A REPORT ON CREDIT APPRAISAL BY ENROLLMENT NO. IBS HYDERABAD CREDIT APPRAISAL 1
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A REPORT
ON
CREDIT APPRAISAL
BY
ENROLLMENT NO.
IBS HYDERABAD
CREDIT APPRAISAL
Submitted by
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ENROLL ID
MBA-2013-2015A Project Report submitted in partial fulfilment of the requirements of MBA program of IBS HYDERABAD.
UCO BANK
DATE OF SUBMISSION: 16TH MAY 2013.
AUTHORIZATION
This is to certify that this is a bonafide project report submitted in partial fulfilment of the
requirement of MBA program of ICFAI Business School.
This report of documented titled “Credit appraisal Process at UCO Bank”.
This report has been formally submitted to Prof. Praveen Srivastava-Member of Faculty, IBS
Hyderabad.
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-
ACKNOWLEDGEMENT
At the completion of my Summer Internship Project, I feel obliged to express my heartfelt
gratitude towards all those who have made this possible. The three months of internship has been
an enriching experience in terms of learning and application of theory into practice. The real time
experience that I have received is something which cannot be emulated in a class room scenario
and will be highly helpful for my professional growth. The experience has helped me to
understand and appreciate the dynamics existing in working capital and term loan financing , the
intricacies involved in credit appraisals and also what are the parameters and approaches needed
to be followed by a credit analyst in this regard. I convey my sincere gratitude to Mr. A.K.
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Sharma, DGM Flagship corporate credit, Head office, UCO Bank for extending this opportunity
to me, for doing my summer internship during the three months duration from February 24th to
May 23rd at UCO Bank. I would also like to express my sincere gratitude to Mr. S.P. Singh, Chief
Manager who was my coordinator and guide at UCO Bank for the timely suggestions and
directions which were very helpful during the course of my project. If not for his guidance and
support, this Endeavour would not have been a success. Next, I definitely would like to thank Mr
Praveen Srivastava, Asst. Prof ICFAI HYDERABAD, my college guide for his keen and
dedicated approach in guiding and motivating me.
CHAPTER PLAN
TABLE OF CONTENTS
CHAPTER 1 EXECUTIVE SUMMARY……………………………….. 8
CHAPTER 2 INTRODUCTION TO CREDIT APPRAISAL………………… 10
CHAPTER 3 OBJECTIVES…………………………………………... 12
CHAPTER 4 RESEARCH METHODOLOGY……………………………. 13
CHAPTER 5 INDUSTRY PROFILE……………………………………. 14
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CHAPTER 6 COMPANY PROFILE……………………………………. 17
CHAPTER 7 REVIEW OF LITERATURE………………………………. 19
7.1 Working Capital Assessment…………………………. 19
7.2 Assessment of Term Loans…………………………… 30
7.3 Basel Accord & Risk Management…………………….. 31
CHAPTER 8 CREDIT APPRAISAL…………………………………… 33
8.1 Introduction………………………………………. 33
8.2 Market Analysis…………………………………… 34
8.3 Technical Analysis…………………………………. 36
8.4 Financial Analysis………………………………….. 38
8.5 Management & Organizational Analysis………………… 45
8.6 Credit Appraisal Checklist…………………………… 46
CHAPTER 9 CREDIT RISK MANAGEMENT…………………………… 49
9.1 Credit Risk………………………………………... 49
9.2 Credit Risk Management System in ………………... 49
CHAPTER 10 POST SANCTION FOLLOW UP OF LOANS………………….. 55
CHAPTER 11 ANALYSIS & INTERPRETATION………………………….. 57
11.1 UCO Loan Policy…………………………………. 57
11.1.1 Objective…………………………………..... 57
11.1.2 Basic Tenets of the Policy………………………... 57
11.1.3 Methods of Lending……………………………. 58
11.2 Credit Appraisal Process at UCO……………………… 60
11.2.1 Flowchart…………………………………... 60
11.2.2 Brief on the Process……………………………. 60
11.2.3 Risk Rating of the Borrower………………………. 62
11.2.4 Determination of the Applicable Rate of Interest…………. 65
11.2.5 Post Sanction Follow Up………………………… 66
CHAPTER 12 CASE STUDY 68
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12.1 Borrowers Profile…………………………….... 68
12.2 Credit Appraisal of ABC PARTS Pvt. Ltd……………... 71
I. Management Evaluation……………………
II. Business Evaluation………………………
III. Technical Evaluation……………………...
IV. Legal Evaluation………………………...
V. Financial Evaluation……………………...
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12.3 Present Proposal………………………………. 84
12.4 Security …………………………………… 89
12.5 Credit Risk Rating…………………………….. 90
12.6 Recommendations…………………………….. 94
CHAPTER 13 CONCLUSION & RECOMMENDATIONS……...………… 95
Conclusion……………………………………….. 95
Findings…………………………………………. 97
Recommendations………………………………...... 98
Limitations………………………………………... 99
List of Abbreviations:-
UCO United Commercial Bank
WC Working Capital
CMA Credit Monitoring Arrangement
WCDL Working Capital Demand Loan
SSI Small Scale industries
MPBF Maximum Permissible Bank Finance
NFB Non Fund Based6
FB Fund Based
PAT Profit After Tax
PBDIT Profit Before Depreciation Interest & Tax
TOL Total Outside Liabilities
TNW Total net Worth
CARE Credit Analysis & Research
CC Cash Credit
RBI Reserve Bank Of India
C& I Commercial & Industrial
PBS Projected Balance Sheet
LC Letter Of Credit
NWC Net Working Capital
WCG Working Capital Gap
CCA Core Current Assets
OCL Others Current Liability
DFI Development Financial Institutions
CA Current Assets
CL Current Liabilities
BOI Bank Of India
Chapter 1 EXECUTIVE SUMMARY
This project was undertaken at the UCO Bank. Companies that intend to seek credit facilities
approach the bank. Primarily, credit is required for following purposes:
a. Working capital finance
b. Term loan for mega projects
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c. Non Fund Based Limits like Letter of Guarantee, Letter of Credit etc.
Project Financing discipline includes understanding the rationale for project financing, how to
prepare the financial plan, assess the risks, design the financing mix, and raise the funds. In
addition, one must understand some project financing plans have succeeded while others have
failed. A knowledge-base is required regarding the design of contractual arrangements to support
project financing; issues for the host government legislative provisions, public/private
infrastructure partnerships, public/private financing structures; credit requirements of lenders, and
how to determine the project's borrowing capacity; how to analyze cash flow projections and use
them to measure expected rates of return; tax and accounting considerations; and analytical
techniques to validate the project's feasibility
Project finance is different from traditional forms of finance because the credit risk associated
with the borrower is not as important as in an ordinary loan transaction; what are most important
are the identification, analysis, allocation and management of every risk associated with the
project.
The purpose of this project is to explain, in a brief and general way, the manner in which risks are
approached by financiers in a project finance transaction. Such risk minimization lies at the heart
of project finance. Efficient management of credit portfolio is of utmost importance as it has a
tremendous impact on the Banks’ assets quality & profitability. The ongoing financial reforms
have no doubt provided unparallel opportunities to banks for growth, but have simultaneously
exposed them to various risks, which need to be effectively managed.
The concept of Credit Management is undergoing radical changes. Credit Risk in all exposures
calls for precise measuring and monitoring for taking considered credit decisions with suitable
risk mitigants, risk premium, etc. Credit portfolio should be well diversified in various promising
sectors with a cautious approach to be adopted in risky segments.
Also, lending continues to be a primary function in banking. In the liberalized Indian economy,
clientele have a wide choice. External Commercial Borrowings and the domestic capital markets
compete with banks. In another dimension, retail lending- both personal advances and SME
advances- competes with corporate lending for funds and for human resources. But lending by
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nature cannot be an aggressive selling activity, disregarding the risks involved. Bank has to be
competitive without compromising on the basic integrity of lending. The quality of the Bank’s
credit portfolio has a direct and deep impact on the Bank’s profitability.
The study has been conducted with the purpose of getting in-depth knowledge about the credit
appraisal and credit risk management procedure in the organization for the above said first two
purposes.
In this report I have also covered the methods applicable to the banks in appraising working
capital and term loan and their analysis. The whole process of appraisal starts when the borrower
arrives at the bank. It is followed by verification and detailed analysis of balance sheets, credit
limits to be sanctioned after considering all parameters like RBI guidelines and bank internal
guidelines and lastly follow-up has to be done by monitoring the cash-credit account and quarterly
information system reporting. After the analysis, the bank’s internal credit rating procedure is
done to rate the client before the final approval is given to the proposal
Chapter 2 CREDIT APPRAISAL – AN INTRODUCTION
It is the process by which a lender appraises the creditworthiness of the prospective borrower.
This normally involves appraising the borrower’s payment history, establishing the quality &
sustainability of his income.
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Factors like age, income, no of dependents, nature of employment, continuity of employment,
repayment capacity, previous loans, etc. are taken into account while appraising the
creditworthiness .Every bank or lending institution has its own panel of officials for this purpose.
CREDITWORTHINESS OF BORROWERS:-
The business of sanctioning unsecured loans & Advances is comparatively more risky & needs
special care & attention on the part of the banker.
The creditworthiness of a person/firm means that he/it deserves a certain amount of credit, which
may safely be granted .Such creditworthiness is judged by the banker on the basis of Character,
Capacity & Capital.
1) CHARACTER:-
In assessing the credit worthiness of the firm, the first consideration is Character of the firm
concerned. The word character implies & includes a number of personal characteristics. Like
honesty, integrity, regularity, & promptness in fulfilling its promises & repaying its dues, sense of
responsibility, good habits & reputation etc. If a firm possesses all these qualities without any
doubt or supervision in mind of others it possesses an excellent character & will be considered
creditworthy by the banker.
2) CAPACITY:-
The success of an enterprise largely depends upon the ability, competence,& experience of the
entrepreneur . If the borrower possesses necessary technical skill, managerial ability& experience
to run a particular industry or trade, success of such unit may be taken for granted & the banker
will consider it a deserving case for granting a loan. The significance of this factor is now growing
as the banks are willing to grant unsecured loans to persons/firms on the basis of soundness of
their business projects, irrespective of their own capital.
3) CAPITAL:-
The banker also gives importance to the adequacy of capital of the borrower. Banks are the
repositories of the public money & lend the borrowed money. The banker therefore does not lend
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money to an entrepreneur who does not have adequate funds of his own. In case of failure of the
business enterprise the banker will be able to realize if the borrower’s own capital is sufficient.
Apart from the above mentioned C’S there are some more criteria which should be
examined before sanctioning the loan. The criteria are as follows
1) CASH FLOW – Cash flow is the vital parameter that is used to identify whether the borrower
will have enough cash to repay the loan or advance. Cash keeps the liquidity to ensure repayment.
The banker rise to identify the annual cash flow from the submitted statements.
2) CONDITIONS – The business & economic conditions may change after the loan is
sanctioned. So these changes should be taken into consideration.
3) CAREFULNESS –Documentation, follow up & consistent monitoring are essential to high
quality loan portfolio.
Importance of Credit Appraisal System:-
The function of commercial bank is to collect deposit from the common people & to invest
deposited money in different sectors for overall development of the economy of the country.
Commercial banks and financial institutions are intermediate between lenders &borrowers. If the
bank manager fails to analyze the client’s viability of repaying the loan, possibility of default may
arise due to the fact. So the importance of APPRAISAL, in sanctioning the loan is the key to
identify the borrower’s ability, expertise, efficiency, industrial analysis (macro) &business
performance. In credit appraisal process the following parameters are taken into account.
RECOVERY OF CREDIT –Appraisal is done to ensure the recovery of the credit along
with the good supervision, monitoring, & the relationship. In other words the purpose of
the appraisal is to be sure that the proposal advance will be safe, liquid& profitable& for
all acceptable purpose covered by adequate security.
SAFETY –The most important measure of appraising the loan proposal is safety of the
project. Safety means the assurance of repayment of distributed loans .Bank is in business
to make money but safety should never be sacrificed for profitability. To ensure the safety
of the loan, the borrower should be chosen carefully.
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LIQUIDITY –The banker must ensure that the borrower is able to repay the loan on
demand or within a short period. This depend upon the nature of assets owned by the
borrower 7 pledged to the banker.eg. Goods& commodities easily marketable while fixed
assets like land & buildings can be liquidated after a time interval. Thus the banker regards
liquidity as important as safety of the funds & grants loans on the security of the assets
which are easily marketable without much loss.
PROFIT –Profit is the blood for any commercial institution .Before approval of any loan
project, the bank authority has to be sure that proposal project will be a profitable venture.
SECURITY –Security serves as a safety value for an unexpected emergency. Since risk
factors are involved, security coverage has to be taken before a lending.
DIVERSIFICATION OF RISK –During sanctioning any loan bank has to be attentive
about diversification of risk. All money must not be disbursed amongst a small no of
people.
NATIONAL INTEREST & GROWTH –Banking industry has significant role to play in
the economic development of a country. The bank would lend if the purpose of the
advances can contribute more to the overall economic development of the country
Sources of Credit Information:
Personal Interview:
The Manager should arrange one or more interviews with the borrower. A personal interview
with the prospective borrower is one of the most important duties of the Manager and this
responsibility should, in no case, be delegated to an inexperienced Officer. During the interview,
the Manager should probe into the past history, present performance and future prospects of the
borrower. The interview may cover whole range of his business such as,
(a) What is the experience of the borrower in the line in which he is engaged or wants to engage
himself?
(b) How many years has this business been operating? Has it produced a record of successful
operations? Do the turnover and profit show rising trend or falling trend?12
(c) What line of the business is the company in—retail, wholesale, manufacturing or service? Are
the products manufactured or sold, or the services performed acceptable to the public?
(d) Is it a proprietorship, partnership or limited company? If it is proprietorship, who is next to
handle the business if anything should happen to the proprietor? If the business is a partnership,
how many partners are there? What is the relationship of partners to each other? Whether all of
them are looking after the business or some of them are sleeping partners?
(f) What is the purpose of advance? How much money is required? How this quantum of advance
being asked for has been arrived at?
(g) What are capital resources of borrower? Does he intend to bring more capital?
(h) How the Management proposes to repay the advance? What will be the duration of advance?
(i) What security will be offered? Whether guarantee of some third party will be available? How
the security will be charged?
Bazar Reports:
Information regarding character and Integrity should be tactfully gathered from sources near to the
borrower. Reports should be obtained from businessmen carrying on in the same trade as the
borrower, some of whom may be his friends, others his rivals or enemies.
Report from other Banks:-
In case of new customers having dealings with other banks, confidential opinion of his bankers
should be obtained. In ascertaining the credit position from other banks, particularly where an
advance account is to be transferred from another bank to our books, care should be taken to see
that the credit information received from the party’s bankers are thoroughly checked up by
making independent bazar enquiries lest to get rid of a bad account, a favourable report is supplied
by the other bank.
Study of Account:-
In case of customer already having an account—current or cash credit/overdraft account—with
the branch, the bank’s own record should be looked into. What does it reveal?
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(a) The bank’s record will reveal the manner in which the borrower has handled his credit. This
information will indicate what can be expected of him in future.
(b) If the borrower formerly was not enjoying any credit limits, then the state of his current
account will indicate approximate turnover of his business, if there have been return of cheques
due to insufficiency of funds; stop payment of cheques etc.
(c) While the turnover of the account would indicate level of business activity, a scrutiny of the
pay in and pay-out items would throw light about the concerns with whom he is dealing with in
course of sales and purchases. If such concerns are repeated parties, it would add to the credibility
of the business.
Financial Statements:
The financial statements i.e. Profit and Loss Account and Balance Sheet for last three years
audited should be called for and properly analysed. In case, they have not been audited, unaudited
statements prepared for income tax purposes should be obtained and analysed. This analysis will
help answer such questions as:
(a) Whether the concern is financially sound and stable?
(b) Whether its profitability or earning capacity is up to the required standard?
(c) Whether its liquidity is satisfactory?
(d) Whether it is well managed?
Financial analysis determines the significant operating and financial characteristics of a firm form
accounting data and financial statements. Analysis can be done through:
1. Ratio Analysis
2. Trend analysis: Trend analysis can be through:
i. Intra firm comparison that is review of the trend of the ratios over the years
within the firm and
ii. Inter firm comparison.
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2. Reading of notes to accounts and other information: Careful reading and analysis of the
notes on accounts, one can gauge the policies of the management, performance of the
company, and its future planning.
Overtrading indications:
Over trading implies doing more business than can be conveniently carried on by the finance
available. Some of the indications of over trading are mentioned below:—
(a) Current liabilities increased at a faster rate of current assets.
(b) Creditors far exceed debtors.
(c) Borrowings tend to increase.
(d) Fixed assets tend to increase.
(e) More liquid current assets like cash and bank balance decrease and less liquid assets like
inventories, book debts increase.
(f) Allowing shorter credit than usual or customary.
(g) Obtaining longer credit than usual or customary.
(h) Total current liabilities are much in excess of tangible net worth.
Income Tax, Wealth Tax and Sales Tax Assessment Order:
Manager should call for the originals of Income Tax, Wealth Tax and Sales Tax Assessment
Orders for previous years as well as that for the current year. Wherever Income Tax, Wealth Tax
Assessments are not completed, copies of such returns, as filed, should be obtained. Income Tax
Assessment will give an idea of the borrower’s profits and comments, if any, in such orders on the
maintenance of accounts will be helpful in knowing the pitfalls in borrower’s business records.
Wealth Tax Assessment will indicate the net worth of the individual. Sales Tax assessment will
reveal the turnover in business.
Property Statement:
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The property statement of a borrower will give an idea of his worth, liabilities and his income
from real estate (immovable property). A complete list of property their situation, approximate
valuation should be obtained.
Personal Visit:
The Manager should not straightaway accept the figures presented in the borrower’s financial
statements or the information about business provided by him. The Manager, either alone, or
accompanied by his credit investigator/some other Officer, should visit the plant or place of
business of the borrower.
Project / Credit appraisal is done by banks or financial institutions by obtaining credit information
of the borrowing company.
Information required to be submitted by the Company (Borrower) to the
Bank:
The company should make sure that the following information required for processing credit
requests are collected by the company for submitting it to the bank or financial institution in order
to obtain the required credit facility:
1. Basic background information on the company:
2. Required facility
3. Key industry dynamics:
4. Management:
5. Management information system: Details of the planning, controlling and monitoring systems which have been put in place have to give.
6. Financials
7. Details of the Security to be pledged:
8. Present banking relationship: The bank requires full details of the present credit facilities being enjoyed at the moment.
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Chapter 3 OBJECTIVES
To Study/ analyse merits/demerits of the methodologies & guidelines directed by RBI
about financing working capital and term loan and its practical approach adopted by UCO
BANK ..
To understand the meaning & importance of Credit Appraisal System.
To study the eligibility criteria for sanctioning loans and advances.
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To analyse the procedure followed by the bank for sanctioning loans.
To study the documentation required for credit appraisal. To know the authorities &
committees involved in Credit Appraisal System.
To determine the efficiency of Credit Appraisal System of UCO BANK
To identify & suggest the scope for improvement in Credit Appraisal System of the bank.
Chapter 4 RESEARCH METHODOLOGY
Project Methodology’ is the procedure followed by the students for collecting the required data
for project. The necessary information is collected by following two types of sources:-
PRIMARY SOURCES OF DATA COLLECTION:-
Primary Data is the first hand data collected by following ways:-
Personal Interview: -
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By interviewing the CHIEF MANAGER –MR S.P. Singh (MY COMPANY GUIDE) essentials
for loan sanctioning were understood.
Observation: -
By observing the working of manager as well as employees in the bank, the actual procedure of
loan sanctioning was understood.
SECONDARY SOURCES OF DATA COLLECTION:-
Secondary Data is the readymade or readily available data obtained from following sources:-
Internet: -
The use of internet was beneficial for knowing the history & functioning of UCO BANK as well
as theory of Credit Appraisal System. credit rating report of CRISIL, CARE, internal rating report
prepared by risk management dept, ,BSE ,NSE sites for getting data about share market
perception of respective firms for collecting & analysing data.
Manual:-
Manual contains the detail description of the process followed by the UCO bank for credit appraisal
before sanctioning loans and advances and what can the manager do if he doesn’t find the relevant
information about the borrower. What are the various parameters on which the borrower should be
examined and what are the documents required during appraisal process of the borrower.
Chapter 5 BANKING INDUSTRY
Definition of Bank:-
Bank is a financial institution that borrows money from the public & lends money to the public for
productive purpose. The Indian banking regulation act of 1949 defines the term banking company
as “Any company which transacts banking business in India” & the term banking as “Accepting
the purpose of lending all investment of deposits, of money from the public, repayable on demand
or otherwise & withdrawal by cheque, draft or otherwise”.
Industry Overview:-
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History:-
Banking in India has its origin as carry as the Vedic period. It is believed that the transition from
money lending must have occurred even before Manu, the great Hindu jurist, who had devoted a
section of his work to deposits & advances, laid down rules relating to the interest. During the
Mughal period, the indigenous bankers played a very important role in lending money& financing
foreign trade & commerce. During the days of east India Company, it was to turn of the agency
houses top carry on the banking business. The general bank of India was the first joint stock bank
to be established in the year 1786.The other which followed was the Bank of Hindustan& Bengal
bank. The bank of Hindustan is reported to have continued till 1906, while the other two failed in
the meantime. In the 1st half of 19th century the east India company established three banks, The
bank of Bengal in 1809,The bank of Bombay in 1840, The bank of madras in 1843.The three
banks also known as presidency banks & were independent units & functioned well. These three
banks were amalgamated in 1920 & the imperial bank of India was established on Jan 1921, with
the passing of the SBI act in 1955, the undertaking of the imperial bank of India was taken over
by the newly constituted SBI. The reserve which is the central bank was created in 1935 by
passing of RBI act 1934. In the wake of swadeshi movement, a number of banks with Indian
management were established in the country namely Punjab national bank, canara bank limited,
Indian bank limited, The bank of Baroda limited, The central bank of India limited. On July 19 th
1969, 14 major banks of country were nationalized &in 15 thApril 1980 six more commercial
private sector banks were also taken over by the government .The Indian banking industry which
was governed by the banking regulation act of India 1949, can be broadly classified into two
major categories, non-scheduled banks &scheduled banks .Scheduled banks comprise commercial
banks & co-operative banks.
The first phase of financial reforms resulted in the nationalization of 14 major banks in 1969
&resulted in a shift from class banking to mass banking. This in turn resulted in the significant
growth in the geographical coverage of banks. Every bank had to earmark a min percentage of
their loan portfolio to sectors identified as “priority sectors”. The manufacturing sectors also grew
during the 1970s in protected environments & the banking sector was a critical source of capital.
The next wave of reforms saw the nationalization of 6 more commercial banks in 1980. Since then
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the no of scheduled commercial banks increased fourfold and the no of bank branches increased to
eight fold.
After the second phase of financial sector reforms & the liberalization of sector in the early
nineties the public sector banks found it difficult to compete with the new private sector banks &
foreign banks. The new private sector first made their appearance after the guidelines permitting
them issued in January 1993.
Indian Banking System:-
Banking in our country is already witnessing the see changes as the banking sector seeks new
technology &its application. The best part is that the benefits are beginning to reach masses.
Earlier this domain was the preserve of very few organizations. Foreign banks with heavy
investments in technology started giving some “out of the world” customer services. But the
services were available only to selected few very large account holders. Then came the
liberalization & with it a multitude of private banks, a large segment of urban population then
requires minimal time & space for its banking needs. One of the classical economic functions of
the banking industry that has remained virtually unchanged over the centuries is lending. On the
other hand competition has had considerable adverse impact on the margins, which lenders have
enjoyed ,but on the other hand technology has some extend reduced the cost of delivery of various
products & services.
The IT revolution had a great impact in the Indian banking system. The use of the computers had
led to introduction of online banking in India. The use of modern innovation &computerization of
the banking sector has increased many fold after the economic liberalization of 1991 as the
country’s banking sector exposed to the world market. The Indian banks were finding it difficult
to compete with the international banks in terms of the customer service without the use of the
information technology. Automated teller machine or popularly known as ATM are the three
alphabets that have changed the concept of banking like nothing before. Instead of tellers handing
your own cash, today there are efficient machines that don’t talk but just dispense cash. Total no
of ATMs installed in India by various banks as on end June 2012 is 99218.The new private sector
banks in India is having the largest no of ATMs which is followed by offsite ATMs belongs to
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SBI and its subsidiaries and then it is followed by new private banks, nationalized banks, &
foreign banks.
Current Scenario:-
Currently overall banking in India is considered as fairly mature in terms of supply, product range,
reach even though reach in rural India still remains a challenge for private sectors & foreign
banks. Even in terms of quality of assets & capital adequacy, Indian banks are considered to have
clean, strong and transparent balance sheets as compared to other banks in comparable economies.
The RBI is an autonomous body, with minimal pressure from the government. The stated policy
of the bank on the Indian rupee is to manage volatility –without any stated exchange rate & this
has mostly been true.
With the growth of the Indian economy expected to be strong for quite some time especially in its
service sectors, the demand for banking services –especially retail banking, mortgages&
investment services are expected to be strong. Currently India has 88 scheduled commercial banks
(SCBs) -28 public sector banks, 29 private banks and 31 foreign banks. They have a combined
network of 53000 branches .According to a report by ICRA limited, the public sector banks hold
over 75 percent of total assets of the banking industry, with the private and foreign banks holding
18.2% and 6.5% respectively.
Importance of Banking Sector in Growth of Indian economy:-
In the recent times when the service industry is attaining greater importance compare to
manufacturing industry banking has evolved as prime sector providing financial services to
growing needs of the economy.
Banking industry has undergone a paradigm shift from providing ordinary banking in the past to
such complicated & crucial services like merchant banking, housing finance, bill discounting etc.
The sector has become more active with entry of new players like foreign & private banks. It has
also evolved as a prime builder of the economy by understanding the needs of same &
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encouraging the development by way of giving loans, providing infrastructure facilities &
financing activities for the promotion of entrepreneurs & other business establishments.
For a fast developing country like India, presence of a sound financial system to mobilize &
allocate savings of the public towards productive activities is necessary. Commercial banks play a
crucial role in this regard.
The banking sector in recent years has incorporated new products in their business which is
helpful for growth. The banks have started to provide fee based services like, treasury operation,
managing derivatives, options& futures, acting as banker to the industry during the public
offering, providing consultancy services, acting as an intermediary between two business entities
etc. At the same time banks are reaching out to the other end of the customer requirements like
insurance premium payment, tax payment etc. It has changed itself from transaction type bank
into relationship banking, where we can find friendly &quick services suited to our needs. This is
possible with understanding the customer needs their value to the bank by well-organized staff,
computer based network for speedy transactions, plastic money facilities etc. The customer at
present ask for convenience of banking transactions, like 24 hours banking .The relationship
banking plays a major & important role in growth.
Another major role played by banks in a transactional business, transactions& networking. Many
Indian leading banks have spread out their network to other countries, which helps in currency
transfer & earn exchange over it.
These banks play a major role in commercial import & export business. This foreign presence also
helps in bringing in the international standards of operations &ideas. The liberalization of 1991
has allowed many foreign banks to enter in the Indian market & establish their business. This has
helped large amount of foreign capital inflow & increase our foreign exchange reserves.
Banks play important role in economic development of the country like:-
Banks mobilize the small savings of the people & make them an available for productive
purpose.
Promotes the habits of savings among the people thereby offering attractive ROI on their
deposits.
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Provides safety & security to the surplus money of the depositors and as well provides a
convenient & economical method of payment.
Banks provides convenient means of transfer of fund from one place to another.
Helps in movement of capital from regions where it is not very useful to regions where it
can be more useful.
Banks advances exposure in trade &commerce, industry& agriculture by knowing their
financing requirements & prospects.
Banks act as an intermediary between the depositors & the investors. Banks also act as
mediator between exporter &importer.
THE STRUCTURE OF INDIAN BANKING:-
The Indian banking industry has reserve bank of India as its regulatory authority. This is a mix of
public sector, private sector, co-operative banks & foreign banks. The private sector banks are
again split into old banks & new banks.
RESERVE BANK OF
INDIA
( Central bank)
Scheduled banks
24
New private sector
banksPublic sector banks
Chapter 6 COMPANY PROFILE
UCO bank is commercial public sector bank. It was established in 1943 by Ghanshayam Das
Birla. Earlier it was known as united commercial bank, it was started with Kolkata as its head
office with issued capital of 2 crores and paid up capital of 1 crore. As per current market position
government holding in UCO bank is 65.19 per cent.
Bank is managed around the nation by 41 zonal offices and 10 circle offices present in all the
crucial part of country. In terms of its availability to the customers it has 2200 branches and 568
ATM all over the country. UCO bank has vital presence in financial market outside India. It has
four overseas branches, two of which are in important financial centres of the world that is
Singapore and Hong Kong. This bank include many services to its customers which includes
25
International banking services , services for NRI, e-banking solutions , loan scheme and deposit
schemes. It has many branches for direct tax collections in India.
At present it has market capital of 5874.28 crores and its ROE is 19.4 per cent. Being a
commercial bank loan and advances is among the primary activity of the bank. Apart from
lending credit for both term loan and working capital loan for the different sectors like
Agriculture sector, Trade and Service sector, Large, Medium and Small Scale Industries sector,
Infrastructure sector etc. including taking care of their export import and non-fund based needs
like Letter of Credit, Bank Guarantee etc. Bank has large basket for the product for retail sector,
some of these are:
26
UCO Home UCO Car UCO Trader
UCO Education Loan UCO Cash UCO Rent
UCO Mortgage UCO Securities UCO Real Estate
UCO Pensioner UCO Two Wheeler UCO Premier
Educational Loan
Scheme
UCO Swabhiman – Reverse
Mortgage Loan Scheme for
Senior Citizen
Interest Subsidy
Scheme for Housing
the Urban Poor
(ISHUP)
UCO Education Loan
Scheme for
Vocational Education
and Training
UCO Gold Loan Kisan Credit Card
(KCC)
UCO KISAN
BHOOMI VRIDHI
(UKBV )
UCO KISAN TATKAL
SCHEME
UCO ESTATE
PURCHASE LOAN
SCHEME
UCO KISAN ALL
PURPOSE TERM
LOAN SCHEME
UCO HOME:-
This scheme is for individuals (including NRI and PIO) having minimum 21 years of age and
maximum 60 years of age (salaried person) and 65 years of age (non-salaried person) inclusive of
repayment period.
The purpose of this scheme is:-
Purchase and construction of independent house or flat for residential purpose.
Extension, Repair and Renovation of existing house not more than 50 years old.
Takeover of home loans availed from other banks/FIs.
Loan is also available for furnishing of house property.
UCO REAL ESTATE:-
Under the scheme advances are provided to the Promoter of real estate who must be well
established and experienced in their line of activities at least for a period of three years.
Cooperative Societies are not eligible.
UCO SWABHIMAN- REVERSE MORTGAGE LOAN MORTGAGE LOAN SCHEME
FOR SENIOR CITIZEN:-
under Reverse Mortgage a Senior Citizen, owning a house/flat, can enjoy a monthly Income
against the mortgage of his property while remaining the owner and occupying the house
throughout his lifetime, without repayment or servicing of the loan.
KISAN CREDIT CARD:-
Purpose of this scheme is:-
To meet the short term credit requirements for cultivation of crops
Self-consumption requirement of farmer.
Working capital for agriculture, dairy animals, inland fishery etc.
Investment credit requirement for agriculture and activities like pump sets, dairy animals
etc.
27
UCO KISAN ALL PURPOSE TERM LOAN SCHEME:-
This scheme was made:- To provide single term loan limit to farmers for all term loan
requirements like Farm Mechanization, Water Conservation, Horticulture, Allied Activities and
Other Agriculture related activities etc.
HISTORY:-
The idea of an Indian supporting bank was conceived of by Mr. G.D Birla, the doyen of Indian
Industrial renaissance, after the historic "Quit India" movement in 1942. Soon this nascent idea
came into reality and, on the 6th of January 1943, The United Commercial Bank Ltd. was
established with its Registered and Head Office at Kolkata. The very first Board of Directors was
represented by eminent personalities of India drawn from many fields, and this all-India character
of the Bank has been assiduously maintained till date not only in the composition of its Board but
also in the geographical spread of its 2500 and more branches in the country as well as in its
overseas centers in Singapore and Hong Kong.
Having traversed periods of expansion and consolidation, the Bank was nationalized by the
Government of India on 19 July 1969 whereupon 100 per cent ownership was taken over by the
government in UNITED COMMERCIAL BANK. This historic event brought about a sea-change
in the entire fabric of the bank's thinking and activities, commensurate with the government's
socio-political approach of mass banking as against class banking hitherto practiced. The Bank
had gone for Rs.200 crore of IPO during the year 2003-04 and is now a listed Company.
BRANCH PROFILE:-
This branch is located in Gomtinagar area of Lucknow.
IFSC code of this branch is- UCBA0001654
Branch code is – 1654
MICR number- 226028007
Major Clients of the Firm:-
28
NRVS enterprises, Modern Communications, Gunjan Enterprises, Everrite Machines Limited.
Major product:-
UCO home, UCO car, UCO trader, UCO cash, UCO swabhiman, Organization is known for
honouring the trust of its customers as it focus on satisfying its customers. Organization has
highly focused employee. Being the PSU bank it gets great support from government which helps
it in competing with other key players. This bank has strong policy regarding evaluation and
appraisal of credit. As bank is focusing on financial inclusion, it has great chance of increasing its
Customer base in rural areas. There is increase in the income of middle class hence bank can
launch different scheme to attract these customers .there is anticipation of improvement of
economic condition of country which can act as a great opportunity for bank. By communicating
different scheme to potential customers, bank can attract them.
Lending to priority sector may act as a hindrance in its growth. Increasing number of competitors
may decrease its customer base. Tactics of keeping low base rate by some private institution may
act as a great threat for bank.
Current Market Position:-
As on 31 March 2012, Government Share-holding of the Bank was 65.19 per cent. Branch
expansion started at a fast pace, particularly in rural areas, and the bank achieved several unique
distinctions in Priority Sector lending and other social uplift activities. To keep pace with the
developing scenario and expansion of business, the Bank undertook an exercise in organizational
restructuring in the year 1972. This resulted into more functional specialization, decentralization
of administration and emphasis on development of personnel skill and attitude. Side by side,
whole hearted commitment into the government's poverty alleviation programmes continued and
the convenor ship of State Level Bankers' Committee (SLBC) was entrusted on the Bank for
Odisha and Himachal Pradesh in 1983.
29
The year 1985, the name 'United Commercial Bank' was changed into UCO BANK by an Act of
Parliament. Over the years, UCO Bank been regarded as one of the well-known and vibrant banks
in the country.
UCO BANK’s Financial Result for the Fin. Year ended March 31, 2013:-
In crores
Parameters 31.03.2012
Audited
31.03.2013
audited
Change over FY 12
(%)
Global business 271508 305000 12.34
Global deposits 154003 173431 12.62
Global advances 117504 131569 11.97
Operating profit 2811 3357 19.41
Net profit 1109 618 -44.24
Net interest income 3902 4582 17.42
Book value per share 94.72 97.92 3.38
Table 1: UCO BANK’s Financial Result March 31, 2013
Key ratios
Parameters 31.03.12 31.06.12 30.09.12 31.12.12 31.03.13
Return on asset 0.59 0.81 0.22 0.21 0.10
CAR 12.35 12.33 12.27 13.19 14.22
Gross NPA (%) 3.48 3.88 4.88 5.53 5.42
Net NPA(%) 1.96 2.23 2.94 3.32 3.17
30
Table 2: UCO BANK’s Key ratios March 31, 2013
Key observations:-
Total business as at end Mar’13 stood at Rs. 305000 crore as compared to Rs. 271508
crore in Mar’12, exhibiting a growth of 12.34 % on Y-o-Y basis.
Business per Employee increased to Rs. 12.66 crore as at March 2013 from Rs. 11.73
crore as at March 2012.
Business per Branch improved to Rs. 116.92 crore as at March 2013 compared to
Rs. 113.60 crore last year.
Total income for the full year Rs. 17704 crore compared to Rs. 15598 crore for FY12.
The Bank's interest income for the whole year was at Rs. 16752 crore compared to Rs.
14632 crore for FY12.
Total expenses for the whole year was Rs. 14347 crore compared to Rs. 12787 crore for
FY12.
Operating expenses reached Rs. 2177 crore compared to Rs. 2056 crore for FY12.
The Bank continues to maintain healthy capital base. As at March 2013, Capital Adequacy
Ratio as per Basel-II stood at 14.22% (as against mandatory level of 9%).
International Presence:-
Besides providing inland banking services through its vast network of branches in India, UCO
Bank has a vital presence in the financial markets outside India. UCO Bank presently has four
overseas branches in two important international financial centers in Singapore and Hong
Kong and representative office at Kuala Lumpur, Malaysia and Guangzhou, China.and is
considering proposals to open further branches in major financial centers across the globe. UCO
bank has international presence for over 60 years now.
The Bank’s Singapore Operations commenced from 21.04.1951 with the opening of Singapore
Main branch and subsequently Sera goon branch was opened in “Little India” on 07.03.1959.The
international linkage from Singapore is supported by a large number of Indian branches network
31
through Integrated Treasury Branch, Mumbai. Other branches in India also provide international
banking facilities through Authorized Branches of the bank.
This international network is further augmented by correspondent arrangements with leading
Banks at all important world centers in various countries
MISSION, VISION &VALUE:-
Mission Statement:-
To be a Top-class Bank to achieve sustained growth of business and profitability, fulfilling socio-
economic obligations, excellence in customer service; through up gradation of skills of staff, their
effective participation and making use of state-of-the-art technology.
Vision Statement:-
To emerge as the most trusted, admired and sought-after world class financial institution and to be
the most preferred destination for every customer and investor and a place of pride for its
employees.
Organization Structure:-
Headquartered in Kolkata, the Bank has 39 Zonal Offices spread all over India. Branches located
in a geographical area report to the Zonal Office having jurisdiction over that area. These Zonal
Offices are headed by Senior Executives ranging upto the rank of General Manager, depending on
size of business and importance of location. The Zonal Offices report to at Head Office in
Kolkata.
32
ABOUT THE LOGO:-
33
“HONORS YOUR TRUST”
The logo of UCO bank consists of a pair of clasped hands covered with an Octagonal Structure.
The logo is two hands encircling a point, or its the symbol of protecting ones trust with two hands
and the fists are also enclosed within a box shaped formed by the same hand. Overall, it's the
protection of trust and depict a sense of security in the customer's mind.It has been coloured blue
since the organization's inception, blue representing the Bank's national responsibility. The
background has remained yellow since the beginning as well.
The motto UCO Bank has been - "Honors your Trust".
34
Chapter 7 REVIEW OF LITERATURE
7.1 WORKING CAPITAL AND ITS ASSESSMENT
The objective of running any industry is earning profits. An industry will require funds to acquire
“fixed assets” like land and building, plant and machinery, equipments, vehicles etc… and also to
run the business i.e. its day to day operations.
Working capital is defined, as the funds required for carrying the required levels of current assets
to enable the unit to carry on its operations at the expected levels uninterruptedly. Thus working
capital required (WCR) is dependent on
i. The volume of activity (viz. level of operations i.e. Production and Sales)
ii. The activity carried on viz. manufacturing process, product, production programme, and
the materials and marketing mix.
The purpose of assessing the WC requirement of the industry is to determine how the total
requirements of funds will be met. The two sources for meeting these requirements are the unit’s
long-term sources (like capital and long term borrowings) and the short-term borrowings from
banks. The long-term resources available to the unit are called the liquid surplus or Net Working
Capital (NWC).
It can be explained by visualizing the process of setting up of industry. The unit’s starts with a
certain amount of capital, which will not normally be sufficient, even to meet the cost of fixed
assets. The unit, therefore, arranges for a long-term loan from a financial institution or a bank
towards a part of the cost of fixed assets. From these two sources after meeting the cost of fixed
assets some funds remain to be used for working capital. This amount is the Net Working Capital
or Liquid Surplus and will be one of the sources of meeting the working capital requirements.
The remaining funds for working capital have to be raised from banks; banks normally provide
working capital finance by way of advantage against stocks and sundry debtors. Banks, however,
do not finance the full amount of funds required for carrying inventories and receivables: and
35
normally insist on the stake of the enterprise at every stage, by way of margins. Bank finance is
normally restricted to the amount of funds locked up less a certain percentage of margins. Margins
are imposed with a view to have adequate stake of the promoter in the business both to ensure his
adequate interest in the business and to act as a protection against any shocks that the business
may sustain. The margins stipulated will depend on various factors like salability, quality,
durability, price fluctuations in the market for the commodity etc. taking into account the total
working capital requirements as assessed earlier, the permissible limit, up to which the bank
finance cab be granted is arrived.
While granting working capital advances to a unit, it will be necessary to ensure that a reasonable
proportion of the working capital is met from the long-term sources viz. liquid surplus. Normally,
liquid surplus or net working capital be at least 25% of the working capital requirement
(corresponding to the benchmark current ratio of 1.33), though this may vary depending on the
nature of industry/ trade and business conditions.
Various methods for assessment of Working Capital are discussed in detail:-
1. Operating cycle method :
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. The time that lapses between cash outlay & cash realization by sale of
finished goods & realization of sundry debtors is known as the length of the operating cycle.
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)
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 36
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. length of operating cycle = a + b + c + d.
E.g.:- 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.
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 Material Rs.14,000 p.m.
Wages Rs.2,000 p.m.
Other manufacturing expenses Rs.3,000 p.m.
Total Expenditure Rs.19,000 p.m. (B)
Profit Rs 1000 p.m.
Table 4: illustration (a)37
The operating cycle is:-
Raw material 15 days
Stock in process 2 days
Finished goods 3 days
Sundry debtors 15 days
Table 5: illustration (b)
the total length of operating cycle = 35 days (D)
Working Capital Requirement = B * D / 30
= 19000 * 35 / 30
= Rs.22166 (approx.)
Traditional method of assessment of working capital requirement:-
38
The operating cycle concept serves to identify the areas requiring improvement for the purpose of
control and performance review. But, bankers 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
While computing the WCR of a unit, it is necessary to take into account two other factors:-
1) Credit received on purchases
2) Advance received against orders placed for the products for industry.
Raw Material Months
Requirement
Rs.A
Stock-in-Process (for period of processing)
Months cost of
Production
Rs.B
Finished Goods Months cost of
Production required to be
stocked
Rs.C
Sundry Debtors Months cost of
Production (Outstanding
Credits)
Rs.D
Expenses One month (say) Rs.E
Credit received on purchases Rs.F
Advance Payment on Order Received
Rs.G
39
Working Capital Requirement (Wcr)
(A+B+C+D+E)
- (F+G)
Table 6: Illustration (c)
The unit starts with a certain amount of capital which will not normally be sufficient even to meet the cost of Fixed Assets. The unit thus arranges for a long term loan from a financial institution or a bank towards a part of the cost of fixed assets. From these two sources, after meeting the cost of fixed assets, some funds remain to be used for working capital. This amount is ‘Net Working Capital’ or ‘Liquid Surplus’ & will be one of the sources of meeting working capital requirement. The remaining funds for working capital have to be raised from Banks. Banks normally provide working capital finance by way of advances against stocks & sundry debtors. However, banks do not finance the full amount of funds required for carrying inventories & receivables & normally insist on the stake of the enterprise at every stage, by way of margins. Margins are imposed with a view to have adequate stake of the promoter in the business both to ensure his adequate interest in the business & to act as a bulwark against any stocks that the business may sustain. The margins stipulated will depend on various factors like saleability, quality, durability, price fluctuations in the market for the commodity, etc. Taking into account the total working capital requirement as assessed earlier, the permissible limit, up to which the bank finance can be granted is arrived at as shown below:-
Raw Material Rs . A
Less : % margin Rs.B
Rs.A – Rs.B = Rs.P
Stock-in-process Rs.C
Less : % margin Rs.D
Rs.C – Rs.D = Rs.Q
Finished Goods Rs.E
Less : % margin Rs.F
40
Rs.E – Rs.F = Rs.R
Sundry Debtors (at sale value) Rs.G
Less : % margin Rs.H
Rs.G – Rs.H = Rs.S
Total Permissible Limit P + Q + R + S = T
Table 7: Illustration (d)
‘P + Q + R’ will indicate the total limit against stock & ‘S’ the limit against sundry debtors or receivables in the form of bills. The difference between the Working Capital Requirement (WCR) & the total permissible bank borrowing (T) should be met from the Liquid Surplus or Net Working Capital. When the liquid surplus is not sufficient to meet the long term working capital requirements, there will be a ‘deficit’ in meeting the unit’s working capital requirement.
Assessment of WC
Name of the Unit: - M/s ABC Ltd.
Particulars
(Rs. in 000’s)
Anticipated monthly sales Rs.100
Cost of production per month Rs.90
of Raw Material Rs.80
Table 8: Illustration (e)
Item Stocking /
Payment
Period Working
capital
Margin % Amount Permissible
41
Required limit
Raw material --- --- --- --- ---
Indigenous Raw
Material
1 month 80 25 20 60
Work in Process
2 weeks 45 25 11 34
Finished goods
2 weeks 45 25 11 34
Receivables (at
sales value)
1 month 90 33 23 67
Expenses 1 month 10 100 10 ---
Total 270 75 195
advance payment received 10
Credit on purchase 40
Working Capital Required (WCR) 270-(10+40) =220
Table 9: Illustration (f)
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.
42
Bankers provide working capital finance for holding an acceptable level of current assets viz. raw
materials, stock-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 of an industry.
Raw material: Any industrial unit has to necessarily stock a minimum quantum of materials used
in its production to ensure uninterrupted production. Factors, which affect or influence the funds
requirement for holding raw material, are:
i. Average consumption of raw materials.
ii. Their availability – locally or form places outside, easy availability / scarcity,
number of sources of supply
iii. Time taken to procure raw materials (procurement time or lead time)
iv. Imported or indigenous.
v. Minimum quantity supplied by the market (Minimum Order Quantity (MOQ)).
vi. Cost of holding stocks (e.g. insurance, storage, interest)
vii. Criticality of the item.
viii. Transport and other charges (Economic Order Quantity (EOQ)).
ix. Availability on credit or against advance payment in cash.
x. Seasonality of the materials.
This raw material requirement is generally expressed as so many months requirement
(consumption).
Stock in process:-
Barring a few exceptional types of industries, when the raw material get converted into finished
products within few hours, there is normally a time lag or delay or period of processing only after
which the raw materials get converted into finished product. During this period of processing, the
raw materials get converted into finished goods and expenses are being incurred. The period of
processing may vary from a few hours to a number of months and unit will be blocked working
funds in the stock-in-process during this period. Such funds blocked in SIP depend on:
i.The processing time
43
ii.Number of products handled at a time in the process
iii.Average quantities of each product, processed at each time (batch quantity)
iv.The process technology
v.Number of shifts.
Finished goods:
All products manufactured by an industry are not sold immediately. It will be necessary to stock
certain amount of goods pending sale. This stock depends on:
i. Whether the manufacture is against firm order or against anticipated order
ii. Supply terms
iii. Minimum quantity that can be dispatched
iv. Transport availability and transport cost
v. Pre-dispatch inspection
vi. Seasonality of goods
vii. Variation in demand
viii. Peak level/ low level of operations
ix. Marketing arrangement- e.g. direct sale to consumers or through dealers/
wholesalers.
The requirement of funds against finished goods is expressed so many months’ cost of production.
Sundry debtors (receivables):
Sales may be affected under three different methods:
i. Against advance payment
ii. Against cash
iii. On credit
A unit grants trade credit because it expects this investment to be profitable. It would be in the
form of sales expansion and fresh customers or it could be in the form of retention of existing
customers. The extent of credit given by the industry normally depends upon:
44
i. Trade practices
ii. Market conditions
iii. Whether it is bulky by the buyer
iv. Seasonality
v. Price advantage
Even in cases where no credit is extended to buyers, the transit time for the goods to reach the
buyer may take some time and till the cash is received back, the unit will have to be cut out of
funds. The period from the time of sale to receipt of funds will have to be reckoned for the
purpose of quantifying the funds blocked in sundry debtors. Even though the amount of sundry
debtors according to the unit’s books will be on the basis of Sale Price, the actual amount blocked
will be only the cost of production of the materials against which credit has been extended- the
difference being the unit’s profit margin- (which the unit does not obviously have to spend). The
working capital requirement against Sundry Debtors will therefore be computed on the basis of
cost of production (whereas the permissible bank finance will be computed on basis of sale value
since profit margin varies from product to product and buyer to buyer and cannot be uniformly
segregated from the sale value).
The working capital requirement is expressed as so many months’ cost of production.
Expenses:
It is customary in assessing the working capital requirement of industries, to provide for 1
month’s expenses also. A question might be raised as to why expenses should be taken separately,
whereas at every stage the funds required to be blocked had been taken into account. This amount
is provided merely as a cushion, to take care of temporary bottlenecks and to enable the unit to
meet expenses when they fall due. Normally 1-month total expenses, direct and indirect, salaries
etc. are taken into account.
While computing the working capital requirements of a unit, it will be necessary to take into
account 2 other factors,
i. Is the credit received on purchases- trade credit is a normal practice in trading
circles. The period of such credit received varies from place to place, material to
45
material and person to person. The amount of credit received on purchases reduces
the working capital funds required by the unit.
ii. Industries often receive advance against orders placed for their products. The
buyers, in certain cases, have to necessarily give advance to producers e.g. custom
made machinery. Such funds are used for the working capital of an industry. It can
be thus summarized as follows:
Raw materials Months requirement Rs. A
Stock-in-process Months (cost of Production) Rs. B
Finished Goods Months cost of Production required to be stocked Rs. C
Sundry Debtors Months cost of Production (o/s credits) Rs. D
Expenses One month(normally) Rs. E
Total Current Assets A+B+C+D+E
Credit received on Purchases (months’ Purchase value) Rs. F
Advance payment on order received Rs. G
WORKING CAPITAL REQUIRED (H) = (A+B+C+D+E)- (F+G)
46
2. Projected Annual Turnover Method for SME units (Nayak Committee):-
For SME units, which enjoy fund based working capital limits up to Rs.5 crore, 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.
Example:
Anticipated Annual Output (A) 120
Working Capital Requirement: 25% of A (B) 30
Margin : 5% of A (C) 6
Maximum Permissible Bank Finance (B-C) 24In Rs lacs
Important clarifications:
i. The assessment of WC limits should be done both as per Projected Turnover Method and
Traditional Method; the higher of the two is to be sanctioned as credit limit. If the
operating cycle is more than 3 months, there is no restriction on extending finance at more
than 20% of the turnover provided that the borrower should bring n proportionally higher
stake in relation to his requirements of bank finance.
ii. While the approach of extending need based credit will be kept in mind, the financial
strengths of the unit is also important, the later aspect assumes greater significance so as to
take care of quality of bank’s assets. The margin requirement, as a general rule, should not
be diluted.
47
3. MPBF Method (Tandon and Chore Committee Recommendations):-
The Tandon Committee was appointed to suggest a method for assessing the working capital
requirements and the quantum of bank finance. Since at that time, there was scarcity of bank’s
resources, the Committee was also asked to suggest norms for carrying current assets in different
industries so that bank finance was not drawn more than the minimum required level. The
Committee was also asked to devise an information system that would provide, periodically,
operational data, business forecasts, production plan and resultant credit needs of units. Chore
Committee, which was appointed later, further refined the approach to working capital
assessment. The MPBF method is the fall out of the recommendations made by Tandon and Chore
Committee. Regarding approach to lending: the committee suggested three methods for
assessment of working capital requirements.
i. First Method of lending: According to this method, Banks would finance up to a max. of
75% of the working capital gap (WCG= the total current assets - current liabilities other
than bank borrowing) and the balance 25 % of the WCG considered as margin is to come
out of long term source i.e. owned funds and term borrowings. This will give rise to a
minimum current ratio of 1.17:1. The difference of (1.17-1) represents the borrower’s
margin which is popularly known as Net Working Capital (NWC) of the unit
ii. Second Method of lending: As per the 2nd method Bank will finance maximum up to 75%
of total current assets (TCA) & Borrowers has to provide a minimum of 25% of total
current assets as the margin out of long term sources. This will give a minimum current
ratio of 1.33:1
iii. Third Method of lending: Same as 2nd method, but excluding core current assets from
total assets and the core current assets is financed out of long term funds. The term ‘core
current assets’ refers to the absolute minimum level of investment in current assets, which
is required at all times to carry out minimum level of business activity. The current ratio is
further improved i.e. 1.79: 1
48
Example:
Current Liabilities Current assets
Creditors for purchase 100 Raw material 200
Other current liability 50 Stock in process 20
Bank borrowings 200 Finished goods 90
Receivables 50
Other current assets 10
Total Current Liabilities 350 Total Current Assets 370
(In Rs lacs)
Calculating NWC
First method of lending Second method of lending Third method of lending
Total CA 370 Total CA 370 Total CA 370
Less: CL – Bank Borrowing
150 Less: 25% of CA 92Less: core CA from LT
95
275
Working Capital Gap 220Less: CL - Bank Borrowing
150Less: 25% from LTS
69
25% of WCG from long term sources
55Less: CL – Bank Borrowing
150
MPBF 165 MPBF 128 MPBF 56
Current ratio 1.17: 1 Current ratio 1.33: 1 Current ratio 1.79: 1
49
The above example shows that the contribution of margin by the borrower increases when
financing is shifted from First method to Second method which is known to be stringent from
borrower point of view (Third method was not accepted by RBI).
4. Projected Balance Sheet Method (PBS):-
The PBS method of assessment will be applicable to all borrowers who are engaged in
manufacturing, services and trading activities who require fund based working capital finance of
Rs. 25 lacs and above. In 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.. The
assessment will be based on the borrower’s projected balance sheet, the funds flow planned for
current/ next year and examination of the profitability, financial parameters etc. unlike the MPBF
method, it will not be necessary in this method to fix or compute the working capital finance on
the basis of a stipulated minimum level of liquidity (Current Ratio). The working capital
requirement worked out is based on the following:
i. CMA assessment method is continued with certain modifications.
ii. Analysis of the Profit and Loss account, Balance Sheet, Funds flow etc. for the past
periods is done to examine the profitability, financial position, and financial
management etc of the business.
iii. Scrutiny and validation of the projected income and expenses in the business and
projected changes in the financial position (sources and uses of funds). This is carried
out to examine whether these parameters are acceptable from the angle of liquidity,
overall gearing, efficiency of operations etc.
In the PBS method, the borrower’s 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. The assessment procedure is as follows:
i. Collection of financial information from the borrower
ii. Classification of current assets / current liabilities
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iii. Verification of projected levels of inventory/ receivables/ sundry creditors
iv. Evaluation of liquidity in the business operation
v. Validation of bank finance sought
Working Capital Flowchart:-
Collection of financial data
Analysis of financial data
Classification of Current Assets (CA)/ Current Liabilities (CL)
Verification of projected levels of current assets/ current liabilities with specialEmphasis on inventory/ receivables/ sundry creditors
Evaluation of liquidity in the business operation
Validation of bank finance sought on the project balance sheet
Fixing of sub-limits
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Disbursement of Working Capital Loan
7.2 ASSESSMENT OF TERM LOANS:-
Term Loans are generally granted to finance capital expenditure, i.e. for acquisition of land,
building and plant and machinery, required for setting up a new industrial undertaking or
expansion/diversification of an existing one and also for acquisition of movable fixed assets.
Term Loans are also given for modernization, renovation, etc. to improve the product quality or
increase the productivity and profitability.
The basic difference between short-term facilities and term loans is that short-term facilities are
granted to meet the gap in the working capital and are intended to be liquidated by realization of
assets, whereas term loans are given for acquisition of fixed assets and have to be liquidated from
the surplus cash generated out of earnings. They are not intended to be paid out of the sale of the
fixed assets given as security for the loan. This makes it necessary to adopt a different approach
in examining the application of the borrowers for term credits.
For the assessment to Term Loan Techno Economic Feasibility Study is done. The success of a
feasibility study is based on the careful identification and assessment of all of the important issues
for business success. A detailed Project Report is submitted by an entrepreneur, prepared by a
approved agency or a consultancy organization. Such report provides in-depth details of the
project requesting finance. It includes the technical aspects, Managerial Aspect, the Market
Condition and Projected performance of the company. It is necessary for the appraising officer to
cross check the information provided in the report for determining the worthiness of the project.
The feasibility study is a part of Credit Appraisal process and the same is discussed in the
following chapter.
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Chapter 8 CREDIT APPRAISAL
8.1 INTRODUCTION
Effectiveness of Credit Management in the bank is highlighted by the quality of its loan portfolio.
Every Bank is striving hard to ensure that its credit portfolio is healthy and that Non Performing
Assets are kept at lowest possible level, as both of these factors have direct impact on its
profitability. In the present scenario efficient project appraisal has assumed a great importance as
it can check and prevent induction of weak accounts to our loan portfolio. All possible steps need
to be taken to strengthen pre sanction appraisal as always “Prevention is better than Cure”. With
the opening up of the economy rapid changes are taking place in the technology and financial
sector exposing banks to greater risks, which can be broadly classified as under:
Industry RisksGovernment regulations and policies, availability of infrastructure facilities, Industry Rating, Industry Scenario & Outlook, Technology Up gradation, availability of inputs, product obsolescence, etc.
Business RisksOperating efficiency, competition faced from the units engaged in similar products, demand and supply position, cost of labor, cost of raw material and other inputs, pricing of product, surplus available, marketing, etc.
Management Risks
Background, integrity and market standing/ reputation of promoters, organizational set up and management hierarchy, expertise/competence of persons holding key position in the organization, delegation and decentralization of authority, achievement of targets, track record in execution of project, debt repayment, industry relations etc.
Financial Risks Financial strength/standing of the promoters, reliability and reasonableness of projections, past financial performance, reliability of operational data and
53
financial ratios, adequacy of provisioning for bad debts, qualifying remarks of auditors/inspectors etc.
In light of the foregoing risks, the banks appraisal methodology should keep pace with ever
changing economic environment. The appraisal system aims to determine the credit
needs/requirements of the borrower taking into account the financial resources of the client. The
end objective of the appraisal system is to ensure that there is no under - financing or over -
financing. Following are the aspects, which need to be scrutinized and analyzed while appraising:
8.2 MARKET ANALYSIS :-
(Demand & Potential)
The market demand and potential is to be examined for each product item and its
variants/substitutes by taking into account the selling price of the products to be marketed vis-a-
vis prices of the competing products/substitutes, discount structure, arrangement made for after
sale service, competitors' status and their level of operation with regard to production and products
and distribution channels being used etc. Critical analysis is required regarding size of the market
for the product(s) both local and export, based on the present and expected future demand in
relation to supply position of similar products and availability of the other substitutes as also
consumer preferences, practices, attitudes, requirements etc. Further, the buy-back arrangements
under the foreign collaboration, if any, and influence of Government policies also needs to be
considered for projecting the demand. Competition from imported goods, Government Import
Policy and Import duty structure also need to be evaluated.
8.3 TECHNICAL ANALYSIS
In a dynamic market, the product, its variants and the product-mix proposed to be manufactured in
terms of its quality, quantity, value, application and current taste/trend requires thorough
investigation.
Location and Site54
Based on the assessment of factors of production, markets, Govt. policies and other factors,
Location (which means the broad area) and Site (which signifies specific plot of land) selected for
the Unit with its advantages and disadvantages, if any, should be such that overall cost is
minimized. It is to be seen that site selected has adequate availability of infrastructure facilities
viz. Power, Water, Transport, Communication, state of information technology etc. and is in
agreement with the Govt. policies. The adequacy of size of land and building for carrying out its
present/proposed activity with enough scope for accommodating future expansion needs to be
judged.
Raw Material
The cost of essential/major raw materials and consumables required their past and future price
trends, quality/properties, their availability on a regular basis, transportation charges, Govt.
policies regarding regulation of supplies and prices require to be examined in detail. Further, cost
of indigenous and imported raw material, firm arrangements for procurement of the same etc.
need to be assessed.
Plant & Machinery, Plant Capacity and Manufacturing Process
The selection of Plant and Machinery proposed to be acquired whether indigenous or imported
has to be in agreement with required plant capacity, principal inputs, investment outlay and
production cost as also with the machinery and equipment already installed in an existing unit,
while for the new unit it is to be examined whether these are of proven technology as to its
performance. The technology used should be latest and cost effective enabling the unit to compete
in the market. Purchase of reconditioned/old machinery is to be dealt in terms of laid down
guidelines. Compatibility of plant and machinery, particularly, in respect of imported technology
with quality of raw material is to be kept in view. Also plant and machinery and other equipments
needed for various utility services, their supply position, specification, price and performance as
also suppliers' credentials, and in case of collaboration, collaborators' present and future support
requires critical analysis. Plant capacity and the concept of economic size has a major bearing on
the present and future plans of the entrepreneur(s) and should be related to the availability of raw
material, product demand, product price and technology.
55
The selected process of manufacturing indicating the adequacy, availability and suitability of
technology to be used along with plant capacity, manufacturing process needs to studied in detail
with capacities at various stages of production being such that it facilitates optimum utilization
and ensures future expansion/ debottlenecking, as and when required. It is also to be ensured that
arrangements are made for inspection at intermediate/final stages of production for ensuring
quality of goods on successful commencement of production and completion, wherever required.
8.4 FINANCIAL ANALYSIS
The aspects which need to be analyzed under this head should include cost of project, means of
financing, cost of production, break-even analysis, financial statements as also profitability/funds
flow projections, financial ratios, sensitivity analysis which are discussed as under:
Cost of Project & Means of Financing
a. The major cost components of any project are land and building including transfer,
registration and development charges as also plant and machinery, equipment for auxiliary
services, including transportation, insurance, duty, clearing, loading and unloading charges
etc. It also involves consultancy and know-how expenses which are payable to foreign
collaborators or consultants who are imparting the technical know-how. Recurring annual
royalty payment is not reflected under this head but is accounted for under the profitability
statements. Further, preliminary expenses, such as, cost of incorporation of the Company, its
registration, preparation of feasibility report, market surveys, pre-operative expenses like
salary, travelling, start up expenses, mortgage expenses incurred before commencement of
commercial production also form part of cost of project. Also included in it are capital issue
expenses which can be in the form of brokerage, commission, advertisement, printing,
stationery etc. Finally, provisions for contingencies to meet any unforeseen expenses, such
as, price escalation or any other expense which have been inadvertently omitted like margin
for working capital requirements required to complete the production cycle, interest during
construction period, etc. are also part of capital cost of project. It is to be ensured while
appraising the project that cost and various estimates given are realistic and there is no
56
under/over estimation. Further, these cost components should be supported by proper
quotations, specifications and justifications of land, machinery and know-how expenses etc.
ii. Besides Bank’s loan, the project cost is normally financed by bringing capital by the
promoters and shareholders in the form of equity, debentures, unsecured long term loans and
deposits raised from friends and relatives which are not repayable till repayment of Bank's
loan. Resources are raised for financing project by raising term loans from Institutions/Banks
which are repayable over a period of time, deferred term credits secured from suppliers of
machinery which are repayable in installments over a period of time. The above is an
illustrative list, as the promoters have now started raising funds through Euro-issues, Foreign
Currency loans, premium on capital issues, etc. which are sometimes comparatively cheap
means of finance. Subsidies and development loans provided by the Central/State
Government in notified backward districts to attract entrepreneurs are also means of financing
a project. It is to be ascertained that requirement of finance has been properly tied-up for
unhindered implementation of a project. The financing structure accepted must be in
consonance with generally accepted levels along with adequate Promoters' stake. The
resourcefulness, willingness and capacity of promoter to contribute the same have also to be
investigated.
In case of project finance, the promoter/borrower may bring in upfront his contribution (other
than funds to be provided through internal generation) and the branches should commence its
disbursement after the stipulated funds are brought in by the promoter/borrower. A condition
to this effect should be stipulated by the sanctioning authority in case of project finance, on
case to case basis depending upon the resourcefulness and capacity of the promoter to
contribute the same. It should be ensured that at any point of time, the promoter’s
contribution should not be less than the proportionate share.
Profitability Statement
The profitability statement which is also known as `Income and Expenditure Statement' is
prepared after considering the net sales figure and details of direct costs/expenses relating to raw
material, wages, power, fuel, consumable stores/spares and other manufacturing expenses to
57
arrive at a figure of gross profit. Thereafter, all other expenses like salaries, office expenses,
packing, selling/distribution, interest, depreciation and any other overhead expenses and taxes are
taken into account to arrive at the figure of net profit. The projections of profit/loss are prepared
for a period covering the repayment of term loans. The economic appraisal includes scrutinizing
all the items of cost, and examining the assumptions, if any, to ensure that these are realistic and
achievable. There should not be any optimism or pessimism in working out profitability
projections since even a little change in the product-mix from non-remunerative to remunerative
or vice-versa can distort the picture. While preparing profitability projections, the past trends of
performance in an industry and other environmental factors influencing the cost and revenue items
should also be considered objectively.
Generally speaking, a unit may be considered as financially viable, progressive and efficient if it
is able to earn enough profits not only to service its debts timely but also for future
development/growth.
Break-Even Analysis
Analysis of break-even point of a business enterprise would help in knowing the level of output
and sales at which the business enterprise just breaks even i.e. there is neither profit nor loss. A
business earns profit if it operates at a level higher than the break-even level or break-even point.
If, on the other hand, production is below this level, the business would incur loss. The break-
even point in an algebraic equation can be put as under:
The fixed costs include all those costs which tend to remain the same up to a certain level of
production while variable costs are those costs which tend to change in proportion with the
volume of production. As regards unit sales price, it is generally the same for all levels of output.
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Break-even point
(Volume or Units)Total Fixed Cost / (Sales price per unit - Variable Cost per unit)
Break-even point
(Sales in rupees)(Total Fixed Cost x Sales) / (Sales - Variable Costs)
The break-even analysis can help in making vital decisions relating to fixation of selling price
make or buy decision, maximizing production of the item giving higher contribution etc. Further,
the break-even analysis can help in understanding the impact of important cost factors, such as,
power, raw material, labor, etc. and optimizing product-mix to improve project profitability.
Fund-Flow Statement
A fund-flow statement is often described as a ‘Statement of Movement of Funds’ or ‘where got:
where gone statement’. It is derived by comparing the successive balance sheets on two specified
dates and finding out the net changes in the various items appearing in the balance sheets.
A critical analysis of the statement shows the various changes in sources and applications (uses)
of funds to ultimately give the position of net funds available with the business for repayment of
the loans. A projected Fund Flow Statement helps in answering the under mentioned points.
How much funds will be generated by internal operations/external sources?
How the funds during the period are proposed to be deployed?
Is the business likely to face liquidity problems?
Balance Sheet Projections
The financial appraisal also includes study of projected balance sheet which gives the position of
assets and liabilities of a unit at a particular future date. In other words, the statement helps to
analyze as to what an enterprise owns and what it owes at a particular point of time.
An appraisal of the projected balance sheet data of the unit would be concerned with whether the
projections are realistic looking to various aspects relating to the same industry.
Financial Ratios
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While analyzing the financial aspects of project, it would be advisable to analyze the important
financial ratios over a period of time as it may tell us a lot about a unit's liquidity position,
managements' stake in the business, capacity to service the debts etc. The financial ratios which
are considered important are discussed as under:
Ratio Formula Remarks
1Debt-Equity
Ratio
Debt (Term Liabilities)
Equity
(Where, Equity = Share capital,
free reserves, premium on shares,
, etc. after adjusting loss balance)
There cannot be a rigid rule to a satisfactory debt-
equity ratio, lower the ratio higher is the degree of
protection enjoyed by the creditors. These days the
debt equity ratio of 1.5:1 is considered reasonable.
It, however, is higher in respect of capital intensive
projects. But it is always desirable that owners
have a substantial stake in the project. Other
features like quality of management should be kept
in view while agreeing to a less favorable ratio.
In financing highly capital intensive projects like
infrastructure, cement, etc. the ratio could be
considered at a higher level.
2
Debt-
Service
Coverage
Ratio
Debt + Depreciation +
Net Profit (After Taxes)
+ Annual interest on long
term debt
Annual interest on long
term debt + Repayment
of debt
This ratio of 1.5 to 2 is considered reasonable. A
very high ratio may indicate the need for lower
moratorium period/repayment of loan in a shorter
schedule. This ratio provides a measure of the
ability of an enterprise to service its debts i.e.
`interest' and `principal repayment' besides
indicating the margin of safety. The ratio may vary
from industry to industry but has to be viewed with
circumspection when it is less than 1.5.
3 TOL / TNW
Ratio
Tangible Net Worth
(Paid up Capital + This ratio gives a view of borrower's capital
structure. If the ratio shows a decreasing trend, it 60
Reserves and Surplus -
Intangible Assets)
Total outside Liabilities
(Total Liability - Net
Worth)
indicates that the borrower is relying more on his
own funds and less on outside funds and vice versa
4Profit-Sales
Ratio
Operating Profit (Before
Taxes excluding Income
from other Sources)
Sales
This ratio gives the margin available after meeting
cost of manufacturing. It provides a yardstick to
measure the efficiency of production and margin
on sales price i.e. the pricing structure
5
Sales-
Tangible
Assets Ratio
Sales
Total Assets - Intangible
Assets
This ratio is of a primary importance to see how
best the assets are used. A rising trend of the ratio
reveals that borrower has been making efficient
utilization of his assets. However, caution needs to
be exercised when fixed assets are old and
depreciated, as in such cases the ratio tends to be
high because the value of the denominator of the
ratio is very low.
6Current
Ratio
Current Assets
Current Liabilities
Higher the ratio greater the short term liquidity.
This ratio is indicative of short term financial
position of a business enterprise. It provides
margin as well as it is measure of the business
enterprise to pay-off the current liabilities as they
mature and its capacity to withstand sudden
reverses by the strength of its liquid position. Ratio
analysis gives indications; to be made with
reference to overall tendencies and parameters in
relation to the project.
7 Output Sales
This ratio is indicative of the efficiency with which 61
Investment
Ratio
Total capital employed
(in fixed & current
assets)
the total capital is turned over as compared to other
units in similar lines.
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Internal Rate of Return
The discount rate often used in capital budgeting that makes the net present value of all cash flows
from a particular project equal to zero. Higher a project's IRR the more desirable it is to undertake
the project. IRR should be higher than the Cost of the project (interest rate in case of project
financing)
Sensitivity Analysis
While preparing and appraising projects certain assumptions are made in respect of certain
critical/sensitive variables like selling price/cost price per unit of production, product-mix, plant
capacity utilization, sales etc. which are assigned a `VALUE' after estimating the range of
variation of such variables. The `VALUE' so assumed and taken into consideration for arriving at
the profitability projections is the `MOST LIKELY VALUE'. Sensitivity Analysis is a systematic
approach to reduce the uncertainties caused by such assumptions made. The Sensitivity Analysis
helps in arriving at profitability of the project wherein critical or sensitive elements are identified
which are assigned different values and the values assigned are both optimistic and pessimistic
such as increasing or reducing the sale price/sale volume, increasing or reducing the cost of inputs
etc. and then the project viability is ascertained. The critical variables can then be thoroughly
examined by generally selecting the pessimistic options so as to make possible improvements in
the project and make it operational on viable lines even in the adverse circumstances.
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8.5 MANAGEMENT & ORGANIZATION ANALYSIS
Appraisal of project would not be complete till it throws enough light on the person(s) behind the
project i.e. management and organization of the unit. It is seen that some projects may fail not
because these are not viable but because of the ineffectiveness of the management and the
organization in controlling various functions like production, marketing, finance, personnel, etc.
The appraisal report should highlight the strengths and weaknesses of the management by
commenting on the background, qualifications, experience, and capability of the promoter, key
management personnel, and effectiveness of the internal control systems, relation with labor,
working conditions, wage structure, and the other assigned essential functions. In case the
promoter(s) have interest, in other concerns as Proprietor or Partner or Director, the appraisal
report should also comment on their performance in such concerns.
A business is more vulnerable if decision making in all the functional areas rests with a particular
person, in other words, `one man show'. Further, the management and the organization should be
conducive to the size and type of business. In case it is not so, it should be ensured that
professional managers are inducted to strengthen the organization.
8.6 APPRAISAL OF PROJECT - A CHECK LIST
An indicative list of issues which need to be looked into while appraising a project is given below:
64
MARKETING
1. Reasonable demand projections keeping in view the size of the
market, consumption level, supply position, export potential, import
substitute, etc.
2. Competitors' status and their level of operation with regard to
production and sales.
3. Technology advancement/Foreign Collaborator's Status/Buy-back
arrangements etc.
4. Marketing policies in practice, for promotion of product(s) and
distribution channels being used. Expenses on marketing are done
so as to popularize the product.
5. Local/foreign consumer preferences, practices adopted, attitudes,
requirements etc.
6. Influence of Govt. policies, imports and exports in terms of quantity
and value.
7. Marketing professionals employed their competence, knowledge
and experience.
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TECHNICAL
1. Product and its life cycle, product-mix and their application.
2. Location, its advantages/disadvantages, availability of
infrastructural facilities, Govt. concessions, if any, available there.
3. Plant and machinery with suppliers' credentials and capacity
attainable under normal working condition.
4. Process of manufacturing indicating the choice of technology,
position with regard to its commercialization and availability.
5. Plant and machinery - its availability, specification, price,
performance.
6. Govt. clearance/ license, if any, required.
7. Labor/ Manpower, type of skills required and its availability
position in the area.
FINANCIAL
1. Total project cost and how it is being funded/financed.
2. Contingencies and inflation duly factored in project cost.
3. Profitability projections based on realistic capacity utilization and
sales forecast with proper justification. Unrealistic/ambitious sales
projections without reference to past performance and justification
to be avoided.
4. Break-even analysis, fund flow and cash flow projections.
5. Balance sheet projections should be realistic and based on latest
available data. The components of financial ratios should be
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subjected to close scrutiny.
6. Aspect of support of parent company, wherever applicable, may be
taken into account.
MANAGERIAL
1. Financial standing and resourcefulness of the management.
2. Qualifications and experience of the promoters and key
management personnel.
3. Understanding of the project in all of its aspects - financing pattern,
technical knowledge and marketing programme etc.
4. Internal control systems, delegation of adequate powers and
entrusting responsibility at various levels.
5. Other enterprises, if any, wherein the promoters have the interest
and how these are functioning.
ECONOMIC
1. Impact on increase in level of savings and income distribution in
society and standard of living.
2. Project contribution towards creation and rate of increase of
employment opportunity, achieving self sufficiency etc.
3. Project contribution to the development of the region, its impact on
environment and pollution control
To judge whether the project is viable, i.e. it can generate adequate surplus for servicing its debts
within a reasonable period of time and still left with some funds for future development. This
involves taking an over-all view to analyse the strengths and weaknesses of the project. It should
67
also be analysed to see whether the management and organisation can prove effective for
successful implementation of the project.
Chapter 9 CREDIT RATING
Rating has to be assigned to all the Credit accounts with the bank in terms of the guidelines
prescribed for the purpose. In addition, credit portfolio of the branches, regions and the Bank as a
whole are also to be rated.
In rating individual accounts, the extant guidelines provide for rating of all individual accounts
(excluding accounts under retail segment) having exposure above Rs 25 lacs. Accounts having
exposure of Rs 25 lacs and below and those under retail segment are also to be rated, but rating
for these accounts are determined based on aggregate default performance of group of similar
accounts (pooled assets). For example, all accounts under ‘UCO Shelter’ may have one rating
assigned to it. All accounts under this category would be assigned the rating. Classification of all
accounts having exposure of Rs 25 lacs and below in to various asset pools and their respective
rating would be communicated by Head Office, Risk Management Department over a period of
time. Portfolio rating of the entire credit exposure at branches, regions and the Bank as a whole is
determined based on weighted average rating (based on outstanding balance as well as limit
sanctioned) of all credit accounts at branches, regions and Bank as a whole respectively.
68
Keeping in view what has been stated above, this chapter is divided in to the following three
sections.
1. Rating of Accounts with Exposure of Rs 25 Lacs or below & Accounts under Retail Segment.
2. Rating of Accounts (excluding accounts under retail segment) with Exposure of more than Rs
25 Lacs.
3. Portfolio Rating
Section 1:-
Rating of Accounts with Exposure of Rs 25 Lacs or below & Accounts under Retail Segment:-
Credit rating of accounts having exposure of Rs 25 lacs or less and Bank’s mid-market products
i.e.,
UCO Car
UCO Cash
UCO Education
UCO Mega Cash
UCO Nari Shakti
UCO Pension
UCO Shelter
UCO Shopper
are to be arrived at based on bank’s default experience at aggregate level. The rating of such
accounts would be advised from time to time. Branches and controlling offices would be required
to assign credit rating on these accounts based on instructions issued by Head Office, Risk
69
Management Department. All accounts falling under following categories are to be assigned
rating as indicated below
Exposure type- classification Exposure type- sub classification
Rating model to be used/rating to be assigned
Rating Based on
Aggregate/Pool Performance
Loans against banks own deposits
A++
Staff loans A++
Accounts under UCO Securities Scheme
A++
Gold loans A++
Accounts with aggregate FB
and NFB limit up to Rs.25 lacs
Rating to be assigned - Would be advised subsequently
with due approval of Risk
Management Committee of
Board.
Accounts under Mid-Market Scheme*
UCO Car UCO Cash
UCO Education Board.
UCO Mega Cash
UCO Nari Shakti
UCO Pension
UCO Shelter
UCO Shopper
Rating to be assigned –
Would be advised subsequently
with due approval of Risk Management Committee of
Section 2.:-
70
Rating of Accounts (excluding accounts under retail segment) with Exposure of
more than Rs 25 Lacs:-
Rating of Accounts with Exposure of more than Rs 25 Lacs (excluding accounts under retail
segment) are to be carried out for each account using an appropriate rating model. The rating
process involves:-
A) Selection of Appropriate Rating Model
B) Operational instructions
C) Awarding score in terms of guidelines prescribed
D) Total Weighted Score & Rating
A. Selection of Appropriate Rating Model:-
It is clarified that Credit rating of all the accounts cannot be carried out using a single rating
model. Bank has developed various rating models depending upon the size, type and our
experience with an account. Accordingly, appropriate rating model has to be selected depending
upon
Size of exposure,
Type of exposure and
whether the account is an existing account or a new account or a green field Account or a
green field project.
Existing Accounts:-
These are borrowal accounts of business units which are already in existence and are having
account with us. The business units would have annual financial statements i.e., balance sheet and
profit & loss accounts and would also have a track record with the Bank that enables us to assess
them on conduct of accounts etc.
New Accounts:-71
These are borrowal accounts of business units which are already in existence but are not having
account with us. The business units would have annual financial statements i.e., balance sheet and
profit & loss accounts but would not have a track record with the Bank. This makes it difficult to
assess them on conduct of accounts including that on non-fund based facilities, performance in
relation with projections etc.
Green Field Accounts:-
These are new business accounts and therefore do not have past financial statements i.e., balance
sheet and profit & loss accounts and also have no track record to assess them on conduct of
accounts etc. This makes it difficult to assess them on conduct of accounts including that on non-
fund based facilities, performance in relation with projections, performance on operational and
financial parameters.
Green Field Projects:-
These are new projects started by a new company or projects of an existing company where
investment in the asset of the new project is more than 50% of the tangible net worth of the
company.
Newly Promoted NBFCs/ Infrastructure Development Corporation, Industrial Development
Corporation and Financial & Development Institutions:-
These are new accounts of NBFCs/ Infrastructure Development Corporation, Industrial
Development Corporation and Financial & Development Institutions and therefore do not have
past financial statements i.e., balance sheet and profit & loss accounts and also have no track
record to assess them on conduct of accounts etc. This makes it difficult to assess them on conduct
of accounts including that on non-fund based facilities, performance in relation with projections,
performance on operational and financial parameters.
Operational Instructions
General Instructions
1. Rating models enclosed provide for rating of existing, new and green field accounts. However,
depending on the type of account, limit and tenure of the facility relevant rating model should be
72
used. The maximum marks will be different for existing, new and green field accounts. Therefore,
total marks scored is to be converted out of 100 for uniformity for management rating as well as
rating of operational performance/financial ratios.
2. Rating is to be based on financial data as on immediate past financial year closing. This would
imply that if we are rating a business unit on 15th September 2005, rating should be based on
audited (or certified by owner/promoter where accounts are not audited) financial statements as on
31st March 2005, assuming that financial year of the business unit ends on March 31.
3. While rating a business unit there is no need to take into account proposed borrowings etc. The
rating is to be carried out on the position as it exists on the immediate past financial year closing.
This is for the purpose of rating only.
4. It is clarified that “Entry Barriers” may provide for certain bench mark ratios that may include
proposed borrowings. Such ratios may be computed as has been provided for in the Loan Policy.
5. In fact, with every new activity undertaken by a business unit or with every additional dose of
financial facilities, rating may undergo a change. This would call for re-rating of the unit based on
revised data. But, for the time being this may not be carried out. Bank shall issue necessary instru
instructions in the matter in due course.
Rating & Rating Review
Rating of all accounts, which are to be sanctioned at Head Office level, would be carried out by
Risk Management Department at Head Office. In addition, Risk Management Department, Head
Office shall review the rating of accounts sanctioned by regional heads on random basis.
Similarly, rating of all accounts, which are to be sanctioned at Regional Offices, would be carried
out by Credit Monitoring Department at regional offices. Further, in respect of accounts
sanctioned by regional heads, credit monitoring department of regional office shall forward
necessary details to Head Office, Risk Management Department for review of rating as and when
called for. Necessary details would include the following.
Process Note
Audited Financial Statements for the relevant Year
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MCMR in respect of the account (in respect of existing accounts)
Project Report (in respect of green field accounts/projects)
In branches, rating would be carried out at appraisal level and confirmed by sanctioning authority.
Concerned region’s Credit Monitoring Department shall review the rating. The branch shall
forward necessary details (i.e., Process Note, Audited Financial Statements for the relevant year,
MCMR in respect of existing account and Project Report in respect of green field
accounts/projects) to SPC Head of concerned regional office.
Rating Based Action Points
Review/Renewal of accounts
Review/Renewal exercise in accounts rated B or below should be carried out every 9 months. In
other accounts annual review/renewal exercise should be carried out.
Stock Audit
Stock audit of accounts shall be carried out in accordance with the extant guidelines of Credit
Monitoring Policy of the bank.
Pricing
As pricing is related to rating, on review of rating by HO Risk Management Department/ Credit
Monitoring Department of Regional Office the pricing may require revision. This would be
applicable to accounts sanctioned at branches and by regional heads. However, revision in pricing,
if any, on account of review of rating by Risk Management Department at Head Office would be
decided by Executive Director or Chairman & Managing Director.
Concessionary Rate of Interest
In permitting concessionary rate of interest, the competent authority shall use the rating assigned
by Risk Management Department, Head Office / Credit Monitoring Department of the concerned
Regional Office
Rating Guidelines:-
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Rating guidelines are given below for various exposure types as listed.
1) Accounts with aggregate FB and NFB limit over Rs. 25 lacs and up to Rs. 5 crores
2) Accounts with aggregate FB and NFB limit over Rs.5 crores without term facilities or with
term facilities of maturity not exceeding 5 years
3) Accounts with aggregate FB and NFB limit over Rs.5 crores with term facilities with maturity
of more than 5 years
4) Exposure on Green Field projects with aggregate FB and NFB limit over Rs.5 crores with
maturity of more than 5 years
5) Exposure on NBFCs with aggregate FB and NFB limit of Rs.25 lacs and above
6) Exposure on Accounts of infrastructure Development Corporation, Industrial Development
Corporation and Financial & Development Institutions with aggregate FB and NFB limit of Rs.25
lacs and above
All rating models have been designed to for evaluating ‘Management’, ‘Operational Performance
& Financial Ratios’ and ‘Industry Outlook or Project rating’. However, depending upon type of
exposure, the relevant factors differ. All the relevant factors applicable for rating have been
detailed below.
1. Accounts with aggregate FB and NFB limit over Rs. 25 lacs and up to Rs. 5 crores:-
The credit rating model adopted by the bank for these accounts has taken into consideration the
following relevant factors grouped under three heads:
A. Management
Integrity / Commitment
Financial Strength
Technical / Finance Knowledge
Organizational Structure / Succession Plan
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Selling and distribution network
Experience of Directors & Promoters
Pending Litigations
Market Reputation & Past Track Record
Conduct of Bank Accounts
Accounts running regular/Irregular
Compliance of terms/conditions of sanction
Discipline in timely submission of data/information
Inventory & Receivables
Management of Inventory & Receivables
Realisability of Receivables & Valuation of Inventory
Comments given by Bank Inspectors/Stock Auditors
Transparency in Accounting Statements
B. Operational Performance & Finance Ratios
Sales/ Break Even Sales
Current Ratio
Return on Capital Employed
Debt Service Coverage Ratio (DSCR)
Long Term Debt/ Equity
Total Out side Liabilities/Tangible Net Worth
Achievement of Net Sales Projections
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Achievement of Net Profit Projections
Operations in Non - Fund Based Loan Limits
Diversion of Funds
Net Profit / Net Operating Cash Flow
Assessment on relevant factors would be made as detailed below.
A. Management
In predicting performance of a business unit, assessment of management quality is a crucial
factor. Single most important reason for business failure has been attributed to inefficient
management. Management inefficiency can stem from lack of integrity and commitment to lack
of necessary expertise and inability to raise resources in time of need. Assessment of management
is also difficult, as quite a few of the attributes of efficient management need qualitative
assessment. Management efficiency reflects in the way they maintain their accounts with banks,
manage business inventory and the accounting practices they follow. In predicting management
success in managing business these factors have been found to be very relevant.
Integrity and Commitment:-
This is a qualitative assessment of promoter(s) or proprietor or partners or top management in case
of professionally managed companies (i.e., public limited companies where majority of shares are
held by public/FIs/MFs etc. like Larsen & Toubro, ITC etc.). Assessment on this aspect of
management should be based on market and bankers’ report, willingness to offer securities to
secure Bank’s loan, commitment of the management towards the business, management’s track
record in honoring its commitment in the past.A qualitative view on the management may be
taken based on the attributes mentioned above and the management can be categorized as
excellent, good, average or poor.
Financial Strength:-
“Financial Strength“ under management rating should be carried out in the following manner:
1. Market value of the shares ( as on the date of rating) of the company to its Nominal value.
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Market Value of the shares is the price at which the shares are traded in the market. Nominal
Value is the face value of the shares.Example:
The market value of the 10 Rs.shares of a company is say Rs.142 on the date of rating. In this
case, Market Market value of the shares/Nominal value = 142/10=14.2. The company will,
therefore, score 3 marks on this parameter.
In case of companies where no share has been issued or in the case of companies
where shares are not traded in the market or regular quotes are not available in the market, marks
awarded should be “0”. This is because of the reason that such companies would not be in a
position to raise additional funds from the market.
2. Capacity of internal generation of funds.
Return on Equity has been taken as an indicator for the Capacity of Internal generation of funds.
This is defined as under:
Return on Equity (ROE) = Profit after Tax/ Total Equity( paid up Capital)
Allocation of marks:
Example:
In case of a company, profit after tax is say Rs.50 crores. The company has paid up equity capital
of Rs. 200 crores.
ROE= 50/200=1/4=.25 i.e. 25%. The company will, therefore, score “ 0” on the Net Worth of the
promoters excluding stake in the business:
This will indicate the extent to which the promoters would be able to inject additional funds from
their own sources whenever required.
Technical/Finance Knowledge:-
This again is a qualitative assessment of promoter(s) or proprietor or partners or top management
in case of professionally managed companies (i.e., public limited companies where majority of
shares are held by public/FIs/MFs etc. like Larsen & Toubro, ITC etc.).
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This aspect of the Management is rated based on technical and financial qualification of the
promoters/key personnel, their knowledge of financial and banking related aspects, their ability to
manage funds in an optimum manner, their ability to manage manufacturing processes in an
efficient manner etc. These attributes should be relevant to the line of business. A qualitative view
on the management may be taken based on the attributes mentioned above and the management
can be categorized as excellent, good, average or poor.
Organisation Structure / Succession plan:-
This is a qualitative assessment of the company’s organisation and its functioning. This aspect of
the management is assessed based on type of organization structure and hierarchy,
qualification/quality of persons holding key positions, employee turnover in the organization,
coordination among executives of different departments, delegation of responsibilities and
powers, succession plan for top management etc.
A qualitative view on the management may be taken based on the attributes mentioned above and
the management can be categorized as excellent, good, average or poor.
Selling and Distribution Network:-
This is a qualitative assessment of company’s capability to sell what it produces. This aspect of
the company is assessed based on its strength to reach its customers and how well it is placed to
meet the market competition. Company’s sales network, marketing plan including advertisement
for its products and quality of sales are relevant factors here. Quality of sales here refers the
realization of cash within reasonable period from credit sales and relative share of cash sales in
total sales.
A qualitative view on this aspect may be taken based on the attributes mentioned above and can
be categorized as excellent, good, average or poor.
Experience of Directors and Promoters:-
This is an assessment of experience in the line of business of promoter(s) or proprietor or partners
or top management in case of professionally managed companies (i.e., public limited companies
where majority of shares is held by public/ FIs/MFs etc. like Larsen & Toubro, ITC etc.).
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This aspect is assessed based on number of years of effective experience in handling similar line
of business and the level at which functional experience has been acquired. More the experience
better will be the awareness about the finer points of the line of business. Higher the functional
level at which the experience has been acquired, better would be the overall knowledge in the line
of business.
Normally five years of experience in the line of business as promoter/top level functionary should
be good enough for highest rating. Where experience in the line of business is not there, minimum
rating should be assigned under this factor.
Pending Litigations:-
Assessment on this aspect is based on number of cases pending against the company and/or its
management. Where litigations involve reputation of the company and/or its management and/or
have financial implications, where litigations relate to non-compliance with requirements of
regulatory/statutory nature such as tax related issues or environmental or license related issues, or
where litigations involve patents/trademark/intellectual property rights related matter etc., such
litigations would have impact on the company’s financial position or operations. In such cases
lowest rating should be awarded under this category.Information on these matters are usually
available from market, annual report of the company including “Notes to Accounts” attached to
annual reports and can be assessed from contingent liability schedule of annual report.
Market Reputation and Past track record:-
This is an overall assessment of promoter(s) or proprietor or partners or top management in case
of professionally managed companies (i.e., public limited companies where majority of shares are
held by public/FIs/MFs etc. like Larsen & Toubro, ITC etc.) in the eyes of parties dealing with it
including the Bank. Market is the major source of information. Track record with the Bank is a
matter of record. One should also look up the RBI Defaulter List and ECGC list for assessing
company’s track record with other banks/financial institutions.
A qualitative view on this aspect of management may be taken based on the information gathered
from market/past records etc. and can be assessed as excellent, good, average or poor.
Conduct of Bank Accounts:-
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This is an objective assessment of a company’s behavior pattern towards his banker and reflects
management’s attitude towards honouring their commitments to the Bank. Where a company
operates its account within agreed limits and in accordance with terms of sanction, has complied
with terms of sanction and has the discipline in timely submission of data/information etc. it may
be rated highest under this area. Deviations from promised behavior are penalized that brings
down the rating.
Assessment under this area is based on records that exist with the bank and therefore, very
transparent assessment can be made.
Inventory & Receivables:-
This also is an objective assessment of a company’s ability to manage its inventory. This is
assessed based on level of inventory maintained in relation to its sales and an assessment of
realisability and valuation of inventories based on Comments given by Bank’s inspectors/Stock
Auditors. Assessment under this area is also based on records that exist with the bank and
available in company’s accounts and therefore, very transparent assessment can be made in this
area as well.
Transparency in Accounting Statements:-
Transparency and adherence to the standard accounting practices lend credibility to the financial
numbers reported in the balance sheet and profit and loss account. These numbers are critical in
assessment of credit worthiness of a borrower. Bankers would encourage its borrowers to adhere
to proper practices in the matter.
A financial statement prepared as per standard accounting practice and that reflects true position
of the borrower should be rated best.
B. Operational Performance & Finance Ratios:-
Apart from management evaluation, operational performance and financial parameters can be
used to predict the performance of a business organisation or a business unit. The financial and
performance ratios that have high predictive power and have been taken into account in rating of
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borrowers are listed below. Ratios have been defined so that every borrower is rated on the same
standard.
Net Sales/ Break Even Sales
= (Net Sales – Variable Expenses)/ Fixed Expenses
Higher the sale to break-even sales ratio, higher is our margin of safety. Depending on the value
of the ratio, this performance area may be assessed on a five point scale and marks may be
awarded as given in the “Rating Sheet”.
Note: Variable expenses may be taken as Cost of Sales and fixed expenses as
Total Expenses less Cost of Sales and Extraordinary Expenses, if any.
Current Assets/Current Liabilities:-
This ratio is popularly known as Current ratio and indicates ability of a business unit to meet its
short term obligations. This indicates business unit’s ability to carry on its day-to-day business
activities. A current ratio greater than 1.33 is considered as highly satisfactory. Depending on the
value of the ratio, this performance area may be assessed on a five point scale and marks may be
awraded as given in the “Rating Sheet”.
Return on Capital Employed = (Profit after Tax + Interest) / (Tangible Net Worth + Long
Term Borrowings + Bank Borrowings)
Return on capital employed (ROCE) is a measure of efficiency of capital employed in business as
also earning capacity of the business. ROCE should be higher than the cost of capital. Where
interest rate on borrowings is higher than ROCE, it is loosing proposition for equity holder. In
other words, ROCE should be higher than the rate of interest chargeable adjusted for taxes.
Assuming a tax rate of 30% and interest rate of 13%, the minimum ROCE a company should earn
is 9% [(1- 0.3) x 13 %]. Depending on the value of the ratio, this performance area may be
assessed on a five point scale and marks may be awraded as given in the “Rating Sheet”.
Debt Service Coverage Ratio:-
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= (Net Profit + Depreciation + Interest on Term Loan) / (Annual Repayment of Term
Loan + Interest on Term Loan)
This ratio measures the capacity of a company to service its debts i.e. repay term loan installments
and interest on it in time. Higher the ratio, higher is our margin of safety.
Depending on the value of the ratio, this performance area may be assessed on a five point scale
and marks may be awarded as given in the “Rating Sheet”.
Long Term Debt/ Tangible Net Worth:-
= Total long term debt / Tangible Net Worth (Including subordinated interest free borrowings
from promoters).
The ratio is an indicator of promoters/shareholders stake in business when compared to total long
term debts. Low debt equity ratio means higher long term stability and in case the ratio is
generally coming down, represents plough back of profits. Depending on the value of the ratio,
this performance area may be assessed on a five point scale and marks may be awarded as given
in the “Rating Sheet”.
Total Outside Liabilities/Tangible Net Worth:-
= Total Out side Liabilities/Tangible Net Worth (Including subordinated interest free borrowings
from promoters)
This ratio is also an indicator of promoters/shareholders stake in business when compared to total
outside liabilities. Lower ratio means higher long term stability and in case the ratio is generally
coming down, represents plough back of profits. Depending on the value of the ratio,this
performance area may be assessed on a five point scale and marks may be awarded as given in the
“Rating Sheet”.
Operations in Non - Fund Based Limits:-
Non - Fund Based Limits include letter of guarantee, Letter of Credit (both Inland and foreign),
Deferred Payment Guarantee etc. Where the L/C & B/G limit taken together is less than 5% of the
fund based limit, this may be ignored and need not be taken into account in rating a borrower. L/C
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and B/G do not involve extending any fund or money but involve commitment by the banks on
behalf of their customers to pay in the event of default by the customers. Many a time the non-
fund limits get converted into fund based as the borrowers some times delay and even default in
honouring their commitment. The borrower is less risky if L/Cs and B/Gs do not devolve or
invoked or if he arranges funds whenever any non fund based limit devolves/is invoked.
Associated risks are more if there is delay in arranging funds once any non fund based facilities
devolve or is invoked.
We may assess this performance area on a four point scale and award marks as is given in the
“Rating Sheet”.
Diversion of Funds:-
Banks should critically appraise whether the borrower is diverting funds to their allied and
associate concerns particularly when they are themselves not doing well. Fund diversion may
affect the company’s liquidity position and operation. It also impacts debt equity ratios. A
company utilizing short term fund for long term purposes could also become a matter of concern.
Overall, it may affect financial stability of the firm.
This performance area may be assessed on a four point scale and marks may be awarded as given
in the “Rating Sheet”.
Net Profit / Net Operating Cash Flow:-
This ratio determines quality of earnings. Besides, the importance of operating cash arises from
the fact that it is cash, which actually pays interest and installments. The prospective borrower is
expected to have a net profit after tax as well as a positive net operating cash flow. Usually, it is
less than one indicating net profit at less than net operating cash flow. If the ratio is more than
one, then it indicates sales achieved through more than usual receivables.This parameter may be
assessed on a four point
Note : Net Operating Cash Flow is computed as given below.
+ / (-) Operating profit / (Operating Loss) before extraordinary items
+ Depreciation
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- Taxes
+ / (-) Increase / (Decrease) in Net Working Capital
= Net Operating Cash Flow
2. Accounts with aggregate FB and NFB limit over Rs.5 crores without term facilities
or with term facilities of maturity not exceeding 5 years:-
The credit rating model adopted by the bank for these accounts have taken into consideration all
the relevant factors applicable for accounts with aggregate FB and NFB limit over Rs 25 lacs and
up to Rs.5 crores (Item 1 above). The guidelines applicable for accounts with aggregate FB and
NFB limit over Rs 25 lacs and up to Rs.5 crores would apply to accounts under this category as
well. In addition the model takes into account the following factor.
Industry Outlook
Industry Outlook:-
Impact of expected industry performance would be taken into account in such cases. For this
purpose, the latest industry scores as advised by Head Office, Risk Management Department from
time to time would be factored into the rating model.
3. Accounts with aggregate FB and NFB limit over Rs. 5 crores with term facilities
with maturity of more than 5 years:-
The credit rating model adopted by the bank for these accounts have taken into consideration all
the relevant factors applicable for accounts with aggregate FB and NFB limit over Rs 25 lacs and
up to Rs.5 crores (Item 1 above). The guidelines applicable for accounts with aggregate FB and
NFB limit over Rs 25 lacs and up to Rs.5 crores would apply to accounts under this category as
well. In addition the model takes into account the following factor.
Project Rating Index
Impact of expected industry performance is taken into account in such cases by estimating
‘Project Rating Index’ (PRI). Method of computing PRI is indicated in the following paragraph.
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Critical Success Factors, needed in computing PRI, in respect of various industries is enclosed. In
case industry “Critical Success Factors”
(CSFs) is desired on any industry that is not covered in the Annexure, it may be provided
by Head Office on reference.
The “Project Rating Index” (PRI) would be factored into the rating model.
Project Rating Index:-
Business units may have different strengths vis-à-vis the industry specific attributes. In view of
this, in case of projects/term finance that repays over a longer period, “Project Rating Index”
(PRI) is estimated and factored into in lieu of simply incorporating industry rating.
Based on the environment and industry analysis 7 to 10 factors may be identified that are most
likely to impact the success probability of the project under examination. These are called
‘Critical success Factors’ or ‘Indicators for Industry Attractiveness’. An illustrative list of such
factors is given below.
Market size
Market growth rate
Cyclicality
Competitive structure
Barriers to entry
Industry profitability
Technology
Inflation
Regulation
Workforce availability
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Social issues
Environmental issues
Political issues
Legal issues
Strategic Group/Borrower Analysis:-
This would basically include an analysis of strengths and weaknesses and core competencies of
the borrower group in relation to critical success factors identified for the
product/service/industry. The capacity of the borrower group to respond to changes in the
environment and industry characteristics would be a critical input Project Rating Index/Industry-
Business Attractiveness Index
This is a matrix developed based on identified CSFs and its relative weight as applicable to the
industry vis-à-vis group’s/borrower’s strength on each of the CSFs on a scale of say 10. A
weighted score indicates an objective measurement on the project. The matrix along with a
hypothetical example is worked out below by way of illustration
CSFs Identified Relative Weight Group’s
Performance
Weighted Score
A .30 7 2.10
B .25 8 2.00
C .20 5 1.00
D .12 4 0.48
E .08 6 0.48
F .05 5 .25
TOTAL 1.0 6.31
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The PRI in the subject case is 6.31 on a scale of 10.
The PRI may change as the external factors change. It may also change as a group’s strength or
weaknesses undergo changes due to proactive approaches adopted by them or due to lack of it.
The above analysis, it may be noted that is an approach to objective measurement which is akin to
SWOT analysis that are carried out. Strengths and weaknesses are internal to the organization and
are captured through strategic group analysis. Threats and opportunities are external to the
organizations and are captured under environment and industry analysis.
The “Project Rating Index” (PRI) would be factored into the rating model.
4. Exposure on Green Field projects with aggregate FB and NFB limit over Rs.5 crores with
maturity of more than 5 years:-
The credit rating model adopted by the bank for these accounts have taken into consideration the
following relevant factors grouped under three heads:
A. Management
Integrity / Commitment
Financial Strength
Technical / Finance Knowledge
Organizational Structure / Succession Plan
Selling and distribution network
Experience of Directors & Promoters
Pending Litigations
Market Reputation & Past Track Record
B. Project Financial Evaluation
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Project Debt Equity Ratio
Timing of Capital Infusion
Cash Flow from other Sources
C. Project Rating Index
Assessment of ‘Management’ may be carried out as applicable for accounts with aggregate FB
and NFB limit over Rs 25 lacs and up to Rs.5 crores (Item 1 above). Similarly, assessment of
‘Project Rating Index’ may be carried out in accordance with the guidelines provided in case of
accounts with aggregate FB and NFB limit over Rs.5 crores with term facilities with maturity of
more than 5 years (item 3 above).
Assessment of factors under ‘Project Financial Evaluation’ is given below.
Project Debt Equity Ratio:-
Lenders comfort in project finance comes from the owner’s/promoter’s stake in the project.
Where the stake of the owner/promoter is higher, the comfort level is also higher. This is assessed
through Project Debt Equity Ratio. Higher the ratio comfort level is more and risk is lesser.
Timing of Capital Infusion:-
Timing of owner’s capital infusion also adds to the comfort of a lender. Where owners bring in
their share in the project upfront, lenders comfort is more as compared to a situation where
lender/owner brings in funds in equitable proportion.
The comfort is least where capital contribution of the owner is infused in the project at a later
date.
Cash Flow from other Sources:-
In stand alone project financing banker depends primarily on the revenue generated by a single
project as a source of repayment and on the collateral value of the project’s assets for security.
Project finance may take the form of financing of the construction of a new capital installation or
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refinancing of an existing installation with or without improvements. The examples are power
plants, infrastructure etc.
5. Exposure on NBFCs with aggregate FB and NFB limit of Rs.25 lacs and above:-
The credit rating model adopted by the bank for these accounts have taken into consideration the
following relevant factors grouped under three heads:
A. Management
B. Operational Performance & Finance Ratios
C. Industry Outlook
Assessment of ‘Management’ may be carried out as applicable for accounts with aggregate FB
and NFB limit over Rs 25 lacs and up to Rs.5 crores (Item 1 above). However, assessment of
Operational Performance & Finance Ratios differs as in evaluating the same for NBFCs the
following factors are taken in to account.
Operating Profit/Average Assets
Investment as percentage of outstanding Public Deposit
Current Ratio
Return on Capital Employed
Total Outside Liability/ Net Owned Funds
Capital Adequacy Ratio
Overdues to Total Cumulative DemandsØ Net NPA as percent of Credit Exposure
Achievement of Net sales Projections
Achievement of Net Profit Projections
Diversion of Funds
Net Profit/Net Operating Cash Flow
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Evaluation of the following factors may be carried out as applicable for accounts with aggregate
FB and NFB limit over Rs 25 lacs and up to Rs.5 crores (Item 1 above).
Current Ratio
Return on Capital Employed
Achievement of Net sales Projections
Achievement of Net Profit Projections
Diversion of Funds
Net Profit/Net Operating Cash Flow
Operating Profit/Average Assets:-
Operating Profit= Fund Based Income+ Non-fund based Income-Financial Expenditure-
Operating & other expenditure.
This ratio is an indicator of profitable use of the assets of the business unit. An unit with large
asset base but with low operating profit would indicate that either the assets are not income
generating or the use of the assets has not been proper.
Investment as percentage of outstanding Public Deposit:-
NBFCs accepting public deposits would be given better marks based on the percentage of their
investment in unencumbered approved securities to the outstanding public deposit. This is because
such investment gives a comfort towards ascertaining the strength of the NBFCs in meeting public
deposit at maturity.
Total Outside Liabilities / Net Owned Funds:-
(Total outside liability would not include the proposed long term and short term borrowings)
This ratio is also an indicator of promoters’/ shareholders’ stake in business when compared to
total outside liabilities. Lower ratio means higher long term stability and in case the ratio is
generally coming down, represents plough back of profits. Depending on the value of the ratio,
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this performance area may be assessed on a five point scale and marks may be awarded as
indicated in the rating model.
Capital Adequacy Ratio:-
The balance sheets of NBFCs get strengthened with compliance of prudential norms for Capital
Adequacy. This ratio being an indicator of as to what extent the risk weighted assets are covered
by the capital base, a higher ratio would indicate soundness of the business unit. Depending upon
the value of the ratio, this performance area may be assessed on a five-point scale and marks may
be awarded as indicated in the rating model.
Over dues to Total Cumulative Demands:-
The level of over dues to total cumulative demands is an indicator of the quality of the receivables
of the unit. Over dues above a certain tolerable level would certainly indicate that the unit is not
doing well.
Net NPA as percent of Credit Exposure:-
This ratio will indicate the quality of the credit the unit has extended. High level of NPAs eats
away the profits and makes the existence of the unit vulnerable.
Industry Outlook:-
Future outlook of NBFCs is to be factored into based on industry rating advised by Head Office,
Risk Management Department. The NBFC industry outlook has been given a weight of 20%.
6. Exposure on Accounts of infrastructure Development Corporation, Industrial
Development Corporation and Financial & Development Institutions with aggregate FB and
NFB limit of Rs.25 lacs and above:-
The credit rating model adopted by the bank for these accounts are basically same excepting that
in evaluating Operational Performance & Finance Ratios, Total Outside Liabilities / Net Owned
Funds has been replaced with Total Outside Liabilities / Tangible Net Worth. Evaluation of
factors relevant may be carried out as in case of Exposure on NBFCs with aggregate FB and NFB
limit of Rs.25 lacs and above (item 5 above).
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D. Total Weighted Score & Rating:-
Final rating of the accounts would be awarded on the basis of total weighted scores arrived at
using the above rating modules, as applicable. This would be as under:
Weighted Score Equivalent Rating
90% and above A++ ( Negligible risk)
80% to less than 90% A+ ( Very Low Risk)
70% to less than 80% A ( Low Risk)
60% to less than 70% B+ ( Medium Risk)
50% to less than 60% B ( Medium Risk
40% to less than 50% B- ( High Risk)
Below 40% C ( High Risk)
Note:
i. The above rating is subject to correlation with and structural changes in the economy.
ii. As the risk rating efficiency of the model cannot be ascertained at this moment before it is put
to use over a period of time, the above meaning attached to the rating nomenclature is only
provisional. The objective meaning of the nomenclature would be finalized only after the risk
rating efficiency of the model is established.
Section 3
Portfolio Rating:-
Portfolio Rating (Exposure) is the weighted average of rating-wise exposure (i.e., total limits, fund
based as well as non-fund based). Similarly, Portfolio rating (Outstanding) is the weighted
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average of rating-wise outstanding balances (i.e., total outstanding, fund based as well as non-fund
based). Portfolio ratings are a major determinant of portfolio quality and it needs to be monitored.
Portfolio rating also provides an indication of available risk appetite of the bank and can be used
to optimize return on the credit portfolio. Accordingly, it is desirable that this is tracked on a
regular basis.
Need for credit Ratings:-
With financial market reforms, the traditional dividing lines for banks, Development Financial
Institutions (DFIs), NBFC’s and other players in the financial system are gradually disappearing.
The commercial banks, whose traditional forte has been working capital lending, are increasingly
moving into long term financing, while the DFIs are moving into short term working capital
lending. In this context, LR is aimed at providing a valuable input in assisting the decision making
process in BANK. Banks and DFIs often use credit ratings on debt securities as an indicator of the
borrower’s ability to honour its obligations on loans. Credit rating directly addresses their needs
by rating the loan itself and incorporating in the analysis, the specific characteristics of the loan.
Benefits of Credit rating:-
CR will meet the requirements of Banks for the following purposes:
a. Assessing the credit worthiness of borrowers;
b. Serving as a simple objective indicator for the internal credit risk exposure guidelines;
c. Determining the risk premium to be charged;
d. Portfolio monitoring;
e. Making quick credit decisions.
Rating Methodology:-
The analytical framework for rating methodology would be divided into three Interdependent
segments. The first would deal with economy and industry characteristics, the second with
management aspects and the third with financial characteristics. In addition to quantitative and
objective factors, qualitative aspects like assessment of management capabilities would be very
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important factors in arriving at the rating for an instrument. Key areas considered in a rating
analysis would include the following:
A. Economy and Industry Outlook :-
The upcoming risks and opportunities in the borrower’s industry would be weighed to provide a
framework for understanding the future ability of borrower to generate income. Factors
considered would include:
Effect of economic cycles on the industry.
Business cycles in the industry and their severity.
Tariff structure, threat from imports, price competitiveness of the domestic industry, and
pace of technological change.
Basis of competition and key success factors.
Structure of the industry. Entry and exit barriers.
Vulnerability of industry to new technologies.
Environmental factors.
B. Management Assessment
Background and history of borrower.
Corporate strategy
Quality of management and management capabilities under stress.
Organizational structure, Personnel policies including succession planning.
Corporate governance.
Marketing and distribution arrangements.
Bargaining power of the borrower’s suppliers and customers.
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C. Financial Risk
Financial management philosophy and track record (capital structure, profitability,
liquidity position, financial flexibility and cash flow adequacy).
Working capital management.
Asset cover and liquidity profile of assets.
Financial projections (with particular emphasis on achievability of sales targets, the
components of the cash flow and ability to meet debt obligations as and when they fall
due).
Free cash flows and their sensitivity to various economic, industrial and business risks
over the term of the instrument.
Inter-firm comparison of the financial structure and profitability margins.
Accounting policies and practices.
Track record of payments to the banks and financial institutions.
In addition, while conducting an analysis for short term loans, emphasis will be laid on:
Sources of alternate liquidity
Access to financial markets.
Quality of relationships with the lenders.
Most companies would be hard pressed to liquidate their short term working capital borrowings
from current cash flows. Short term ratings will, therefore, examine the alternative sources of
liquidity available to a company, including its liquid investments.
D. Terms of the Loan
Rating may vary according to loan covenants such as:
Maturity of loan.
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Nature of loan - senior or subordinated, covenants and other provisions that may reduce
the amount of recovery in case of default.
Repayment terms- moratorium period, repayment in installments or bullet repayment, etc
Chapter 10 POST SANCTION FOLLOW UP OF LOANS
Supervision and Follow-up of bank credit has assumed considerable significance particularly after
introduction of new norms of assets classification, provisioning and derecognition of interest
income on NPAs, affecting profitability. System of supervision and follow up can be defined as
the systematic evaluation of the performance of a borrowal account to ensure that it operates at
viable level and, if problems arise, to suggest practical solutions. It helps in keeping a watch on
the conduct and operational/financial performance of the borrowal accounts. Further, it also helps
in detecting signals/symptoms of sickness and deteriorations, if any, taking place in the conduct of
the account for initiating timely corrective actions to check slippage of accounts to NPA category.
The goals and objectives of monitoring may be classified into fundamental and supplementary
goals. Fundamental goals help a bank to ensure safety of funds lent to an enterprise while,
supplementary goals are directed towards keeping abreast of problems arising out of changes in
both the internal and the external environment for initiating timely corrective actions. Some of
the important goals of monitoring are listed as under:
i. To keep a watch on the project during implementation stage so that there are no time &
cost overruns.
ii. To ensure that the funds released are utilized for the purpose for which these have been
provided and there is no diversion of such funds.
iii. To evaluate operational and financial results, such as production, sales, profit/loss, flow
of funds, etc. and comparing these with the projections/estimates given by the borrower
at the time of sanction of credit facilities.
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iv. To ensure that the terms and conditions as stipulated in the sanction have been complied
with.
v. To monitor operations in the account particularly cash credit facilities which indicate
health of the account.
vi. To obtain market report on the borrower, to gather information like reputation/financial
standing etc.
vii. To detect signals and symptoms of sickness or deterioration taking place in
conduct/performance of the account.
viii. To ensure that the unit's management and organizational set-up is effective.
ix. To keep a check on aspects like accumulation of statutory liabilities, creditors, debtors,
raw-material, stocks-in-process, finished goods, etc.
x. To ensure charging of applicable rate of interest/penal interest/ commitment charges as
per bank's guidelines.
System of supervision & monitoring of credit as laid down by the Bank needs to be meticulously
followed by the branches/controlling offices which, inter alia, covers the following:
i. Conveying the sanction
ii. Maintenance of Loan Document File
iii. Quarterly Review Sheet
iv. Preventive Monitoring System
v. Quarterly Monitoring System
vi. Inspection and Physical Verification of stocks – Stock Audit
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CREDIT APPRAISAL PROCESS AT UCO BANK:-
FLOWCHART:-
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Not feasible
No Queries
Queries
Feasible
Submission of Project Report along with the Request Letter
Carrying out Due Diligence on the Client
Submission of Proposal to designated Authority (Circle office)
Re-verification and analysis of the Proposal
Submission of Proposal to designated Authority
Preparing Credit Report / Feasibility Report and Risk Rating
Determining of Interest Rate and Preparation of Proposal
Meeting with the client to clarify the queries
Vetting of Credit Risk Rating Report Approval of request made by the client like Reduction of Interest Rates etc
Sanction of Proposal on various Terms & Conditions
Acknowledgement of Sanction Terms & Condition by the client
Application to comply with Sanction T&C. Execution of Loan Documents
Disbursement of Sanctioned Amount from the branch office
Chapter 11 CASE STUDY
1. DATA SET OF REPORT:-
1.1.ABC MACHINES PVT. LTD.
ABC machines Pvt. Ltd had applied for working capital loan of 20 lacs in the year 2012 at the Gomtinagar branch, Lucknow branch of UCO bank. Its details are as under:-
NAME OF THE COMPANY:- ABC MACHINES PVT. LTD.
ACTIVITY:-Manufacturing of agricultural and farm equipment/machines etc.
MANUFACTURING PROCESS (indicates to the extent possible, state wise capacity data, yield/conversion data, material flow etc):-
-cutting
-grinding
-fabrication
-assembly
-testing
-final product
RAW MATERIAL REQUIRED
-Iron steel
-electrical component
-sheet plats
-misc. items
PROJECT COST
100
Working capital required: 25 lacs
FINANCING
-Own funds: 5 lacs
-cash credit required: 20 lacs
Three lacks of machinery to be provided by the promoters
RATE OF INTEREST CHARGED:- 11.75% (subject to change)
DIRECTOR:- ARVIND BANSAL
DATE OF INCORPORATION:- 2011-12
TOTAL CAPITAL:- capital of the company is 5 Lacs divided by 5000 equity share of rs.100 each.
BANKING ARRANGEMENT:- SOLE
PRIMARY SECURITY FOR THE TERM LOAN:-
1)Hypothecation of raw material of Rs.146000
2)Hypothecation of WIP of Rs. 3064200
3)Hypothecation of finished goods of Rs. 79750
CURRENT RATIO:- 1.07:1
DOCUMENTS SECURITIES PROVIDED TO THE BANK BY THE BORROWER
-Insurance
-statement of stock in factory/godowns/workshops sales office of Everrites machines Pvt. Ltd hypothecated to UCO bank.
-hypothecation of goods to secure a demand cash credit
-Forms of letter of guarantees
-deeds of hypothecations of movable plant and machinery to secure a term loan
-Acknowledgement of debt and securities
-draft of the letter of the title deeds obtained by mortgagers (property plots)
-copy of resolution passed by board of directors of the company.
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-Memorandum of association
-Registration of company under government of India, ministry of finance
-article of association.
1.2.XYZ BOTTLING LTD.
XYZ BOTTLING LTD. had applied for working capital loan as well as term loan, on the basis of their past record and current securities that was provided their loan was sanctioned on 10th April 2013.
DETAILS OF THE TERM LOAN OF XYZ BOTTLING LTD.
RS.3545lac including take over of term loan of 1745 lac from PNB Gomtinagar, Lucknow.
PURPOSE :-For the establishment of bottling plant.
MARGIN:- 33.33%
PROJECT COMMERCIAL OPERATION DATE :-1 JUNE 2013.
TOTAL TENOR INCLUDING MORATORIUM PERIOD:- 6 years and 3 months.
REPAYMENT SCHEDULE :- Principal in 72 equal monthly instalments of 49.24 lacs.
RATE OF INTEREST:- base rate +3%(presently 13.20 )
PRIMARY SECURITY:- 1) plot of 1296.77lacs
2)hypothecation of property of 3200 lacs
COLLATERAL SECURITY :- total collateral security of 298.33 had been provided.
DETAILS OF WORKING CAPITAL LOAN OF XYZ BOTTLING LTD.
AMOUNT:- 418 lacs
PRIMARY SECURITY:- 792.77 lacs
COLLATERAL SECURITY:- as in term loan
RATE OF INTEREST:- base rate+2.50%
Online inspection of the record of XYZ BOTTLING LTD. was conducted by AP & associates.
2.METHOD OF THESE DATA ANALYSIS
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Data analysis is done with the help of secondary data that are made available by credit seeking entity. Analysis of data is done by comparing different financial ratios and on the basis of that it is verified that project is financially viable or not. Other than financial ratio, actual and estimated balance sheet and profit and loss account analysis is done. In the case of retail lending salary of loan seeker and his income tax returns are analyzed and appraisal is done on the basis of analysis of these data. Which type of data is required for the analysis depends on the information needs.
In the case bank receive any application related to corporate lending. The information required by the bank will be actual and estimated profit and loss account , balance sheet of the entity. Industry performance, market demand, future prospects, economic scenario, government guidelines, effect on environment of that particular product, effect on the health of the users of that product. On the basis of these data there are different type of appraisal that need to be done before appraisal of credit. These includes:-
2.1.Market appraisal
1) In market appraisal, analysis of demand for the product proposed to be manufactured requires collection of data and preparation of estimates.
2) Market appraisal requires a description of the product, its major uses,
3) It requires scope of the market, possible competitions from substitutes, and special features of the product.
4) That are proposed to be manufactured in regard to quality and price which would result in consumer preference for the product in relation to competitive products.
5) Estimates have to be made about existing and future demand and supply of the product proposed to be manufactured.
6) An assessment of likely competition in future and special features of the project which may enable it to meet competition has to be made.
7) Export facilities have to be identified and comparative data on manufacturing cost has to be compiled.
2.2.Technical appraisal
1)Technical appraisal is primarily concerned with the project concept covering technology, design, scope and content of the plant.
2) It also covers input and infrastructure facilities used for the project.
3) Basically the project should be able to deliver marketable product from the resources deployed, at a cost which would a leave a margin adequate to service the investment.
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4) Technical appraisal has a bearing on the financial viability of the project as reflected by its ability to earn satisfactory return on the investment made and to service equity and debt.
2.3.Financial appraisal.
1)Financial appraisal is concerned with assessing the feasibility of a new proposal for investment for setting up a new project or expansion of existing product facilities.
2) This involves an assessment of funds required to implement the project and sources of the same.
3)The other aspect of financial appraisal relates to estimation of operating cost and revenue, prospective liquidity and and financial returns in the operating phase.
4) In appraising a project, the project direct benefits and cost are estimated at the prevailing market prices.
5) This analysis is used to appraise the viability of the project as well as to rank projects on the basis of their profitability.
2.4.Economic appraisal.
1)Economic appraisal of a project deals with impact of the project on economic project on economic aggregates.
2) We may classify these under two broad categories. The first deals with the effect of the project on employment and foreign exchange.
3) And second deals with the impact of the project on net social benefits or welfare.
VARIOUS PHASE OF THE PROJECT ARE:-
1)Project identification
2)Project selection and preparation of project report.
3)Project appraisal
4)Financing the project
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5)Project implementation
6)Recovery and advances
DOCUMENTS TO BE SUBMITTED BY BORROWER TO THE BANK
1) Project report
2) Promoters details
3) Memorandum of association
4) Article of association
5) Copy of insurance document
6) Statement of stocks in factory, workshop or store if any.
7) Copies of hypothecation of goods
8) Letter of guarantee
9) Copies of hypothecation of goods to secure a demand cash credit
10) Acknowledgement of debt and securities
11) Draft of the letter of the title deeds obtained by mortgager.
12) Copies of registration of company under Government of India, ministry of finance.
13) Manufacturing process, if any.
14) Tax invoice
15) Agreement of tie-ups.
If bank receive any application of credit for retail lending like housing loan, car loan in that case information need for the appraisal will be gross annual income of credit seeker from all source of earning, income tax return other credits taken by him and his record or past performances record. On the basis of all these information analysis of data is done and from all these it is analysed that whether potential borrowers financial strength is good enough that he will return the amount borrowed with interest.
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Chapter 13 CONCLUSION& RECOMMENDATIONS
Before providing any advances to corporate sector for the purpose of working capital or the
purpose of term loan. Bank should always consider few things, one of them is technology that is
being used. If bank is providing any advances to any manufacturing unit, and technology that is
being used by that manufacturing unit is going to be obsolete in one or two years, then it will
become difficult for the company to return the borrowed amount with interest as sell of product
will decrease and operating cost may increase.
For the type of sector where technology becomes obsolete in smaller period of time, bank may
suggest the borrower to take the technology on lease instead of buying it by investing heavy
amount. If company takes the technology on lease which gets obsolete in smaller period of time, it
can replace it with the new technology whenever required. And can survive in this competitive
market.
Another thing that should be taken care is period of cash conversion cycle. Lesser the cash
conversion cycle suggests more quickly the inventory is being converted into goods. More quickly
the receivable is being converted into cash. Lesser cash conversion cycle suggest efficient
management of inventory and bank can take it as a good sign before extending any credit, and it
increases the chance for bank to get back its advances with interest.
Bank should carefully analyze the sales pattern of the company’s product as well as market trend.
Because of trend It may happen that sales may increase for some time and then there is chance for
sudden falling. Bank also need to analyze the PAT and sales pattern because it gives the fair idea
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of increasing or decreasing operating cost. And bank may take it as a source of future estimation
of company performance.
Bank should timely verify that whether company is using the advances properly for the specified
work, or there is any diversion of fund. Because if any company diverse the borrowed fund to
other place or involves it in other activity then it may affect the proper running of business for the
purpose of which advances had been taken and it may act hindrance for the bank in getting back
it advances with interest.
Bank should also be concerned about how much is the cash sale or credit sale of company’s
product. Higher cash sales reflect that company is in better position in market and more cash sales
increases liquidity of company. In similar way more credit sales may affect the performance of
company as sometime it may not get its receivable on proper time which can affect its operational
activity.
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FINDINGS
1.KEY FINDING FOR MSME AND CORPORATE LENDING AND THEIR
IMPLICATION
1. corporate lending is one of the important function of the bank. As it provide an
opportunity for the growth of medium and small scale industry which helps in economic
development of country. It also acts as one the important source of income for the banks.
2. Bank is always concerned about the liquidity ratios of the company. As it gives an fair idea
that whether company will able to return the amount along with interest or not. It is helpful
in estimating the company performance in repaying the loan at the time of any financial
crisis.
3. For working capital finance, normal current ratio required is 1.33:1 , but it should not be
less than level of 1.77:1.
4. Total outside liabilities (including the proposed borrowing) to equity shall normally be 3:1
as benchmark but should not exceed 3.5:1.
5. All new proposals shall conforms to the satisfactory market reports and at least b+ credit
rating and minimum 2/3 score under management rating as internal rating system of the
bank.
6. In case of green field project with credit rating of B and management rating of 50% can be
considered for the finance at the G.M level.
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7. For term loan / project finance, promoters contribution should normally be 25% or above.
8. Term debt equity ratio( including the proposed borrowing) not to exceed 2:1. However in
case of project finance term debt( including the proposed borrowing) equity ratio should
not exceed 3:1.
9. Debt service coverage ratio of minimum 1.5:1 with benchmark level of 2:1 should be
maintained.
10. There are mainly three type of accounts that are maintained for the borrower:-
a) Existing account: these are the borrowal accounts of business units which are already
in existence and are having account with bank.
b) Green field account: these are the new business accounts and therefore do not have
past financial statements.
c) New accounts: these are the borrowal account of business unit which are already in
existence but are not having account with bank.
11. Integrity and commitment of loan seeker is taken in consideration as it reflects his
willingness to perform and return the amount with interest to the bank.
12. Financial strength of company is checked by evaluating market value of share to the
nominal value.
13. Capacity of internal generation of funds, that is, return on equity which is calculated by
dividing profit after tax with total equity (paid up capital). It is also a very good measure
of financial strength of a company which reflects the return company is getting on its
investment.
14. Banks also measure financial strength before lending to any company by calculating the
net worth of the promoters excluding stock in business.
15. Before providing any corporate advances bank always consider the technical and financial
knowledge that the promoters of the company have, because this knowledge helps sustain
in this competitive market.
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16. Organizational structure of a company and its succession plan is always considered before
providing any term loan as in long run organizational structure of a company determines
its success or failure.
17. If advances is being taken for the production of a goods, then it become necessary for the
bank to verify its selling and distribution network.
18. Bank also consider experience of director and promoters and their market reputation with
past track record as it helps in knowing capability and willingness of their performance.
19. Account of company with bank is regular or irregular determines its conduct hence it also
becomes one of the many important factors that are considered.
20. Discipline in timely submission of data information also determines conduct of the
company accounts.
21. How company is managing its inventory and receivable is also one of the important factors
to be considered for the bank, it also verifies company’s realization of receivable and
valuation of inventory.
22. To measure the performance of operation and for estimating that whether company will
able to repay bank consider many financial ratios, one of them is sales/break even sales
ratio which is equal to net sales minus variable expenses divided by fixed expenses.
Higher the sales to break even sales ratio, higher is the margin of safety. Variable expenses may
be taken as cost of sales and fixed expenses as total expenses less cost of sales extraordinary
expenses, if any.
23. Current ratio is one of the important measure of the liquidity of a company it is calculated
by dividing current asset of a company and its current liability. Current ratio greater than
1.33 is considered as higher satisfactory.
24. Return on capital employed gives the fair idea about company performance it is calculated
by adding profit after tax with interest and dividing it with the sum of tangible net worth
+long term borrowing +bank borrowing.
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Return on capital employed should be higher than rate of interest chargeable adjusted for tax. If
it is lower than rate of interest charged company will not be able to repay its borrowing.
25. One of important ratio that bank always consider before providing any advance is Debt
service coverage ratio it is calculated by adding net profit, depreciation and interest on
term loan and dividing it with the sum of annual repayment of term loan and interest on
term loan.
Higher the debt service coverage ratio, higher is the margin of safety.
26. One of the ratios that bank always considers is total long term debt/ tangible net worth. It
reflects whether company will be able to all its debts at the time of some financial crisis.
27. Bank also calculate total outside liability/tangible net worth. Lower ratio means higher
satisfaction for banks.
28. Another important ratio that is calculated is effective TOL(total outside liability)/ effective
TNW(total net worth)
Effective TOL= long term borrowing+ short term borrowing+ sundry creditors+ other liability+
credit equivalent of non- fund based outstanding.
Effective net worth= paid up capital +reserve excluding revaluation reserve+ interest free
subordinate loans –investment in sister/associate concern(unquoted share) –loans to sister/
associate concern- intangible assets.
It also reflects company capability in repaying its liabilities at the time of any financial crisis.
29. Another ratio which is not very important but banks consider it for knowing the
achievement of net sales projection= actual net sales achieved/ net sales projected for the
year.
30. Another ratio which is also not very important, but bank may consider it for knowing the
achievement of net profit projection= actual net profit achieved/ net profit projected for the
year.
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31. Bank is always attentive toward diversion of the funds as it may affects the company
liquidity position and operations. and it may also impact the debt equity ratio.
32. Another ratio that is considered sometime is net profit/ net operating cash flow, usually it
is less than one indicating net profit at less than net operating cash flow.
If the ratio is more than one, then it indicates sales achieved through more than usual receivables.
33. Different charges that bank puts before providing any advances are:
a) Processing charge.
b) Documentation charge.
c) Supervision charge.
d) Inspection charge.
e) Mortgage charge.
f) Payment charge.
34. UCO bank share in consortium where bank is the leader shall generally not exceed 60% of
the total fund based requirements and where bank is the member, minimum shall be 5%
and maximum 40%.
35. Bank finance to high value project (50 crore and above) must be accompanied by project
appraisal including the technical appraisal. While project appraisal would be compulsory
in respect of project with debt component of 50 crore and above.
36. Inland bill and export bill discounting up to 180 days and demand loan repayable with a
period of less than three years comes under short term financing.
37. Maturity range from 3 year and above up to and inclusive of 5 years comes under medium
term loan.
38. Terms loan in the maturity range of above 5 years to 10 years comes under the long term
loan.
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39. No penal is charged for the loan up to 25000.
2.KEY FINDING AND THEIR IMPLICATION FOR RETAIL LOANS
1. Insurance paper is required.
2. Statements of stocks in factory /gowdowns / workshops are required for any
manufacturing unit.
3. Hypothecation of goods to secure demand cash credit is required.
4. Form of letter of guarantee.
5. Deeds of hypothecation of movable plant and machinery to secure a term loan.
6. Acknowledgement of debt and securities.
7. Draft of the letter of title deed obtained by mortgagers if any.
8. Copy of resolution passed by the board of directors.
9. Memorandum of association.
10. Registration of company under government of India, ministry of finance.
11. Article of association.
12. KYC guidelines to be filled and submitted by the borrower.
13. Full information about the borrower , partner and guarantor.
14. Source of the fund that is being provided as the margin by the borrower.
15. If construction is to take place it must be done according to the building plan. And
borrower will pay the charge of timely verification by the bank.
16. Borrower declaration take it is not taking any other credit under the same scheme with this
bank or any other bank.
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LIMITATIONS
LIMITATION OF THE STUDY AND FUTURE DIRECTION:-
1) In this changing market scenario and economic instability, it become tough to formulate
the policy and make assumption that full-fill every needs, and reduces the risk up to the
extent that is required before appraisal of any credit.
2) Changing political scenario of the nation also act as the hindrance in any prediction. As
with the change in government or the alliance with the help of which government is
running, rules changes there is also a chance of some change in economic scenario and
strategy to improve the economic condition of country.
3) Data may not be accurate enough so that exact prediction can be made.
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