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CREDIT APPRAISAL IN BANKING SECTOR

CHAPTER-1

INTRODUCTION TO BANKING

SECTOR & SBI

HISTORY OF 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.

State Bank of India is still the largest bank in India with the market share of 20% ICICI and its

two subsidiaries merged with ICICI Bank, leading creating the second largest bank in India with

a balance sheet size of Rs. 1040bn.

Higher provisioning norms, tighter asset classification norms, dispensing with the concept of

past due for recognition of NPAs, lowering of ceiling on exposure to a single borrower and

group exposure etc., are among the measures in order to improve the banking sector.

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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.

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 paveway for smoother functioning of the credit market in the country. The government will hold 49%

stake and private players will hold the rest 51%- the majority being held by ICICI Bank (24.5%).

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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 earlynineties, 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. These banks due to their late start have access to state-of-

the-art technology, which in turn helps them to save on manpower costs and provide 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.

CLASSIFICATION OF BANKS:

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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 ISIDBI

Commercial Regional Rural Land Development Co-operativeBanks Banks Banks Banks

Public Sector Banks Private Sector Banks

SBI Groups Nationalized Banks Indian Banks Foreign Banks

ABOUT SBI:

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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 andproposes to cover 100,000 villages in the next two years.

It is also focusing at the top end of the market, on whole sale banking capabilities to 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.

The Bank is changing outdated front and back end processes to modern customer friendly

processes to help improve the total customer experience. With about 8500 of its own 10000

branches and another 5100 branches of its Associate Banks already networked, today it offers the

largest banking network to the Indian customer. The Bank is also in the process of providing

complete payment solution to its clientele with its over 8500 ATMs, and other electronic

channels such as Internet banking, debit cards, mobile banking, etc.

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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 7 Subsidiaries in

India SBI Capital Markets, SBICAP Securities, SBI DFHI, SBI Factors, SBI Life and SBI

Cards - 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.

Throughout all this change, the Bank is also attempting to change old mindsets, attitudes and

take all employees together on this exciting road to Transformation. In a recently concluded mass

internal communication programme termed Parivartan the Bank rolled out over 3300 two day

workshops across the country and covered over 130,000 employees in a period of 100 days using

about 400 Trainers, to drive home the message of Change and inclusiveness. The workshops

fired the imagination of the employees with some other banks in India as well as other Public

Sector Organizations seeking to emulate the programme.The Bank is actively involved since

1973 in non-profit activity called Community Services Banking. All their branches and

administrative offices throughout the country sponsor and participate in large number of welfare

activities and social causes.

Their business is more than banking because they touch the lives of people anywhere in many

ways. Their commitment to nation-building is complete & comprehensive.

TRANSFORMATION JOURNEY IN STATE BANK OF INDIA:

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

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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.

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 largestarranger of external commercial borrowings in the country. It is the only Indian bank to feature

in the Fortune 500 list.

The Bank is changing outdated front and back end processes to modern customer friendly

processes to help improve the total customer experience. With about 8500 of its own 10000

branches and another 5100 branches of its Associate Banks already networked, today it offers the

largest banking network to the Indian customer. The Bank is also in the process of providing

complete payment solution to its clientele with its over 8500 ATMs, and other electronic

channels such as Internet banking, debit cards, mobile banking, etc.

With four national level Apex Training Colleges and 54 learning Centers spread all over the

country the Bank is continuously engaged in skill enhancement of its employees. Some of the

training programmes are attended by bankers from banks in other countries.

The bank is also looking at opportunities to grow in size in India as well as internationally. It

presently has 82 foreign offices in 32 countries across the globe. It has also 7 Subsidiaries in

India SBI Capital Markets, SBICAP Securities, SBI DFHI, SBI Factors, SBI Life and SBI

Cards - 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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Throughout all this change, the Bank is also attempting to change old mindsets, attitudes and

take all employees together on this exciting road to Transformation. In a recently concluded mass

internal communication programme termed Parivartan the Bank rolled out over 3300 two day

workshops across the country and covered over 130,000 employees in a period of 100 days using

about 400 Trainers, to drive home the message of Change and inclusiveness. The workshopsfired the imagination of the employees with some other banks in India as well as other Public

Sector Organizations seeking to emulate the programme.

The CNN IBN, Network 18 recognized this momentous transformation journey, the State Bank

of India is undertaking, and has awarded the prestigious Indian of the Year Business, to its

Chairman, Mr. O. P. Bhatt in January 2008.

State Bank of India (SBI) has history of more than 200 years of existence. SBI is the largest

commercial bank in India and accounts for approximately 18% of the total Indian banking

business and the group account for 25% of the total Indian banking business.

The central bank, Reserve Bank of India (RBI) is the largest shareholder in the bank with59.7%

stake followed by overseas investors including GDRs with 19.78% shareholdingas on September

06. RBIs stake in the bank is likely to be transferred to the Governmentof India (GOI).

SBI has the largest distribution network in India spread across every nook and corner of India.

As on September 06, the bank has 14,061 branches which include 4,755 branches of its

associated banks. The bank also has the largest network of 5,624 ATMs.

Background:

State Bank of India is the largest and one of the oldest commercial bank in India, in existence 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

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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 14,000 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, 2006. 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%.

EVOLUTION OF SBI:

The origin of the State Bank of India goes back to the first decade of the nineteenth century

with the establishment of the Bank of Calcutta in Calcutta on 2 June 1806. Three years later the

bank received its charter and was re-designed as the Bank of Bengal (2 January 1809). A unique

institution, it was the first joint-stock bank of British India sponsored by the Government of

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Bengal. The Bank of Bombay (15 April 1840) and the Bank of Madras (1 July 1843) followed

the Bank of Bengal. These three banks remained at the apex of modern banking in India till their

amalgamation as the Imperial Bank of India on 27 January 1921.

Imperial Bank

The Imperial Bank during the three and a half decades of its existence recorded an impressive

growth in terms of offices, reserves, deposits, investments and advances, the increases in some

cases amounting to more than six-fold. The financial status and security inherited from its

forerunners no doubt provided a firm and durable platform. But the lofty traditions of banking

which the Imperial Bank consistently maintained and the high standard of integrity it observed in

its operations inspired confidence in its depositors that no other bank in India could perhaps thenequal. All these enabled the Imperial Bank to acquire a pre-eminent position in the Indian

banking industry and also secure a vital place in the country's economic life.

When India attained freedom, the Imperial Bank had a capital base (including reserves) of

Rs.11.85 crores, deposits and advances of Rs.275.14 crores and Rs.72.94 crores respectively and

a network of 172 branches and more than 200 sub offices extending all over the country.

Key Areas of Operations:

The business operations of SBI can be broadly classified into the key income generating areas

such as National Banking, International Banking, Corporate Banking, & Treasury operations.

The functioning of some of the key divisions is enumerated below:

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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:

1) Corporate Accounts

This SBU is important for the bank as its loan portfolio constituted about 27.05% of thebanks

commercial and institutional non-food credit and 12.85% of the total domestic credit portfolio as

on 31st March 2006.

Some of the products under corporate accounts SBU are as follows:

SBI-FAST, which is the cash management product offered by this SBU, had a turnover of

Rs.4,705.75bn as of 31st March 2006. This product is now comprehensive cash management

solution, offering payments in addition to collections.

Vendor financing activity is being integrated with core banking through the internet platform.This is identified as a focus area to capture the credit portfolio of vendors.

The foreign exchange business grew by around 55% y-o-y and reached Rs.1,747.70bn as of

31st March 2006. This SBU now handles nearly 12% of the countrys visible trade and about

43% of banks forex business.

2) Leasing

This SBU is not writing any leases since the past few years as unfavorable business climate and

availability of alternative funding options at cheaper cost. As at the end March 2006, the

disbursements and capitalization were zero and profit amounted to Rs.245.9mn.

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3) Project Finance

This SBU focuses on funding core projects like power, telecom, roads, ports, airports, special

economic zones and others. During FY06, total sanctions for 18 projects involving a total State

Bank of India, Corporate Banking, National Banking, International Banking, Treasury

Operations Associates & Subsidiaries amount of Rs.42.11bn were in place as against 13 projects

involving Rs.25.08bn in the previous year. It also handles non-infrastructure projects with certain

ceilings on minimum project costs. During FY06 sanctions for 29 projects involving a total

amount of Rs.55.80bn were in place as against 27 projects involving Rs.51.63bn in the previous

year. As a whole, this SBU achieved total sanctions of Rs.238.86bn (fund based and non fund

based) including syndication amount of Rs.140.95bn during the period ended March 2006.

During FY06, this SBU entered into financing of aviation sector actively by sanctioning loans for

modernization of airports and acquisition of aircrafts.

4) Mid Corporate Group

The Mid Corporate Group (MCG) created in June 2004 has 7 MCG Regional Officescontrolling

28 large branches with high concentration of Mid Corporate (MC) business.The entire Off-Site

MC business of all branches at 31 identified centres has been broughtunder the fold of MCG.

The average processing time of credit proposals is about 15 daysand quicker decision making on

credit proposals of the Mid Corporate units has resulted in greater customer satisfaction. As of

March 2006, 21 MCG branches have been migrated to core banking platform. New technology

products like RTGS, CINB, Multi-City cheque facility and Core Power have been introduced in

all these branches. These technology products coupled with quick Turn Around Time (TAT)

have enabled Mid-Corporate Group to increase its business substantially and generate higher

income, both interest and fee based.

5) Stressed Assets Management

During FY06, the banking industry witnessed a major policy initiative by Reserve Bank of India

with the opening up of sale / purchase of non performing assets to banks, FIs and non-banking

finance companies (NBFCs). During FY06, the bank sold NPAs to the tune of Rs.8.9bn against

security receipts and Rs.11.41bn on cash basis to Asset Reconstruction Company (ARCIL). The

progress in enforcing the security interest has somewhat slowed down due to the requirement of

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withdrawing suits pending before the tribunal prior to action being initiated against the defaulting

borrowers under the SARFAESI Act.

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:

1) Personal Banking SBU

This SBU is mainly responsible for retail business. During FY06, personal banking advances

increased from Rs.464.51bn to Rs.610.67bn, showing a growth of Rs.146.16bn at the rate of

31.47 % against a growth rate of 40.12% in the previous year.

On the home loan front, several new products were introduced, tailored to fit the needs ofspecific customer segments, such as SBIMaxgain (minimize interest burden, earn on savings, at

no extra cost), SBI NRI-Home Loans, SBI Freedom Home Loans (Loans given without mortgage

of property, but against alternate securities, instead), SBI Tribal Plus Home Loans. The auto

loans portfolio has shown a growth of Rs.17.74bn in absolute terms and 65% which is

considerably higher than last years growth, mainly due to implementation of well planned

strategies.

2) Small & Medium Enterprises

The SME Business Unit implemented comprehensive strategies, revamped business processes

and with its focus on market dynamics and customer preferences, achieved commendable

business growth. The initiative was implemented by focusing on specific industry segments, and

concentrating on various players in the value chain. Debt restructuring mechanism for units in

SME sector has been devised to ensure restructuring of debt of all eligible Small and Medium

Enterprises (SMEs) on favorable terms.

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Focused on the SME sector, projects under Uptech are taken up in location specific and activity

specific industry clusters. So far the bank has taken 28 projects for modernization under the

Project Uptech covering industries like foundry, pumps, glass, auto components, and knitwear,etc. The bank has also covered agro based industries like rice mills, sago and starch and

horticulture activities like Apple Orchards and grape farming under the scheme. The deposits of

the SME SBU increased to Rs.1,042.70bn as at the end of March 2006 from Rs.890.60bn of

previous year recording a growth of 17.08% during the year. SME advances increased to

Rs.456.53bn from Rs.328.30bn of previous year, recording a growth of 39.06 %. The criteria laid

down by the Government of India for growth in SME advances is 20%.

3) Agricultural Banking

This SBU is accountable for agricultural credit both traditional and new thrust areas like contract

farming, farmers financed through Agri Export Zones (AEZs) and value chain financing.

Increase in disbursements during FY06 was 83% against the Govt. of India target of 30%.

Agricultural advances grew from a level of Rs.205.26bn in FY05 to Rs.305.16bn as at the end of

March 06. As on November 2006, agriculture loans contribute 11% of the total loan book.

4) Government Banking

With the establishment of the government business unit and the consequent focus on marketing,

business turnover of this segment has grown substantially over the years. Banks business

turnover from the government business segment during 2004-05 was Rs.8,843.81bn. The

turnover increased by 10.52 % to Rs.9,773.90bn during FY06.

c) INTERNATIONAL BANKING

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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 weresuccessfully 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.

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1) Associates Banks:

SBI has seven associate banks namely

State Bank of Indore

State Bank of Travancore

State Bank of Bikaner and Jaipur

State Bank of Mysore

State Bank of Patiala

State Bank of Hyderabad

State Bank of Saurashtra

All associate banks have migrated to Core Banking (CBS) platform. Single window delivery

system has been introduced in all associate banks. SBIs seven associate banks are the first

amongst the public sector banks in India to get fully networked through CBS, providing anytime-

anywhere banking to its customers to facilitate a bouquet of innovative customer offerings.

2) Non-Banking Subsidiaries/Joint Ventures

i) SBI Life:

SBI Life is the third largest private insure with the market share of 10.21% among the private

players and number one in terms of number of lives insured amongst private players (no. of lives

insured and policies is 25mn). In H1FY07 gross premium was Rs.7.68bn.

ii) SBI Capital Markets Limited (SBICAP)

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SBI Caps forged ahead in issue management, project advisory and structured finance, sales and

distribution. To capitalize on the emerging opportunities, SBI Caps has promoted four wholly

owned subsidiaries viz. SBICAP Securities Ltd. for undertaking stock broking activities,

SBICAPS Ventures Limited, SBICAP Trustee Company Limited for undertaking venture capital

business and SBI CAP (UK) LTD., for carrying on the Financial Services Authority (FSA)regulated activities. On the international front, the expertise of SBI Caps in the infrastructure and

project advisory has received international acclaim. In addition, the company has been placed

11th globally in the Mandated Project Advisor league tables by Thompsons, and one of the

projects handled by the company has been selected as the Asia Pacific Infrastructure deal of the

year for FY06. SBI Caps booked gross income amounting to Rs.1.79bn in FY06 as against

Rs.1.75bn in the previous year, while PAT of the company was at Rs.906.2mn in FY06 as

against Rs.881.2mn in the last year.

iii) SBI DFHI LTD

SBI group holds 67.01% of the companys paid up capital, while other nationalized banks hold

22.46%. All India financial institutions and private sector banks hold 5.84% and the Asian

Development Bank holds 4.69% as on March 31, 2006. For the year ended 31st March, 2006, the

company has earned a PAT of Rs.24.4mn. Total secondary market turnover of the company was

Rs.285.39bn which amounted to a market share of 12.89% among all primary dealers.

iv) SBI Cards & Payments Services Pvt. Ltd. (SBICSPL)

SBICSPL is ranked 2nd in industry with cards in force over 3mn as on September 06. During

FY06, the aggregate revenue generated by the SBICSPL was Rs.5.27bn while pre-tax profit was

Rs.558.6mn.

v) SBI Funds Management (P) Ltd. (SBIFMPL)

SBI Mutual Fund is the mutual funds arm of the bank. SBIFMPL reported a total inflow of

Rs.481.67bn in the various schemes during the year. The total assets under management are

Rs.132.49bn. The company reported a net profit of Rs.186.4mn as at the end of March, 2006.

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f) Human Resources

The bank had total staff strength of 198,774 on the 31st March, 2006. Of this, 29.51% are

officers, 45.19% clerical staff and the remaining 25.30% were sub-staff. SBI had launched VRS

scheme for its employees in FY01 in which it has reduced it staff by approximately 5,000 and

estimates natural retirement of another 5,000 employees in next 4-5 year.

NON BANKING SUBSIDIARIES:

The Bank has the following Non-Banking Subsidiaries in India :

SBI Capital Markets Ltd

SBI Funds Management Pvt Ltd

SBI Factors & Commercial Services Pvt Ltd

SBI DFHI Ltd

State Bank of Travancore (SBT)

INVESTOR RELATIONS:

State Bank of India, the countrys largest commercial Bank in terms of profits, assets, deposits,

branches and employees, welcomes you to its Investors Relations Section. SBI, with its

heritage dating back to the year 1806, strives to continuously provide latest and upto date

information on its financial performance. It is our endeavor to walk on the path of transparency

and allow complete access to all the stakeholders enabling total awareness about the Bank. The

Bank communicates with the stakeholders through a variety of channels, such as through e-mail,

website, conference call, one-on-one meeting, analysts meet and attendance at Investor

Conference throughout the world.

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Please find below Banks financial results, analysis of performance and other highlights which

will be of interest to Investors, Fund Managers and Analysts. SBI has always been fundamentally

strong in its core business which is mirrored in its results year after year.

State Bank of India has an extensive administrative structure to oversee the large network of

branches in India and abroad. The Corporate Centre is in Mumbai and 14 Local Head Offices

and 57 Zonal Offices are located at important cities spread throughout the country. The

Corporate Centre has several other establishments in and outside Mumbai, designated to cater to

various functions. Our Colleges/Institutes/Training Centres are the seats of learning and research

and development to spread the wings of knowledge not only to our employees but also other

banks/establishments in India and abroad.

The Corporate Accounts Group is a Strategic Business Unit of the Bank set up exclusively to

fulfil the specialised banking needs of top corporates in the country.

State Bank of India has 52 foreign offices in 34 countries across the globe.

State Bank of India invites you to take a journey to understand the potential of not just a large

but truly global organisation.

CHAPTER-2

BRIEF 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.

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Brief overview of credit:

Credit Appraisal is a process to ascertain the risks associated with the extension of the creditfacility. It is generally carried by the financial institutions which are involved in providing

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 keptin mind at all times.

Character

Capacity

Collateral

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.

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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 eachmonth.

BRIEF OVERVIEW OF LOANS

Credit can be of two types fund base & non-fund base:

FUND BASED includes:

Working Capital

Term Loan

NON-FUND BASED includes:

Letter of Credit

Bank Guarantee

FUND BASED:-

WORKING CAPITAL:-

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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 torun 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 powercharges 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 & workingcapital. 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 termsource.

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.

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 Method

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c) 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.

d) That is, the operating cycle consists of:

Time taken to acquire raw materials & average period for which they are in store.

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Stock inProcess

Cash

RawMaterials

FinishedGoods

Bills

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Raw Materials = Rs. 14,000 p.m.

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 daysStock in Process = 2 days

FG = 3 days

Sundry Debtors = 15 days

The total length ofOperating 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

TERM LOAN1. 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

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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:

Thepurpose 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 ofthe 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 & 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 repaymentof 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.

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7. Appraisal of Term Loans

Appraisal of term loan for, say, an industrial unit is a process comprising severalsteps.

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 & itssufficiency in relation to the repayment obligations pertaining to term assistance;

Financial Feasibility - To determine the accuracy of cost estimates, suitability of

the envisaged pattern of financing & general soundness of the capital structure; &

Managerial Competency To ascertain that competent men are behind the project

to ensure its successful implementation & efficient management after

commencement of commercial production.

7.1 Technical 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.

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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.

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 breakeven point will enable the banker to draw up the repayment programme,

start-up time etc. The profitability estimates will also give the estimate of the Debt 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:

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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 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 BASED:-

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 by the 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 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

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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.

Types of Letter of Credit:-

a) Revocable & Irrevocable:

As the name suggests, revocable LCs are those that can be revoked by the issuing bank &

hence are not in commercial use. Irrevocable LCs cannot be revoked/ cancelled/ amended

without the prior concern of all the parties to the LC.

b) Confirmed LC:

The seller may ask for the confirmation of the LC by a bank in his own country if he is

not satisfied about the issuing banks credentials.

c) Sight/ Usance LCs:

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In case of the sight LCs beneficiary gets immediate payment upon presentation of the

documents while in the case of usance, the payment is made after a certain period as per

the LC terms. Sight LCs have to be paid by the drawee (buyer) immediately whereas he

gets credit as per LC terms under Usance LCs.

d) LC with advance payment to the seller:

The LC which authorizes the advising bank to advance a part of LC amount to the seller

to meet pre-shipment expenses is known as Red Clause Letter of Credit. The seller gives

the receipt & an undertaking to present the documents before the LC expires. Advance

amount would be adjusted from the proceeds of the export documents. However, the risk

is assumed by the buyer. When the Red Clause LC provides for the cost of shortage

facilities at the port of shipment in addition to the pre-shipment advance to the

beneficiary it is called Green Clause LC. The goods are stored in the name of the issuing

bank.

e) Revolving LC:

Under this, the issuing bank undertakes to restore the credit to the original amount after it

has been utilized. Number of such utilization & the period of time by which this should

take place are stipulated in the LC. On receipt of bill payment advise the LC amount gets

reinstated.

f) Transferable LCs:

Transferable LC are transferable in whole or in part to one or more beneficiaries

depending on the terms of LC. As per UCPDC stipulated in the LC, all LC are not

transferable.

g) Back to back LCs:

When the bank opens new LCs against the backing of an LC received by a beneficiary

having the first LC as security for the new LCs opened, the transaction is referred to as

Back to Back. For example let us assume a customer A, who exports marine products by

buying them from a number of suppliers. If A receives an LC for USD 100000 for

shipment of marine products & he approaches the Bank for opening LCs in favour of his

suppliers of marine products within the original value & in keeping with the terms of the

original LC these new LCs are opened against the backing of the original LC. This is the

back to back transaction. However, it may be noted that this arrangement is not under the

provisions of UCPDC though the individual LCs are governed by it.

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Illustration for computation of LC limit

M/S XYZ Co Ltd

Letter of credit limit of Rs. 20 crore

(Rs. in crores)

Total purchase of raw material 172.64

Purchase of raw materials under LC 69.41

Average monthly purchase of raw material under LC (A) 5.78Average holding of imported raw materials (2.2 months consumption) 11.30

Average usance period (B) 3 months

Lead time & transit period (C) 1 month

Total of (B) & (C) (D) 4 months

The requirement of LC limit (A) * (D) 23.12

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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 wouldenable 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 Departmentunder 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. Incase 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

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BGs for a 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-baselimits. 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 normaltrade/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 ofinvocation of bank guarantees, the reasons thereof, the customers response to the

invocation, etc.

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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

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

Specimen of the First Page of Bank Guarantee

(To be stamped as an agreement in accordance with the Stamp Act in force)

STATE BANK OF INDIA

.Branch (Stamp)

Form No. .

.

.

.

Dear Sir,

Guarantee No.

Amount of Guarantee Rs.

Guarantee cover from 1.1.20*0 to 31.3.20*1Last date for lodgement of claim 31.3.20*1

This Deed of guarantee executed by the State Bank Of India constituted under the State Bank of

India Act, 1955 having its Central Office at Nariman Point, Mumbai & amongst other places, a

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branch at.(hereinafter referred to as the Bank) in favour

of(hereinafter referred to as the Beneficiary) for an amount not

exceeding Rs..(Rupees ..only) atthe request of.(hereinafter referred to as the Contractor/(s)).

This guarantee is issued subject to the condition that the liability of the bank under thisGuarantee is limited to a maximum of Rs. (Rupees..only) &

the Guarantee shall remain in full force up to 31.3.20*1 (date of expiry) & cannot be invoked

otherwise than by a written demand or claim under this Guarantee served on the Bank on or

before the 31.3.20*1, last date of claim).

SUBJECT TO AS AFORESAID

(Main Guarantee matter may be typed hereafter)

CREDIT APPRAISAL PROCESS

Receipt of application from applicant

|Receipt of documents

(Balance sheet, KYC papers, Different govt. registration no., MOA, AOA, and

Properties documents)

|

Pre-sanction visit by bank officers

|

Check for RBI defaulters list, willful defaulters list, CIBIL data, ECGC caution

list, etc.

|

Title clearance reports of the properties to be obtained from empanelled advocates

|

Valuation reports of the properties to be obtained from empanelled

valuer/engineers

|

Preparation of financial data

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OBJECTIVES

To study the Credit Risk Assessment Models.

To observe the movements to reduce various risk parameters which are broadly

categorized into financial risk, business risk, industrial risk & management risk.

To check the commercial, financial & technical viability of the project proposed & its

funding pattern.

To check the primary & collateral security cover available for recovery of

such funds.

RESEARCH DESIGN - Analytical in nature

COVERAGE

Study of credit appraisal in banking sector at State Bank of India, Ahmedabad

DATA COLLECTION

Secondary Data

Books & magazines

Database at SBI

Library research

Websites

E-circulars of SBI

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LIMITATION OF STUDY

Due to the constraint limited study on the project has been done

Access to data ( Credit Appraisal data in detail is not available)

EXPECTED CONTRIBUTION OF THE STUDY:

This study will help in understanding the credit appraisal system in banks & 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.

CHAPTER-4

INTRODUCTION OF SME

SME

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4.1 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 globaldominance.

4.2 From SSI to SME:

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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 ofservices 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.

4.3Definition 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. 10 crore may be treated as Medium Enterprises (ME).

The Government of India has enacted the Micro, Small and Medium Enterprises Development

(MSMED) Act 2006 which was notified on October 2, 2006. The definition of the small and

medium enterprises as provided in the Act (Annex VII) will have immediate effect.

4.4 Eligibility criteria

(i) These guidelines would be applicable to the following entities, which are viable 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.

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(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/tinyindustries 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.

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 AssessmentModel (RAM) and a comprehensive rating model for risk assessment of proposals for SMEs. The

banks may consider to take advantage of these models as appropriate and reduce 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.

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They can be compared to two sides of the same coin.

All credit proposals have some inherent risks, excepting the almost negligible volume oflending against liquid collaterals with adequate margin.

LENDING DESPITE RISKS:

So, risk should not deter a Banker from lending.

A bankers task is to identify/ assess the risk factors/ parameters & manage / mitigatethem on a continuous basis.

But its always prudent to have some idea about the degree of risk associated with anycredit proposal.

The banker has to take a calculated risk, based on risk-absorption/ risk-hedging capacity& risk-mitigation techniques of the Bank.

IMPORTANCE OF CREDIT RISK ASSESSMENT

Credit is a core activity of banks & an important source of their earnings, which go to pay

interest to depositors, salaries to employees & dividend to shareholders

In credit, it is not enough that we have sizable growth in quantity/ volume, it is also necessary toensure that we have only good quality growth.

To ensure asset quality, proper risk assessment right at the beginning, that is, at the time of takingan exposure, is extremely important.

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2. Financial parameters: The assessment of financial risk involves appraisal of the

financial strength of the borrower based on performance & financial indicators. The

overall financial risk is assessed in terms of static ratios, future prospects & riskmitigation (collateral security / financial standing).

3. Industry parameters: The following characteristics of an industry which pose varying

degrees of risk are built into Banks CRA model:

Competition

Industry outlook

Regulatory risk

Contemporary issues like WTO etc.

4. Management parameters: The management of an enterprise / group is rated on the

following parameters:

Integrity (corporate governance)

Track record

Managerial competence / commitment

Expertise

Structure & systems

Experience in the industry

Credibility : ability to meet sales projections

Credibility : ability to meet profit (PAT) projections

Payment record

Strategic initiatives

Length of relationship with the Bank

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5. The risk parameters as mentioned above are individually scored to arrive at an aggregate

score of 100 (subject to qualitative factors negative parameters). The overall score thus

obtained (out of a max. of 100) is rated on a 8 point scale from SB1/SBTL1 to SB 8/SBTL8.

SALIENT FEATURES OF CRA MODELS:

(a) Type of Models

S.No.

Exposure Level (FB + NFBLimits )

Non Trading Sector(C&I , SSI , AGL)

Trading Sector( Trade & Services)

(i) Over Rs. 5.00 crore Regular Model Regular Model(ii) Rs 0.25 crore to Rs. 5.00 crore Simplified Model Simplified Model

(b) Type of Ratings

S. No. Model Type of Rating

(i) Regular Model Borrower Rating

Facility Rating

(ii) Simplified Model Borrower Rating

New Rating Scales Borrower Rating: 16 Rating Grades

There are different rating given to the different banks. For example

S.

No.

Borrower

Rating

Range of

scores

Risk level Comfort Level

1 SB1 94-100 Virtually Zero risk Virtually Absolute safety

2 SB2 90-93 Lowest Risk Highest safety

3 SB3 86-89 Lower Risk Higher safety

4 SB4 81-85 Low Risk High safety

5 SB5 76-80 Moderate Risk with

Adequate Cushion

Adequate safety

6 SB6 70-75 Moderate Risk Moderate Safety

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7 SB7 64-69

8 SB8 57-63 Average risk Above Safety Threshold

9 SB9 50-56

10 SB10 45-49 Acceptable Risk

(Risk Tolerance Threshold)

Safety Threshold

11 SB11 40-44 Borderline risk Inadequate safety

12 SB12 35-39 High Risk Low safety

13 SB13 30-34 Higher risk Lower safety

14 SB14 25-29 Substantial risk Lowest safety

15 SB15

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CHAPTER-6

Page 55

S

NO

FACILITY

GRADES

RANGE

OF

SCORES

RISK LEVEL COMFORT

LEVEL

1 FR1 94-100 Virtually Zero Risk Virtually Absolute Safety2 FR2 87-93 Lowest Risk Highest Safety

3 FR3 80-86 Lower Risk Higher Safety

4 FR4 73-79 Low Risk High Safety

5 FR5 66-72 Moderate Risk withAdequate Cushion

Adequate Safety

6 FR6 59-65 ModerateRisk

ModerateSafety7 FR7 52-58

8 FR8 45-51 Average Risk Above Safety

Threshold9 FR9 38-44

10 FR10 31-37

Acceptable Risk

(Risk Tolerance Threshold)

Safety Threshold

11 FR11 24-30 High Risk Low Safety

12 FR12 17-23 Higher Risk Lower Safety

13 FR13 11-16 Substantial Risk Lowest Safety

14 FR14 5-10

15 FR15 1-4 Highest Risk

NIL16 FR16 0

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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.

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 in-

built 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

CREDIT APPRAISAL STANDARDS

1 (A) Qualitative:

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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 anew 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 perforceintroduced 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

DSCR

Net (min.)Gros (min.)

2:11.75:1

2:11.75:1

GearingD/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

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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 specificcases 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 to certain 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 NWC 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.

(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 assess

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