average period for which finished goods are in store &
Average collection period of receivables (Sundry Debtors)
4.5 Operating cycle is also called the cash-to-cash cycle & indicates how cash is converted into
raw materials, 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.
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4.6 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/-
4.7 Assessment of Working Capital Requirement & Permissible Bank Finance using Operating 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.
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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 cycle
The length of the operating cycle is different from industry to industry and from one firm to another
within the same industry. For instance, the operating cycle of a pharmaceutical unit would be quite
different from one engaged in the manufacture of machine tools. The operating cycle concept enables us
to assess the working capital need of each enterprise keeping in view the peculiarities of the industry it is
engaged in and its scale of operations. Operating cycle is an important management tool in decision-
making.
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Traditional Method of Assessment of Working Capital Requirement
The operating cycle concept serves to identify the areas requiring improvement for the purpose of control
and performance review. But, as bankers, we require a more detailed analysis to assess the various
components of working capital requirement viz., finance for
stocks, bills etc. Bankers provide working capital finance for holding an acceptable level of current assets,
viz. raw materials, stocks-in-process, finished goods and sundry debtors for achieving a predetermined
level of production and sales. Quantification of these funds required to be blocked in each of these items
of current assets at any time will, therefore provide a measure of the working capital requirement (WCR)
of an industry.
It can thus be summarized as follows:
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Projected Annual Turnover Method for SSI units (Nayak Committee)
For SSI units which enjoy fund based working capital limits up to Rs.5 cr, the minimum working capital
limit should be fixed on the basis of projected annual turnover. 25% of the output or annual turnover
value should be computed as the quantum of working capital required by such unit .The unit should be
required to bring in 5% of their annual turnover as margin money and the Bank shall provide 20% of the
turnover as working capital finance. Nayak committee Guidelines correspond to working capital limits as
per the Operating Cycle method where the average production / processing cycle is taken to be 3 months
(i.e. working capital would be turned over 4 times in a year).
Projected Annual Turnover Method for C & I industrial units (limits upto Rs 5 cr)
Bank has decided to extend Nayak Committee approach for assessment of limits to C&I industrial units
requiring credit limits upto Rs.5 cr. That is, credit requirement up to Rs.5 crores of C&I borrowers
(industrial units) may be assessed at a minimum of 20% of projected annual turnover. In other words, the
working capital requirement will be assessed at 25% of projected annual turnover, of which 5% should be
borne by entrepreneur as margin and 20% would be allowed as Bank Drawings. While accepting
projected annual sales turnover, a cap of 25% over actual annual sales turnover in the immediately
preceding year should be set, except where production capacity has been substantially increased.
Projected Annual Turnover Method for Business Enterprises in Trade & Services
Sector:
i) For working Capital limits up to Rs. 5 cr to C&I(Trade) sector, the assessment of credit limit is to be
based upon annual turnover. Thus, an across the board credit limit equal to 15% of projected annual
turnover be offered to business enterprises in the T&S sector. It would be available for utilization
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generally as a cash credit limit. However, where needed an LC limit (as a sub-limit of total), may also be
allowed.
ii) The credit limit would be secured by hypothecation charge on the current assets of the enterprise.
Periodical stock statements are to be obtained and margin of 25% be retained.
iii) Credit limits under this assessment method may be offered to established (at least 3 years old) profit
making business enterprises, eligible for credit rating of SB-4 and above. Mortgage of property valued at
least at 33% of the limit is to be prescribed. Further, an interest rebate of 0.50% p.a. may be given to
borrowers who offer mortgage of property valued at over 75% of the credit limit.
iv) While accepting projected annual sales turnover, a cap of 25% over actual annual sales turnover in the
immediately preceding year should be set. When circumstances warrant its breach, reasons therefor
should be recorded.
v) Where borrowers indicate need for credit limits which are higher than the amount indicated above,
assessment under the traditional PBS method may be resorted to.
Projected Balance Sheet Method (PBS)
The PBS method of assessment will be applicable to all C&I borrowers who are engaged in
manufacturing, services, and trading activities, including merchant exports and who require fund based
working capital finance of Rs. 25 lacs and above. In the case of SSI borrowers, who require working
capital credit limit up to Rs.5 cr, the limit shall be computed on the basis of Nayak Committee formula as
well as that based on production and operating cycle of the unit and the higher of the two may be
sanctioned. Fund based working capital credit limits beyond Rs 5 cr for SSI units shall be computed in the
same way as for C&I units. For business enterprises in Trade and Services Sector, where the projected
turnover method is not applicable, PBS method shall be followed.
8.1 In the Projected Balance Sheet (PBS) method, the borrowers total business operations, financial
position, management capabilities etc. are analyzed in detail to assess the working capital finance required
and to evaluate the overall risk of the exposure. The following financial analysis is also to be carried out:
Analysis of the borrowers Profit and Loss account, Balance Sheet, Funds Flow etc. for the
past periods is done to examine the profitability, financial position, financial management, etc.
in the business.
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Detailed scrutiny and validation of the projected income and expense in the business, and
projected changes in the financial position (sources and uses of funds) are carried out to
examine if these are acceptable from the angle of liquidity, overall gearing, efficiency of
operations etc.
8.2 There will not be a prescription like mandatory minimum current ratio or maximum level of a current
asset (inventory and receivables holding level norms) under PBS method. Under the PBS method,
assessment of WC requirement will be carried out in respect of each borrower with proper examination of
all parameters relevant to the borrower and their acceptability.
TERM 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 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 Banks commitment is for a long period
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& 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
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; &
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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 Feasibility
The examination of this item consists of an assessment of the various requirement of the actual
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 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
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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 Banks 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 Feasibility
An economic feasibility appraisal has reference to the earning capacity of the project. Since earnings
depend on the volume of sales, it is necessary to determine how much output or the additional 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 output of the
product concerned & the existing demand for it with a view to establishing whether there is unsatisfied
demand for the product. Care should be taken to see that there is no idle capacity in the existing
industries.
ii) Future possible future changes in the volume & patterns of supply & demand will have to be
estimated in order to assess the long term prospects of the industry. Forecasting of demand is a
complicated matter but one of the vital importance. It is complicated because a variety of factors affect the
demand for product e.g. technological advances could bring substitutes into market while changes in
tastes & consumer preference might cause sizable shifts in demand.
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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 for
automobiles). The market analysis in this case should cover the market for the ultimate product.
7.3 Financial Feasibility
The basis data required for the financial feasibility appraisal can be broadly grouped under the following
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 of profitability &
the break even 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 Service Coverage 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 the appraisal 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 equals the sales
revenue, this point of no profit/ no loss is known as the break-even point. Break-even point is expressed as
a percentage of full capacity. A good project will have reasonably low break-even point which not be
encountered in the projections of future profitability of the unit.
Debt/ Service Coverage:
The debt service coverage ratio serves as a guide to determining the period of repayment of a loan. This is
calculated by dividing cash accruals in a year by amount of annual obligations towards term debt. The
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cash accruals for this purpose should comprise net profit after taxes with interest, depreciation provision
& other non cash expenses added back to it.
Debt Service = Cash accruals
Coverage Ratio Maturing annual obligations
This 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 from industry to
industry but one has to view it with circumspection when it is lower than the benchmark of 1.75. The
repayment programme should be so stipulated that the ratio is comfortable.
7.4 Managerial Competence
In a dynamic environment, the capacity of an enterprise to forge ahead of its competitors depends to a
large extent, on the relative strength of its management. Hence, an appraisal of management is the
touchstone of term credit analysis.
If there is a change in the administration & managerial set up, the success of the project may be put to
test. The integrity & credit worthiness of the personnel in charge of the management of the industry as
well as their experience in management of industrial concerns should be examined. In high cost schemes,
an idea of the units key personnel may also be necessary.
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NON-FUND BASE: -
LETTER OF CREDIT
Introduction
The expectation of the seller of any goods or services is that he should get the payment immediately on
delivery of the same. This may not materialize if the seller & the buyer are at different places (either
within the same country or in different countries). The seller desires to have an assurance for payment bythe purchaser. At the same time the purchaser desires that the amount should be paid only when the goods
are actually received. Here arises the need of Letter of Credit (LCs). The objective of LC is to provide a
means of payment to the seller & the delivery of goods & services to the buyer at the same time.
Definition
A Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at the request & 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 therefore necessary that
the evidence of movement of goods is present. Hence documentary LCs is those which contains
documents of title to goods as part of the LC documents. Clean bills which do not have document of title
to goods are not normally established by banks. Bankers and all concerned deal only in documents & not
in goods. If documents are in order issuing bank will pay irrespective of whether the goods are of
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expected quality or not. Banks are also not responsible for the genuineness of the documents &
quantity/quality of goods. If importer is your borrower, the bank has to advice him to convert all his
requirements in the form of documents to ensure 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
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 LCs
Confirming bank may not be there in a transaction unless the beneficiary demand confirmation by his own
bankers & such a request is made part of LC terms. A bank will confirm an LC for his beneficiary if
opening bank requests this as part of LC terms. Reimbursing bank is used in an LC transaction by an
opening bank when the bank does not have a direct correspondent/branch through whom the negotiating
bank can be reimbursed. Here, the opening bank will direct the reimbursing bank to reimburse the
negotiating bank with the payment made to the beneficiary. In the case of transferable LC, the LC may be
transferred to the second beneficiary & if provided in the LC it can be transferred even more than once.
BANK GUARANTEES:
A contract of guarantee is defined as a contract to perform the promise or discharge the liability of 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 Guarantees
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Bank Guarantees are used to for both both preventive & remedial purposes. The guarantees executed by
banks comprises both performance guarantees & financial guarantees. The guarantees 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 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 business
Branches, as a general rule, should limit themselves to the provision of financial guarantees & exercise
due caution with regards to performance guarantee business. The subtle difference between the two types
of guarantees is that under a financial guarantee, a bank guarantees a customer financial worth,
creditworthiness & his capacity to take up financial risks. In a performance guarantee, the banks
guarantee obligations relate to the performance related obligations of the applicant (customer).
While issuing financial guarantees, it should be ensured that customers should be in a position to
reimburse the Bank in case the Bank is required to make the payment under the guarantee. In case of
performance guarantee, branches should exercise due caution & have sufficient experience with the
customer to satisfy themselves that the customer has the necessary experience, capacity, expertise, &
means to perform the obligations under the contract & any default is not likely to occur.
Branches should not issue guarantees for a period more than 18 months without prior reference to the
controlling authority. Extant instructions stipulate an Administrative Clearance for issue of BGs for a
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period in excess of 18 months. However, in cases where requests are received for extension of the period
of BGs as long as the fresh period of extension is within 18 months. No bank guarantee should normally
have a maturity of more than 10 years. Bank guarantee beyond maturity of 10 years may be considered
against 100% cash margin with prior approval of the controlling authority.
More than ordinary care is required to be executed while issuing guarantees on behalf of customers who
enjoy credit facilities with other banks. Unsecured guarantees, where furnished by exception, should be
for a short period & for relatively small amounts. All deferred payment guarantee should ordinarily be
secured.
Appraisal of Bank Guarantee Limit
Proposals for guarantees shall be appraised with the same diligence as in the case of fund-base limits.
Branches may obtain adequate cover by way of margin & security so as to prevent default on payments
when guarantees are invoked. Whenever an application for the issue of bank guarantee is received,
branches should examine & satisfy themselves about the following aspects:
a) The need of the bank guarantee & whether it is related to the applicants 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) Applicants 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 customers response to the invocation, etc.
f) Present o/s on account of bank guarantees already issued
g) Margin
h) Collateral security offered
Format of Bank Guarantees
Bank guarantees should normally be issued on the format standardized by Indian Banks Association
(IBA). When it is required to be issued on a format different from the IBA format, as may be demanded
by some of the beneficiary Government departments, it should be ensured that the 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
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d) in respect of bona fide trade/ commercial transactions,
e) contains the Banks standard limitation clause
f) not stipulating any onerous clause, &
g) not containing any clause for automatic renewal of the bank guarantee on its expiry
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
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|
Sanction/approval of proposal by appropriate sanctioning authority
|
Documentations, agreements, mortgages
|
Disbursement of loan
|
Post sanction activities such as receiving stock statements, review of accounts,
renew of accounts, etc
(on regular basis)
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CHAPTER-5
SBI NORMS FOR CREDIT APPRAISAL
Credit appraisal means an investigation/assessment done by the bank prior before providing any loans &
advances/project finance & also checks the commercial, financial & technical viability of the project
proposed its funding pattern & further checks the primary & collateral security cover available for
recovery of such funds.
1. Loan policy An Introduction
1.1 State Bank of Indias (SBI) Loan Policy is aimed at accomplishing its mission of retaining the
banks position as a Premier Financial Services Group, with World class standards & significant
global business, committed to excellence in customer, shareholder & employee satisfaction & to
play a leading role in the expanding & diversifying financial services sector, while continuing
emphasis on its Development Banking role.
1.2 The Loan Policy of the any bank has successfully withstood the test of time and with inbuilt
flexibilities, has been able to meet the challenges in the market place. The policy exits & operates at
both formal & informal levels. The formal policy is well documented in the form of circular
instructions, periodic guidelines & codified instructions, apart from the Book of Instructions, where
procedural aspects are highlighted.
1.3 The policy, at the holistic level, is an embodiment of the Banks approach to sanctioning, managing
& monitoring credit risk & aims at making the systems & controls effective.
1.4 The Loan Policy also aims at striking a balance between underwriting assets of high quality, and
customer oriented selling. The objective is to maintain Banks undisputed leadership in the Indian
Banking scene.
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1.5 The Policy aims at continued growth of assets while endeavoring to ensure that these remain
performing & standard. To this end, as a matter of policy the Bank does not take over any Non-
Performing Asset (NPA) from other banks.
1.6 The Central Board of the Bank is the apex authority in formulating all matters of policy in the bank.
The Board has permitted setting up of the Credit Policy & Procedures Committee (CPPC) at the
Corporate Centre of the Bank of which the Top Management are members, to deal with issues
relating to credit policy & procedures on a Bank-wide basis. The CPPC sets broad policies for
managing credit risk including industrial rehabilitation, sets parameters for credit portfolio in terms
of exposure limits, reviews credit appraisal systems, approves policies for compromises, write offs,
etc. & general management of NPAs besides dealing with the issues relating to Delegation of
Powers.
Based on the present indications, following exposure levels are prescribed:
Individuals as borrowers Maximum aggregate credit facilities of
Rs. 20 crores
( Fund based & non-fund based )
Non-corporates
( e.g. Partnerships, JHF, Associations )
Maximum aggregate credit facilities of Rs. 80
crores
( Fund based & non-fund based )
Corporates Maximum aggregate credit facilities as
per prudential norms of RBI on exposures
Term Loans (loans with residual maturity of over 3 years) should not in the aggregate exceed
35% of the total advances of SBI.
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The Bank shall endeavour to restrict fund based exposure to a particular industry to 15% of the
Banks total fund based exposure.
The Bank shall restrict the term loan exposure to infrastructure projects to 10% of Banks total
advances.
The Bank shall endeavour to restrict exposure to sensitive sectors (i.e. to capital market, real
estate, and sensitive commodities listed by RBI) to 10% of Banks total advances.
The Banks aggregate exposure to the capital markets shall not exceed 5% of the total outstanding
advances (including commercial paper) as on March 31 of the previous year.
2. Credit Appraisal Standards
1 (A) Qualitative:
At the outset, the proposition is examined from the angle of viability & also from the Banks prudential
levels of exposure to the borrower, Group & Industry. Thereafter, a view is taken about our past
experience with the promoters, if there is a track record to go by. Where it is a new connection for the
bank but the entrepreneurs are already in business, opinion reports from existing bankers & published data
if available are carefully pursued. In case of a maiden venture, in addition to the drill mentioned
heretofore, an element of subjectively has to be perforce introduced as scant historical data weightage to
be placed on impressions gained out of the serious dialogues with the promoter & his business contacts.
1 (B) Quantitative:
(a) Working capital:
The basis quantitative parameters underpinning the Banks credit appraisal are as follows:-
Sector/ Parameters Mfg Others
Liquidity
Current Ratio (min.)
1.33 1.20
(For FBWC limits above Rs. 5 cr.)
1.00
(For FBWC limits upto Rs. 5 cr.))
Financial Soundness
TOL/TNW (max.)
3.00 5.00
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DSCR
Net (min.)
Gros (min.)
2:1
1.75:1
2:1
1.75:1
Gearing
D/E (max.) 2:1 2:1
Promoters contribution
(min.)
30% of equity 20% of equity
(i) Liquidity:
Current Ratio (CR) of 1.33 will generally be considered as a benchmark level of liquidity. However the
approach has to be flexible. CR of 1.33 is only indicative & may not be deemed mandatory. In cases
where the CR is projected at a lower than the benchmark or a slippage in the CR is proposed, it alone will
not be a reason for rejection for the loan proposal or for the sanction of the loan at a lower level. In such
cases, the reason for low CR or slippage should be carefully examined & in deserving cases the CR as
projected may be accepted. In cases where projected CR is found acceptable, working capital finance as
requested may be sanctioned. In specific cases where warranted, such sanction can be with the condition
that the borrower should bring in additional long-term funds to a specific extent by a given future date.
Where it is felt that the projected CR is not acceptable but the borrower deserves assistance subject tocertain conditions, suitable written commitment should be obtained from the borrower to the effect that he
would be bringing in required amounts within a mutually agreed time frame.
(ii) Net Working Capital:
Although this is a corollary of current ratio, the movements in Net Working Capital are watched to
ascertain whether there is a mismatch of long term sources vis--vis long term uses for purposes which
may not be readily acceptable to the Bank so that corrective measures can be suggested.
(iii) Financial Soundness:
This will be dependent upon the owners stake or the leverage. Here again the benchmark will be different
for manufacturing, trading, hire-purchase & leasing concerns. For industrial ventures a Total Outside
Liability/ Tangible Net worth ratio of 3.0 is reasonable but deviations in selective cases for
understandable reasons may be accepted by the sanctioning authority.
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(iv) Turn-Over:
The trend in turnover is carefully gone into both in terms of quantity & valve as also market share
wherever such data are available. What is more important to establish a steady output if not a rising trend
in quantitative terms because sales realization may be varying on account of price fluctuations.
(v) Profits:
While net profit is ultimate yardstick, cash accruals, i.e., profit before depreciation & taxation conveys the
more comparable picture in view of changes in rate of depreciation & taxation, which have taken place in
the intervening years. However, for the sake of proper assessment, the non-operating income is excluded,
as these are usually one time or extraordinary income. Companies incurring net losses consistently over 2
or more years will be given special attention, their accounts closely monitored, and if necessary, exit
options explored.
(vi) Credit Rating:
Wherever the company has been rated by a Credit Rating Agency for any instrument such as CP / FD this
will be taken into account while arriving at the final decision. However as the credit rating involves
additional expenditure, we would not normally insist on this and only use this tool if such an agency had
already looked into the company finances.
(b) Term Loan
(i) In case of term loan & deferred payment guarantees, the project report is obtained from the
customer,
(ii) which may be compiled either in-house or by a firm of consultants/ merchant bankers. The
technical feasibility & economic viability is vetted by the bank & wherever it is felt necessary, the
Credit Officer would seek the benefit of a second opinion either from the Banks Technical
Consultancy cell or from the consultants of the Bank/ SBI Capital Markets Ltd.
(iii) Promoters contribution of at least 20% in the total equity is what we normally expect.
But promoters contribution may vary largely in mega projects. Therefore there cannot be a
definite benchmark. The sanctioning authority will have the necessary discretion to permit
deviations.
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(iv)The other basic parameter would be the net debt service coverage ratio i.e. exclusive of interest
payable, which should normally not go below 2. On a gross basis DSCR should not be below
1.75. These ratios are indicative & the sanctioning authority may permit deviations selectively.
(v) As regards margin on security, this will depend on Debt: Equity gearing for the project, which
should preferably be near about 1.5: 1 & should not in any case be above 2:1, i.e., Debt should not
be more than 2 times the Equity contribution. The sanctioning authority in exceptional cases may
permit deviations from the norm very selectively.
(vi)Other parameters governing working capital facilities would also govern Term Credit facilities to
the extent applicable.
(C) Lending to Non-Banking Financial Companies (NBFCs)
(D) Financing of infrastructure projects
(E) Lease Finance
(F) Letter of Credit, Guarantees & bills discounting
(G) Fair Practices for lenders
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Documentation standards
1: The systems and procedures for documentation have been laid down keeping in view
the ultimate objective of documentation which is to serve as primary evidence in any dispute between the
Bank and the borrower and for enforcing the Bank's right to recover the loan amount together with
interest thereon (through a court of law as a final resort), in
the event of all other recourses proving to be of no avail. In order that this objective is achieved, our
documentation process attempts to ensure that:
The owing of the debt to the Bank by the borrower is clearly established by the documents.
The charge created on the borrower's assets as security for the debt is maintained and enforceable
The Bank's right to enforce the recovery of the debt through court of law is not allowed to become
time-barred under the Law of Limitation.
2: Documentation is not confined to mere obtention of security documents at the outset. It is a continuous
and ongoing process covering the entire duration of an advance comprising the following stages :
(i) Pre-execution formalities:
These cover mainly searches at the Office of Registrar of Companies and search of the Register of
Charges (applicable to corporate borrowers), also capacity of borrowers to borrow and the formalities to
be completed by the borrowers, searches at the office of the sub-Registrar of Assurances or Land Registry
to check the existence or otherwise of prior charge over the immovable property offered as security,
besides taking other precautions before creating equitable / registered mortgage.
(ii) Execution of Documents
This covers obtention of proper documents, appropriate stamping and correct execution thereof as per
terms of the sanction of the advance and the internal directives of a corporate borrower such as
Memorandum and Articles of Association, etc.
(iii) Post-execution formalities
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This phase covers the completion of formalities in respect of mortgages, if any, registration with the
Registrar of Assurances, wherever applicable, and the registration of charges with the Registrar of
Companies within the stipulated period, etc..
(iv) Protection from Limitation / Safeguarding Securities
These measures aim at saving the documents from getting time-barred by limitation and protecting the
securities charged to the Bank from being diluted by any charge that might be created by the borrower to
secure his other debts, if any. These objectives are sought to be achieved by:
(a) Obtention of revival letter within the stipulated period
(b) Obtention of Balance Confirmation from the borrower at least at annual intervals
(c) Making periodical searches at the Office of the Registrar of Companies.
(d) Insurance of Assets charged - (unless specifically waiv