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CREDIT APPRAISAL IN BANKING SECTOR

CREDIT APPRAISAL IN BANKING SECTOR

INTRODUCTION TO BANKING SECTOR & SBI

HISTORY OF BANKING INDUSTRY:

The Reserve Bank of India (RBI), as the central bank of the country, closely monitors developments in the whole financial sector.

The banking sector is dominated by Scheduled Commercial Banks (SBCs). As at end-March 2002, there were 296 Commercial banks operating in India. This included 27 Public Sector Banks (PSBs), 31 Private, 42 Foreign and 196 Regional Rural Banks. Also, there were 67 scheduled co-operative banks consisting of 51 scheduled urban co-operative banks and 16 scheduled state co-operative banks.

Scheduled commercial banks touched, on the deposit front, a growth of 14% as against 18% registered in the previous year. And on advances, the growth was 14.5% against 17.3% of the earlier year.

State Bank of India is still the largest bank in India with the market share of 20% ICICI and its two subsidiaries merged with ICICI Bank, leading creating the second largest bank in India with a balance sheet size of Rs. 1040bn.

Higher provisioning norms, tighter asset classification norms, dispensing with the concept of past due for recognition of NPAs, lowering of ceiling on exposure to a single borrower and group exposure etc., are among the measures in order to improve the banking sector.

A minimum stipulated Capital Adequacy Ratio (CAR) was introduced to strengthen the ability of banks to absorb losses and the ratio has subsequently been raised from 8% to 9%. It is proposed to hike the CAR to 12% by 2004 based on the Basle Committee recommendations.

Retail Banking is the new mantra in the banking sector. The home loans alone account for nearly two-third of the total retail portfolio of the bank. According to one estimate, the retail segment is expected to grow at 30-40% in the coming years.

Net banking, phone banking, mobile banking, ATMs and bill payments are the new buzz words that banks are using to lure customers.

With a view to provide an institutional mechanism for sharing of information on borrowers / potential borrowers by banks and Financial Institutions, the Credit Information Bureau (India) Ltd. (CIBIL) was set up in August 2000. The Bureau provides a framework for collecting, processing and sharing credit information on borrowers of credit institutions. SBI and HDFC are the promoters of the CIBIL.

The RBI is now planning to transfer of its stakes in the SBI, NHB and National bank for Agricultural and Rural Development to the private players. Also, the Government has sought to lower its holding in PSBs to a minimum of 33% of total capital by allowing them to raise capital from the market.

Banks are free to acquire shares, convertible debentures of corporate and units of equity-oriented mutual funds, subject to a ceiling of 5% of the total outstanding advances (including commercial paper) as on March 31 of the previous year.

The finance ministry spelt out structure of the government-sponsored ARC called the Asset Reconstruction Company (India) Limited (ARCIL), this pilot project of the ministry would pave way for smoother functioning of the credit market in the country. The government will hold 49% stake and private players will hold the rest 51%- the majority being held by ICICI Bank (24.5%).

REFORMS IN THE BANKING SECTOR:

The first phase of financial reforms resulted in the nationalization of 14 major banks in 1969 and resulted in a shift from Class banking to Mass banking. This in turn resulted in a significant growth in the geographical coverage of banks. Every bank has to earmark a minimum percentage of their loan portfolio to sectors identified as priority sectors. The manufacturing sector also grew during the 1970s in protected environs and the banking sector was a critical source. The next wave of reforms saw the nationalization of 6 more commercial banks in 1980. Since then the number scheduled commercial banks increased four-fold and the number of banks branches increased eight-fold.

After the second phase of financial sector reforms and liberalization of the sector in the early nineties, the Public Sector Banks (PSB) s found it extremely difficult to complete with the new private sector banks and the foreign banks. The new private sector banks first made their appearance after the guidelines permitting them were issued in January 1993. Eight new private sector banks are presently in operation. These banks due to their late start have access to state-of-the-art technology, which in turn helps them to save on manpower costs and provide better services.

During the year 2000, the State Bank of India (SBI) and its 7 associates accounted for a 25% share in deposits and 28.1% share in credit. The 20 nationalized banks accounted for 53.5% of the deposits and 47.5% of credit during the same period. The share of foreign banks ( numbering 42 ), regional rural banks and other scheduled commercial banks accounted for 5.7%, 3.9% and 12.2% respectively in deposits and 8.41%, 3.14% and 12.85% respectively in credit during the year 2000.

CLASSIFICATION OF BANKS:

The Indian banking industry, which is governed by the Banking Regulation Act of India, 1949 can be broadly classified into two major categories, non-scheduled banks and scheduled banks. Scheduled banks comprise commercial banks and the co-operative banks. In terms of ownership, commercial banks can be further grouped into nationalized banks, the State Bank of India and its group banks, regional rural banks and private sector banks (the old / new domestic and foreign). These banks have over 67,000 branches spread across the country. The Indian banking industry is a mix of the public sector, private sector and foreign banks. The private sector banks are again spilt into old banks and new banks.

Banking System in India

Reserve bank of India (Controlling Authority)

Development Financial institutions Banks

IFCI IDBI ICICI NABARD NHB IRBI EXIM Bank ISIDBI

Commercial Regional Rural Land Development Co-operative

Banks Banks Banks Banks

Public Sector Banks Private Sector Banks

SBI Groups Nationalized Banks Indian Banks Foreign Banks

ABOUT SBI:

The State Bank of India, the countrys oldest Bank and a premier in terms of balance sheet size, number of branches, market capitalization and profits is today going through a momentous phase of Change and Transformation the two hundred year old Public sector behemoth is today stirring out of its Public Sector legacy and moving with an agility to give the Private and Foreign Banks a run for their money.

The bank is entering into many new businesses with strategic tie ups Pension Funds, General Insurance, Custodial Services, Private Equity, Mobile Banking, Point of Sale Merchant Acquisition, Advisory Services, structured products etc each one of these initiatives having a huge potential for growth.

The Bank is forging ahead with cutting edge technology and innovative new banking models, to expand its Rural Banking base, looking at the vast untapped potential in the hinterland and proposes to cover 100,000 villages in the next two years.

It is also focusing at the top end of the market, on whole sale banking capabilities to provide Indias growing mid / large Corporate with a complete array of products and services. It is consolidating its global treasury operations and entering into structured products and derivative instruments. Today, the Bank is the largest provider of infrastructure debt and the largest arranger of external commercial borrowings in the country. It is the only Indian bank to feature in the Fortune 500 list.

The Bank is changing outdated front and back end processes to modern customer friendly processes to help improve the total customer experience. With about 8500 of its own 10000 branches and another 5100 branches of its Associate Banks already networked, today it offers the largest banking network to the Indian customer. The Bank is also in the process of providing complete payment solution to its clientele with its over 8500 ATMs, and other electronic channels such as Internet banking, debit cards, mobile banking, etc.

With four national level Apex Training Colleges and 54 learning Centres spread all over the country the Bank is continuously engaged in skill enhancement of its employees. Some of the training programes are attended by bankers from banks in other countries.

The bank is also looking at opportunities to grow in size in India as well as internationally. It presently has 82 foreign offices in 32 countries across the globe. It has also 7 Subsidiaries in India SBI Capital Markets, SBICAP Securities, SBI DFHI, SBI Factors, SBI Life and SBI Cards - forming a formidable group in the Indian Banking scenario. It is in the process of raising capital for its growth and also consolidating its various holdings.

Throughout all this change, the Bank is also attempting to change old mindsets, attitudes and take all employees together on this exciting road to Transformation. In a recently concluded mass internal communication programme termed Parivartan the Bank rolled out over 3300 two day workshops across the country and covered over 130,000 employees in a period of 100 days using about 400 Trainers, to drive home the message of Change and inclusiveness. The workshops fired the imagination of the employees with some other banks in India as well as other Public Sector Organizations seeking to emulate the programme.The Bank is actively involved since 1973 in non-profit activity called Community Services Banking. All their branches and administrative offices throughout the country sponsor and participate in large number of welfare activities and social causes.

Their business is more than banking because they touch the lives of people anywhere in many ways. Their commitment to nation-building is complete & comprehensive.

TRANSFORMATION JOURNEY IN STATE BANK OF INDIA:

The State Bank of India, the countrys oldest Bank and a premier in terms of balance sheet size, number of branches, market capitalization and profits is today going through a momentous phase of Change and Transformation the two hundred year old Public sector behemoth is today stirring out of its Public Sector legacy and moving with an agility to give the Private and Foreign Banks a run for their money.

The bank is entering into many new businesses with strategic tie ups Pension Funds, General Insurance, Custodial Services, Private Equity, Mobile Banking, Point of Sale Merchant Acquisition, Advisory Services, structured products etc each one of these initiatives having a huge potential for growth.

It is also focusing at the top end of the market, on whole sale banking capabilities to provide Indias growing mid / large Corporate with a complete array of products and services. It is consolidating its global treasury operations and entering into structured products and derivative instruments. Today, the Bank is the largest provider of infrastructure debt and the largest arranger of external commercial borrowings in the country. It is the only Indian bank to feature in the Fortune 500 list.

The Bank is changing outdated front and back end processes to modern customer friendly processes to help improve the total customer experience. With about 8500 of its own 10000 branches and another 5100 branches of its Associate Banks already networked, today it offers the largest banking network to the Indian customer. The Bank is also in the process of providing complete payment solution to its clientele with its over 8500 ATMs, and other electronic channels such as Internet banking, debit cards, mobile banking, etc.

With four national level Apex Training Colleges and 54 learning Centers spread all over the country the Bank is continuously engaged in skill enhancement of its employees. Some of the training programmes are attended by bankers from banks in other countries.

The bank is also looking at opportunities to grow in size in India as well as internationally. It presently has 82 foreign offices in 32 countries across the globe. It has also 7 Subsidiaries in India SBI Capital Markets, SBICAP Securities, SBI DFHI, SBI Factors, SBI Life and SBI Cards - forming a formidable group in the Indian Banking scenario. It is in the process of raising capital for its growth and also consolidating its various holdings.

Throughout all this change, the Bank is also attempting to change old mindsets, attitudes and take all employees together on this exciting road to Transformation. In a recently concluded mass internal communication programme termed Parivartan the Bank rolled out over 3300 two day workshops across the country and covered over 130,000 employees in a period of 100 days using about 400 Trainers, to drive home the message of Change and inclusiveness. The workshops fired the imagination of the employees with some other banks in India as well as other Public Sector Organizations seeking to emulate the programme.

The CNN IBN, Network 18 recognized this momentous transformation journey, the State Bank of India is undertaking, and has awarded the prestigious Indian of the Year Business, to its Chairman, Mr. O. P. Bhatt in January 2008.

State Bank of India (SBI) has history of more than 200 years of existence. SBI is the largest commercial bank in India and accounts for approximately 18% of the total Indian banking business and the group account for 25% of the total Indian banking business.

The central bank, Reserve Bank of India (RBI) is the largest shareholder in the bank with59.7% stake followed by overseas investors including GDRs with 19.78% shareholdingas on September 06. RBIs stake in the bank is likely to be transferred to the Governmentof India (GOI).

SBI has the largest distribution network in India spread across every nook and corner of India. As on September 06, the bank has 14,061 branches which include 4,755 branches of its associated banks. The bank also has the largest network of 5,624 ATMs.

Background:

State Bank of India is the largest and one of the oldest commercial bank in India, in existence for more than 200 years. The bank provides a full range of corporate, commercial and retail banking services in India. Indian central bank namely Reserve Bank of India (RBI) is the major share holder of the bank with 59.7% stake. The bank is capitalized to the extent of Rs.646bn with the public holding (other than promoters) at 40.3%.

SBI has the largest branch and ATM network spread across every corner of India. Thebank has a branch network of over 14,000 branches (including subsidiaries). Apart fromIndian network it also has a network of 73 overseas offices in 30 countries in all time zones, correspondent relationship with 520 International banks in 123 countries. In recent past, SBI has acquired banks in Mauritius, Kenya and Indonesia. The bank had total staff strength of 198,774 as on 31st March, 2006. Of this, 29.51% are officers, 45.19% clerical staff and the remaining 25.30% were sub-staff. The bank is listed on the Bombay Stock Exchange, National Stock Exchange, Kolkata Stock Exchange, Chennai Stock Exchange and Ahmedabad Stock Exchange while its GDRs are listed on the London Stock Exchange.

SBI group accounts for around 25% of the total business of the banking industry while itaccounts for 35% of the total foreign exchange in India. With this type of strong base, SBI has displayed a continued performance in the last few years in scaling up its efficiency levels. Net Interest Income of the bank has witnessed a CAGR of 13.3% during the last five years. During the same period, net interest margin (NIM) of the bank has gone up from as low as 2.9% in FY02 to 3.40% in FY06 and currently is at 3.32%.

EVOLUTION OF SBI:The origin of the State Bank of India goes back to the first decade of the nineteenth century with the establishment of the Bank of Calcutta in Calcutta on 2 June 1806. Three years later the bank received its charter and was re-designed as the Bank of Bengal (2 January 1809). A unique institution, it was the first joint-stock bank of British India sponsored by the Government of Bengal. The Bank of Bombay (15 April 1840) and the Bank of Madras (1 July 1843) followed the Bank of Bengal. These three banks remained at the apex of modern banking in India till their amalgamation as the Imperial Bank of India on 27 January 1921.

Imperial Bank The Imperial Bank during the three and a half decades of its existence recorded an impressive growth in terms of offices, reserves, deposits, investments and advances, the increases in some cases amounting to more than six-fold. The financial status and security inherited from its forerunners no doubt provided a firm and durable platform. But the lofty traditions of banking which the Imperial Bank consistently maintained and the high standard of integrity it observed in its operations inspired confidence in its depositors that no other bank in India could perhaps then equal. All these enabled the Imperial Bank to acquire a pre-eminent position in the Indian banking industry and also secure a vital place in the country's economic life.

When India attained freedom, the Imperial Bank had a capital base (including reserves) of Rs.11.85 crores, deposits and advances of Rs.275.14 crores and Rs.72.94 crores respectively and a network of 172 branches and more than 200 sub offices extending all over the country.

Key Areas of Operations:

The business operations of SBI can be broadly classified into the key income generating areas such as National Banking, International Banking, Corporate Banking, & Treasury operations. The functioning of some of the key divisions is enumerated below:

a) CORPORATE BANKING

The corporate banking segment of the bank has total business of around Rs1,193bn. SBI has created various Strategic Business Units (SBU) in order to streamline its operations.

These SBUs are as follows:

1) Corporate Accounts

This SBU is important for the bank as its loan portfolio constituted about 27.05% of thebanks commercial and institutional non-food credit and 12.85% of the total domestic credit portfolio as on 31st March 2006.

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

SBI-FAST, which is the cash management product offered by this SBU, had a turnover of Rs.4,705.75bn as of 31st March 2006. This product is now comprehensive cash management solution, offering payments in addition to collections.

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

The foreign exchange business grew by around 55% y-o-y and reached Rs.1,747.70bn as of 31st March 2006. This SBU now handles nearly 12% of the countrys visible trade and about 43% of banks forex business.

2) Leasing

This SBU is not writing any leases since the past few years as unfavorable business climate and availability of alternative funding options at cheaper cost. As at the end March 2006, the disbursements and capitalization were zero and profit amounted to Rs.245.9mn.

3) Project Finance

This SBU focuses on funding core projects like power, telecom, roads, ports, airports, special economic zones and others. During FY06, total sanctions for 18 projects involving a total State Bank of India, Corporate Banking, National Banking, International Banking, Treasury Operations Associates & Subsidiaries amount of Rs.42.11bn were in place as against 13 projects involving Rs.25.08bn in the previous year. It also handles non-infrastructure projects with certain ceilings on minimum project costs. During FY06 sanctions for 29 projects involving a total amount of Rs.55.80bn were in place as against 27 projects involving Rs.51.63bn in the previous year. As a whole, this SBU achieved total sanctions of Rs.238.86bn (fund based and non fund based) including syndication amount of Rs.140.95bn during the period ended March 2006. During FY06, this SBU entered into financing of aviation sector actively by sanctioning loans for modernization of airports and acquisition of aircrafts.

4) Mid Corporate Group

The Mid Corporate Group (MCG) created in June 2004 has 7 MCG Regional Officescontrolling 28 large branches with high concentration of Mid Corporate (MC) business.The entire Off-Site MC business of all branches at 31 identified centres has been broughtunder the fold of MCG. The average processing time of credit proposals is about 15 daysand quicker decision making on credit proposals of the Mid Corporate units has resulted in greater customer satisfaction. As of March 2006, 21 MCG branches have been migrated to core banking platform. New technology products like RTGS, CINB, Multi-City cheque facility and Core Power have been introduced in all these branches. These technology products coupled with quick Turn Around Time (TAT) have enabled Mid-Corporate Group to increase its business substantially and generate higher income, both interest and fee based.

5) Stressed Assets Management

During FY06, the banking industry witnessed a major policy initiative by Reserve Bank of India with the opening up of sale / purchase of non performing assets to banks, FIs and non-banking finance companies (NBFCs). During FY06, the bank sold NPAs to the tune of Rs.8.9bn against security receipts and Rs.11.41bn on cash basis to Asset Reconstruction Company (ARCIL). The progress in enforcing the security interest has somewhat slowed down due to the requirement of withdrawing suits pending before the tribunal prior to action being initiated against the defaulting borrowers under the SARFAESI Act.

b) NATIONAL BANKING

The national banking group has 14 administrative circles encompassing a vast network of 9,177 branches, 4 sub-offices, 12 exchange bureaus, 104 satellite offices and 679 extension counters, to reach out to customers, even in the remotest corners of the country. Out of the total branches, 809 are specialized branches. This group consists of four business group which are enumerated below:

1) Personal Banking SBU

This SBU is mainly responsible for retail business. During FY06, personal banking advances increased from Rs.464.51bn to Rs.610.67bn, showing a growth of Rs.146.16bn at the rate of 31.47 % against a growth rate of 40.12% in the previous year.

On the home loan front, several new products were introduced, tailored to fit the needs of specific customer segments, such as SBIMaxgain (minimize interest burden, earn on savings, at no extra cost), SBI NRI-Home Loans, SBI Freedom Home Loans (Loans given without mortgage of property, but against alternate securities, instead), SBI Tribal Plus Home Loans. The auto loans portfolio has shown a growth of Rs.17.74bn in absolute terms and 65% which is considerably higher than last years growth, mainly due to implementation of well planned strategies.

2) Small & Medium Enterprises

The SME Business Unit implemented comprehensive strategies, revamped business processes and with its focus on market dynamics and customer preferences, achieved commendable business growth. The initiative was implemented by focusing on specific industry segments, and concentrating on various players in the value chain. Debt restructuring mechanism for units in SME sector has been devised to ensure restructuring of debt of all eligible Small and Medium Enterprises (SMEs) on favorable terms.

Focused on the SME sector, projects under Uptech are taken up in location specific and activity specific industry clusters. So far the bank has taken 28 projects for modernization under the Project Uptech covering industries like foundry, pumps, glass, auto components, and knitwear, etc. The bank has also covered agro based industries like rice mills, sago and starch and horticulture activities like Apple Orchards and grape farming under the scheme. The deposits of the SME SBU increased to Rs.1,042.70bn as at the end of March 2006 from Rs.890.60bn of previous year recording a growth of 17.08% during the year. SME advances increased to Rs.456.53bn from Rs.328.30bn of previous year, recording a growth of 39.06 %. The criteria laid down by the Government of India for growth in SME advances is 20%.

3) Agricultural Banking

This SBU is accountable for agricultural credit both traditional and new thrust areas like contract farming, farmers financed through Agri Export Zones (AEZs) and value chain financing. Increase in disbursements during FY06 was 83% against the Govt. of India target of 30%. Agricultural advances grew from a level of Rs.205.26bn in FY05 to Rs.305.16bn as at the end of March 06. As on November 2006, agriculture loans contribute 11% of the total loan book.

4) Government Banking

With the establishment of the government business unit and the consequent focus on marketing, business turnover of this segment has grown substantially over the years. Banks business turnover from the government business segment during 2004-05 was Rs.8,843.81bn. The turnover increased by 10.52 % to Rs.9,773.90bn during FY06.

c) INTERNATIONAL BANKING

SBI has a network of 73 overseas offices in 30 countries in all time zones and correspondent relationship with 520 international banks in 123 countries. The bank is keen to implement core banking solution to its international branches also. During FY06, 25 foreign offices were successfully switched over to Finacle software. SBI has installed ATMs at Male, Muscat and Colombo Offices. In recent years, SBI acquired 76% shareholding in Giro Commercial Bank Limited in Kenya and PT Indomonex Bank Ltd. in Indonesia. The bank incorporated a company SBI Botswana Ltd. at Gaborone.

d) TREASURY

The bank manages an integrated treasury covering both domestic and foreign exchange markets. In recent years, the treasury operation of the bank has become more active amidst rising interest rate scenario, robust credit growth and liquidity constraints. The bank diversified its operations more actively into alternative assets classes with a view to diversify the portfolio and build alternative revenue streams in order to offset the losses in fixed income portfolio. Reorganization of the treasury processes at domestic and global levels is also being undertaken to leverage on the operational synergy between business units and network. The reorganization seeks to enhance the efficiencies in use of manpower resources and increase maneuverability of banks operations in the markets both domestic as well as international

e) ASSOCIATES & SUBSIDIARIES

The State Bank Group with a network of 14,061 branches including 4,755 branches of its seven Associate Banks dominates the banking industry in India. In addition to banking, the Group, through its various subsidiaries, provides a whole range of financial services which includes Life Insurance, Merchant Banking, Mutual Funds, Credit Card, Factoring, Security trading and primary dealership in the Money Market.

1) Associates Banks:

SBI has seven associate banks namely

State Bank of Indore

State Bank of Travancore

State Bank of Bikaner and Jaipur

State Bank of Mysore

State Bank of Patiala

State Bank of Hyderabad

State Bank of Saurashtra

All associate banks have migrated to Core Banking (CBS) platform. Single window delivery system has been introduced in all associate banks. SBIs seven associate banks are the first amongst the public sector banks in India to get fully networked through CBS, providing anytime-anywhere banking to its customers to facilitate a bouquet of innovative customer offerings.

2) Non-Banking Subsidiaries/Joint Ventures

i) SBI Life:

SBI Life is the third largest private insure with the market share of 10.21% among the private players and number one in terms of number of lives insured amongst private players (no. of lives insured and policies is 25mn). In H1FY07 gross premium was Rs.7.68bn.

ii) SBI Capital Markets Limited (SBICAP)

SBI Caps forged ahead in issue management, project advisory and structured finance, sales and distribution. To capitalize on the emerging opportunities, SBI Caps has promoted four wholly owned subsidiaries viz. SBICAP Securities Ltd. for undertaking stock broking activities, SBICAPS Ventures Limited, SBICAP Trustee Company Limited for undertaking venture capital business and SBI CAP (UK) LTD., for carrying on the Financial Services Authority (FSA) regulated activities. On the international front, the expertise of SBI Caps in the infrastructure and project advisory has received international acclaim. In addition, the company has been placed 11th globally in the Mandated Project Advisor league tables by Thompsons, and one of the projects handled by the company has been selected as the Asia Pacific Infrastructure deal of the year for FY06. SBI Caps booked gross income amounting to Rs.1.79bn in FY06 as against Rs.1.75bn in the previous year, while PAT of the company was at Rs.906.2mn in FY06 as against Rs.881.2mn in the last year.

iii) SBI DFHI LTD

SBI group holds 67.01% of the companys paid up capital, while other nationalized banks hold 22.46%. All India financial institutions and private sector banks hold 5.84% and the Asian Development Bank holds 4.69% as on March 31, 2006. For the year ended 31st March, 2006, the company has earned a PAT of Rs.24.4mn. Total secondary market turnover of the company was Rs.285.39bn which amounted to a market share of 12.89% among all primary dealers.

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

SBICSPL is ranked 2nd in industry with cards in force over 3mn as on September 06. During FY06, the aggregate revenue generated by the SBICSPL was Rs.5.27bn while pre-tax profit was Rs.558.6mn.

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

SBI Mutual Fund is the mutual funds arm of the bank. SBIFMPL reported a total inflow of Rs.481.67bn in the various schemes during the year. The total assets under management are Rs.132.49bn. The company reported a net profit of Rs.186.4mn as at the end of March, 2006.

f) Human Resources

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

officers, 45.19% clerical staff and the remaining 25.30% were sub-staff. SBI had launched VRS scheme for its employees in FY01 in which it has reduced it staff by approximately 5,000 and estimates natural retirement of another 5,000 employees in next 4-5 year.

NON BANKING SUBSIDIARIES:

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

SBI Capital Markets Ltd

SBI Funds Management Pvt Ltd

SBI Factors & Commercial Services Pvt Ltd

SBI DFHI Ltd

State Bank of Travancore (SBT)

INVESTOR RELATIONS:

State Bank of India, the countrys largest commercial Bank in terms of profits, assets, deposits, branches and employees, welcomes you to its Investors Relations Section. SBI, with its heritage dating back to the year 1806, strives to continuously provide latest and upto date information on its financial performance. It is our endeavor to walk on the path of transparency and allow complete access to all the stakeholders enabling total awareness about the Bank. The Bank communicates with the stakeholders through a variety of channels, such as through e-mail, website, conference call, one-on-one meeting, analysts meet and attendance at Investor Conference throughout the world.

Please find below Banks financial results, analysis of performance and other highlights which will be of interest to Investors, Fund Managers and Analysts. SBI has always been fundamentally strong in its core business which is mirrored in its results year after year.

State Bank of India has an extensive administrative structure to oversee the large network of branches in India and abroad. The Corporate Centre is in Mumbai and 14 Local Head Offices and 57 Zonal Offices are located at important cities spread throughout the country. The Corporate Centre has several other establishments in and outside Mumbai, designated to cater to various functions. Our Colleges/Institutes/Training Centres are the seats of learning and research and development to spread the wings of knowledge not only to our employees but also other banks/establishments in India and abroad.

The Corporate Accounts Group is a Strategic Business Unit of the Bank set up exclusively to fulfil the specialised banking needs of top corporates in the country.

State Bank of India has 52 foreign offices in 34 countries across the globe.State Bank of India invites you to take a journey to understand the potential of not just a large but truly global organisation.

CHAPTER-2

BRIEF OVERVIEW OF CREDIT APPRAISAL

Credit appraisal means an investigation/assessment done by the bank prior before providing any loans & advances/project finance & also checks the commercial, financial & technical viability of the project proposed its funding pattern & further checks the primary & collateral security cover available for recovery of such funds.

Brief overview of credit:

Credit Appraisal is a process to ascertain the risks associated with the extension of the credit facility. It is generally carried by the financial institutions which are involved in providing financial funding to its customers. Credit risk is a risk related to non repayment of the credit obtained by the customer of a bank. Thus it is necessary to appraise the credibility of the customer in order to mitigate the credit risk. Proper evaluation of the customer is performed which measures the financial condition and the ability of the customer to repay back the loan in future. Generally the credit facilities are extended against the security know as collateral. But even though the loans are backed by the collateral, banks are normally interested in the actual loan amount to be repaid along with the interest. Thus, the customer's cash flows are ascertained to ensure the timely payment of principal and the interest.

It is the process of appraising the credit worthiness of a loan applicant. Factors like age, income, number of dependents, nature of employment, continuity of employment, repayment capacity, previous loans, credit cards, etc. are taken into account while appraising the credit worthiness of a person. Every bank or lending institution has its own panel of officials for this purpose.However the 3 C of credit are crucial & relevant to all borrowers/ lending which must be kept in mind at all times.

Character

Capacity

Collateral

If any one of these are missing in the equation then the lending officer must question the viability of credit.

There is no guarantee to ensure a loan does not run into problems; however if proper credit evaluation techniques and monitoring are implemented then naturally the loan loss probability / problems will be minimized, which should be the objective of every lending officer.

Credit is the provision of resources (such as granting a loan) by one party to another party where that second party does not reimburse the first party immediately, thereby generating a debt, and instead arranges either to repay or return those resources (or material(s) of equal value) at a later date. The first party is called a creditor, also known as a lender, while the second party is called a debtor, also known as a borrower.

Credit allows you to buy goods or commodities now, and pay for them later. We use credit to buy things with an agreement to repay the loans over a period of time. The most common way to avail credit is by the use of credit cards. Other credit plans include personal loans, home loans, vehicle loans, student loans, small business loans, trade.

A credit is a legal contract where one party receives resource or wealth from another party and promises to repay him on a future date along with interest. In simple terms, a credit is an agreement of postponed payments of goods bought or loan. With the issuance of a credit, a debt is formed.

BASIC TYPES OF CREDIT

There are four basic types of credit. By understanding how each works, you will be able to get the most for your money and avoid paying unnecessary charges.

Service credit is monthly payments for utilities such as telephone, gas, electricity, and water. You often have to pay a deposit, and you may pay a late charge if your payment is not on time.

Loans let you borrow cash. Loans can be for small or large amounts and for a few days or several years. Money can be repaid in one lump sum or in several regular payments until the amount you borrowed and the finance charges are paid in full. Loans can be secured or unsecured.

Installment credit may be described as buying on time, financing through the store or the easy payment plan. The borrower takes the goods home in exchange for a promise to pay later. Cars, major appliances, and furniture are often purchased this way. You usually sign a contract, make a down payment, and agree to pay the balance with a specified number of equal payments called installments. The finance charges are included in the payments. The item you purchase may be used as security for the loan.

Credit cards are issued by individual retail stores, banks, or businesses. Using a credit card can be the equivalent of an interest-free loan--if you pay for the use of it in full at the end of each month.

Brief overview of lOANSCredit can be of two types fund base & non-fund base:

FUND BASED includes:

Working Capital

Term Loan

NON-FUND BASED includes:

Letter of Credit

Bank Guarantee

FUND BASED:-

WORKING CAPITAL:-

1. GENERAL

The objective of running any industry is earning profits. An industry will require funds to acquire

Fixed assets like land, building, plant, machinery, equipments, vehicles, tools etc., & also to run the business i.e. its day to day operations.

Funds required for day to-day working will be to finance production & sales. For production, funds are needed for purchase of raw materials/ stores/ fuel, for employment of labour, for power charges etc., for storing finishing goods till they are sold out & for financing the sales by way of sundry debtors/ receivables.

Capital or funds required for an industry can therefore be bifurcated as fixed capital & working capital. Working capital in this context is the excess of current assets over current liabilities. The excess of current assets over current liabilities is treated as net working capital or liquid surplus & represents that portion of the working capital which has been provided from the long term source.2. Definition

Working capital is defined as the funds required to carry the required levels of current assets to enable the unit to carry on its operations at the expected levels uninterruptedly.

Thus Working Capital Required is dependent on

(a) The volume of activity (viz. level of operations i.e. Production & sales)

(b) The activity carried on viz. mfg process, product, production programme, the materials & marketing mix.

3. METHODS & APPLICATION

SEGMENTLIMITSMETHOD

SSIUpto Rs 5 crTraditional Method & Nayak Committee method

Above Rs 5 crProjected Balance Sheet Method

SBFAll loansTraditional / Turnover Method

C&I Trade & ServicesUpto Rs 1 crTraditional Method for Trade &

Projected Turnover Method

Above Rs 1 cr

& upto Rs 5 crProjected Balance Sheet Method &



C&I Industrial UnitsBelow

Rs 25 lacs Traditional Method

Rs 25 lacs &

Over but upto

Rs 5 crProjected Balance Sheet Method &



4. Operating Cycle method

a) 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.

b) Diagrammatically, the operating cycle is represented as under SHAPE \* MERGEFORMAT

c) 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.

d) 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)

Operating cycle is also called the cash-to-cash cycle & indicates how cash is converted into raw material, stocks in process, finished goods, bills (receivables) & finally back to cash.

Working capital is the total cash that is circulating in this cycle. Therefore, working capital

can be turned over or redeployed after completing the cycle.

e) The length of the operating cycle = a+b+c+d (as in 4.4)

If a = 60 days

b = 10 days

c = 20 days

d = 30 days

The operating cycle is 120 days (nearly 4 months). This means there are 365/120 = 3 cycles of operations in a year.

Sales = Rs. 1,00,000 per annum

Operating expenses = Rs. 72,000 per annum

But the working capital requirement, as you know, is not Rs. 72,000.

In these cases, there are 3 operating cycles in a year. That means each rupee of working

deployed in the unit is turned over 3 times in a year. (This is also known as working capital

turnover ratio).

Therefore WCR = Operating Expenses = Rs. 72,000/- = Rs. 24,000/-

No. of cycles per annum 3

WCR is therefore not Rs. 72,000/- but only Rs. 24,000/-

Assessment of Working Capital Requirement & Permissible Bank Finance using Operating Cycle ConceptLet us consider a case of a unit where:

Sales = Rs. 20,000 p.m. (A)

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

Wages = Rs. 2,000 p.m.

Other manufacturing

Expenses = Rs. 3,000 p.m.

Total expenses = Rs. 19,000 p.m. (B)

Profit = Rs. 1,000 P.m. (C)

The operating cycle is

Raw Materials = 15 days

Stock in Process = 2 days

FG = 3 days

Sundry Debtors = 15 days

The total length of

Operating cycle = 35 days (D)

WCR = B * D = 19,000 * 35 = Rs. 22,167/- (approx.)

30 30

Where B = Operating Expenses; &

D = Length of Operating cycle

TERM LOAN

1. A term loan is granted for a fixed term of not less than 3 years intended normally for financing fixed assets acquired with a repayment schedule normally not exceeding 8 years.

2. A term loan is a loan granted for the purpose of capital assets, such as purchase of land, construction of, buildings, purchase of machinery, modernization, renovation or rationalization of plant, & repayable from out of the future earning of the enterprise, in installments, as per a prearranged schedule.

From the above definition, the following differences between a term loan & the working capital credit afforded by the Bank are apparent:

The purpose of the term loan is for acquisition of capital assets.

The term loan is an advance not repayable on demand but only in installments ranging over a period of years.

The repayment of term loan is not out of sale proceeds of the goods & commodities per se, whether given as security or not. The repayment should come out of the future cash accruals from the activity of the unit.

The security is not the readily saleable goods & commodities but the fixed assets of the units.

3. It may thus be observed that the scope & operation of the term loans are entirely different from those of the conventional working capital advances. The Banks commitment is for a long period & the risk involved is greater. An element of risk is inherent in any type of loan because of the uncertainty of the repayment. Longer the duration of the credit, greater is the attendant uncertainty of repayment & consequently the risk involved also becomes greater.

4. However, it may be observed that term loans are not so lacking in liquidity as they appear to be. These loans are subject to a definite repayment programme unlike short term loans for working capital (especially the cash credits) which are being renewed year after year. Term loans would be repaid in a regular way from the anticipated income of the industry/ trade.

5. These distinctive characteristics of term loans distinguish them from the short term credit granted by the banks & it becomes necessary therefore, to adopt a different approach in examining the applications of borrowers for such credit & for appraising such proposals.

6. The repayment of a term loan depends on the future income of the borrowing unit. Hence, the primary task of the bank before granting term loans is to assure itself that the anticipated income from the unit would provide the necessary amount for the repayment of the loan. This will involve a detailed scrutiny of the scheme, its financial aspects, economic aspects, technical aspects, a projection of future trends of outputs & sales & estimates of cost, returns, flow of funds & profits.

7. Appraisal of Term Loans

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

There are four broad aspects of appraisal, namely

Technical Feasibility - To determine the suitability of the technology selected & the adequacy of the technical investigation & design;

Economic Feasibility - To ascertain the extent of profitability of the project & its sufficiency in relation to the repayment obligations pertaining to term assistance;

Financial Feasibility - To determine the accuracy of cost estimates, suitability of the envisaged pattern of financing & general soundness of the capital structure; &

Managerial Competency To ascertain that competent men are behind the project to ensure its successful implementation & efficient management after commencement of commercial production.

7.1 Technical Feasibility

The examination of this item consists of an assessment of the various requirement of the actual production process. It is in short a study of the availability, costs, quality & accessibility of all the goods & services needed.

a) The location of the project is highly relevant to its technical feasibility & hence special attention will have to be paid to this feature. Projects whose technical requirements could have been taken care of in one location sometimes fail because they are established in another place where conditions are less favorable. One project was located near a river to facilitate easy transportation by barge but lower water level in certain seasons made essential transportation almost impossible. Too many projects have become uneconomical because sufficient care has not been taken in the location of the project, e.g. a woolen scouring & spinning mill needed large quantities of good water but was located in a place which lacked ordinary supply of water & the limited water supply available also required efficient softening treatment. The accessibility to the various resources has meaning only with reference to location. Inadequate transport facilities or lack of sufficient power or water for instance, can adversely affect an otherwise sound industrial project.

b) Size of the plant One of the most important considerations affecting the feasibility of a new industrial enterprise is the right size of the plant. The size of the plant will be such that it will give an economic product which will be competitive when compared to the alternative product available in the market. A smaller plant than the optimum size may result in increased production costs & may not be able to sell its products at competitive prices.

c) Type of technology An important feature of the feasibility relates to the type of technology to be adopted for a project. A new technology will have to be fully examined & tired before it is adopted. It is equally important to avoid adopting equipment or processes which are absolute or likely to become outdated soon. The principle underlying the technological selection is that a developing country cannot afford to be the first to adopt the new nor yet the last to cast the old aside.

d) Labour The labour requirements of a project, need to be assessed with special care. Though labour in terms of unemployed persons is abundant in the country, there is shortage of trained personnel. The quality of labour required & the training facilities made available to the unit will have to be taken into account

e) Technical Report A technical report using the Banks Consultancy Cell, external consultants, etc., should be obtained with specific comments on the feasibility of scheme, its profitability, whether machinery proposed to be acquired by the unit under the scheme will be sufficient for all stages of production, the extent of competition prevailing, marketability of the products etc., wherever necessary.

7.2 Economic Feasibility

An economic feasibility appraisal has reference to the earning capacity of the project. Since earnings depend on the volume of sales, it is necessary to determine how much output or the additional production from an established unit the market is likely to absorb at given prices.

a) A thorough market analysis is one of the most essential parts of project investigation. This involves getting answers to three questions.

a) How big is the market?

b) How much it is likely to grow?

c) How much of it can the project capture?

The first step in this direction is to consider the current situation, taking account of the total output of the product concerned & the existing demand for it with a view to establishing whether there is unsatisfied demand for the product. Care should be taken to see that there is no idle capacity in the existing industries.

ii) Future possible future changes in the volume & patterns of supply & demand will have to be estimated in order to assess the long term prospects of the industry. Forecasting of demand is a complicated matter but one of the vital importance. It is complicated because a variety of factors affect the demand for product e.g. technological advances could bring substitutes into market while changes in tastes & consumer preference might cause sizable shifts in demand.

iii) Intermediate product The demand for Intermediate product will depend upon the demand & supply of the ultimate product (e.g. jute bags, paper for printing, parts for machines, tyres for automobiles). The market analysis in this case should cover the market for the ultimate product.

7.3 Financial FeasibilityThe basis data required for the financial feasibility appraisal can be broadly grouped under the following heads

i) Cost of the project including working capital

ii) Cost of production & estimates of profitability

iii) Cash flow estimates & sources of finance.

The cash flow estimates will help to decide the disbursal of the term loan. The estimate of profitability & the breakeven point will enable the banker to draw up the repayment programme, start-up time etc. The profitability estimates will also give the estimate of the Debt Service Coverage which is the most important single factor in all the term credit analysis.

A study of the projected balance sheet of the concern is essential as it is necessary for the appraisal of a term loan to ensure that the implementation of the proposed scheme.

Break-even point:

In a manufacturing unit, if at a particular level of production, the total manufacturing cost equals the sales revenue, this point of no profit/ no loss is known as the break-even point. Break-even point is expressed as a percentage of full capacity. A good project will have reasonably low break-even point which not be encountered in the projections of future profitability of the unit.

Debt/ Service Coverage:

The debt service coverage ratio serves as a guide to determining the period of repayment of a loan. This is calculated by dividing cash accruals in a year by amount of annual obligations towards term debt. The cash accruals for this purpose should comprise net profit after taxes with interest, depreciation provision & other non cash expenses added back to it.

Debt Service = Cash accruals

Coverage Ratio Maturing annual obligations

This ratio is valuable, in that it serves as a measure of the repayment capacity of the project/ unit & is, therefore, appropriately included in the cash flow statements. The ratio may vary from industry to industry but one has to view it with circumspection when it is lower than the benchmark of 1.75. The repayment programme should be so stipulated that the ratio is comfortable.

7.4 Managerial Competence

In a dynamic environment, the capacity of an enterprise to forge ahead of its competitors depends to a large extent, on the relative strength of its management. Hence, an appraisal of management is the touchstone of term credit analysis.

If there is a change in the administration & managerial set up, the success of the project may be put to test. The integrity & credit worthiness of the personnel in charge of the management of the industry as well as their experience in management of industrial concerns should be examined. In high cost schemes, an idea of the units key personnel may also be necessary.

NON-FUND BASED:-

LETTER OF CREDIT

Introduction

The expectation of the seller of any goods or services is that he should get the payment immediately on delivery of the same. This may not materialize if the seller & the buyer are at different places (either within the same country or in different countries). The seller desires to have an assurance for payment by the purchaser. At the same time the purchaser desires that the amount should be paid only when the goods are actually received. Here arises the need of Letter of Credit (LCs). The objective of LC is to provide a means of payment to the seller & the delivery of goods & services to the buyer at the same time.

Definition

A Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at the request & on the instructions of the customer (the applicant) or on its own behalf,

i. is to make a payment to or to the order of a third party (the beneficiary), or is to accept & pay bills of exchange (drafts drawn by the beneficiary); or

ii. authorizes another bank to effect such payment, or to accept & pay such bills of exchanges (drafts); or

iii. authorizes another bank to negotiate against stipulated document(s), provided that the terms & conditions of the credit are complied with.

Basic Principle:

The basic principle behind an LC is to facilitate orderly movement of trade; it is therefore necessary that the evidence of movement of goods is present. Hence documentary LCs is those which contains documents of title to goods as part of the LC documents. Clean bills which do not have document of title to goods are not normally established by banks. Bankers and all concerned deal only in documents & not in goods. If documents are in order issuing bank will pay irrespective of whether the goods are of expected quality or not. Banks are also not responsible for the genuineness of the documents & quantity/quality of goods. If importer is your borrower, the bank has to advice him to convert all his requirements in the form of documents to ensure quantity & quality of goods.

Parties to the LC

1) Applicant The buyer who applies for opening LC2) Beneficiary The seller who supplies goods3) Issuing Bank The Bank which opens the LC4) Advising Bank The Bank which advises the LC after confirming authenticity5) Negotiating Bank The Bank which negotiates the documents6) Confirming Bank The Bank which adds its confirmation to the LC7) Reimbursing Bank The Bank which reimburses the LC amount to negotiating bank8) Second beneficiary The additional beneficiary in case of transferable LCsConfirming bank may not be there in a transaction unless the beneficiary demand confirmation by his own bankers & such a request is made part of LC terms. A bank will confirm an LC for his beneficiary if opening bank requests this as part of LC terms. Reimbursing bank is used in an LC transaction by an opening bank when the bank does not have a direct correspondent/branch through whom the negotiating bank can be reimbursed. Here, the opening bank will direct the reimbursing bank to reimburse the negotiating bank with the payment made to the beneficiary. In the case of transferable LC, the LC may be transferred to the second beneficiary & if provided in the LC it can be transferred even more than once.

Types of Letter of Credit:-

a) Revocable & Irrevocable:

As the name suggests, revocable LCs are those that can be revoked by the issuing bank & hence are not in commercial use. Irrevocable LCs cannot be revoked/ cancelled/ amended without the prior concern of all the parties to the LC.

b) Confirmed LC:

The seller may ask for the confirmation of the LC by a bank in his own country if he is not satisfied about the issuing banks credentials.

c) Sight/ Usance LCs:

In case of the sight LCs beneficiary gets immediate payment upon presentation of the documents while in the case of usance, the payment is made after a certain period as per the LC terms. Sight LCs have to be paid by the drawee (buyer) immediately whereas he gets credit as per LC terms under Usance LCs.

d) LC with advance payment to the seller:

The LC which authorizes the advising bank to advance a part of LC amount to the seller to meet pre-shipment expenses is known as Red Clause Letter of Credit. The seller gives the receipt & an undertaking to present the documents before the LC expires. Advance amount would be adjusted from the proceeds of the export documents. However, the risk is assumed by the buyer. When the Red Clause LC provides for the cost of shortage facilities at the port of shipment in addition to the pre-shipment advance to the beneficiary it is called Green Clause LC. The goods are stored in the name of the issuing bank.e) Revolving LC:

Under this, the issuing bank undertakes to restore the credit to the original amount after it has been utilized. Number of such utilization & the period of time by which this should take place are stipulated in the LC. On receipt of bill payment advise the LC amount gets reinstated.

f) Transferable LCs:

Transferable LC are transferable in whole or in part to one or more beneficiaries depending on the terms of LC. As per UCPDC stipulated in the LC, all LC are not transferable.

g) Back to back LCs:

When the bank opens new LCs against the backing of an LC received by a beneficiary having the first LC as security for the new LCs opened, the transaction is referred to as Back to Back. For example let us assume a customer A, who exports marine products by buying them from a number of suppliers. If A receives an LC for USD 100000 for shipment of marine products & he approaches the Bank for opening LCs in favour of his suppliers of marine products within the original value & in keeping with the terms of the original LC these new LCs are opened against the backing of the original LC. This is the back to back transaction. However, it may be noted that this arrangement is not under the provisions of UCPDC though the individual LCs are governed by it.

Illustration for computation of LC limit

M/S XYZ Co Ltd

Letter of credit limit of Rs. 20 crore

(Rs. in crores)

Total purchase of raw material172.64

Purchase of raw materials under LC69.41

Average monthly purchase of raw material under LC (A)5.78

Average holding of imported raw materials (2.2 months consumption) 11.30

Average usance period (B)3 months

Lead time & transit period (C)1 month

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

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

Limit recommended say23.00

Explanatory notes:

1) While calculating the amount of raw materials purchases on LC basis, the following points need to be noted. (Amount in rupees)

a) Raw material consumption

b) Add: Closing stock of raw material

c) Less: Opening stock of raw material

d) Total Purchases during the period

e) Purchases on LC basis as % of total purchases

f) Purchases on LC basis in rupees

g) Import duty payable, if any

h) Purchases on LC basis net on import duty (CIF value) (f-g)

2) Transit time should be treated as nil if usance period starts from shipment date.

Bank Guarantees

A contract of guarantee is defined as a contract to perform the promise or discharge the liability of the third person in case of the default. The parties to the contract of guarantees are:a) Applicant: The principal debtor person at whose request the guarantee is executedb) Beneficiary: Person to whom the guarantee is given & who can enforce it in case of default.c) Guarantee: The person who undertakes to discharge the obligations of the applicant in case of his default.Thus, guarantee is a collateral contract, consequential to a main contract between the applicant & the beneficiary.

Purpose of Bank Guarantees

Bank Guarantees are used to for both both preventive & remedial purposes. The guarantees executed by banks comprises both performance guarantees & financial guarantees. The guarantees are structured according to the terms of agreement, viz., security, maturity & purpose.

Branches may issue guarantees generally for the following purposes:

a) In lieu of security deposit/earnest money deposit for participating in tenders;

b) Mobilization advance or advance money before commencement of the project by the contractor & for money to be received in various stages like plant layout, design/drawings in project finance;

c) In respect of raw materials supplies or for advances by the buyers;

d) In respect of due performance of specific contracts by the borrowers & for obtaining full payment of the bills;

e) Performance guarantee for warranty period on completion of contract which would enable the suppliers to realize the proceeds without waiting for warranty period to be over;

f) To allow units to draw funds from time to time from the concerned indenters against part execution of contracts, etc.

g) Bid bonds on behalf of exporters

h) Export performance guarantees on behalf of exporters favouring the Customs Department under EPCG scheme.

Guidelines on conduct of Bank Guarantee business

Branches, as a general rule, should limit themselves to the provision of financial guarantees & exercise due caution with regards to performance guarantee business. The subtle difference between the two types of guarantees is that under a financial guarantee, a bank guarantees a customer financial worth, creditworthiness & his capacity to take up financial risks. In a performance guarantee, the banks guarantee obligations relate to the performance related obligations of the applicant (customer).

While issuing financial guarantees, it should be ensured that customers should be in a position to reimburse the Bank in case the Bank is required to make the payment under the guarantee. In case of performance guarantee, branches should exercise due caution & have sufficient experience with the customer to satisfy themselves that the customer has the necessary experience, capacity, expertise, & means to perform the obligations under the contract & any default is not likely to occur.

Branches should not issue guarantees for a period more than 18 months without prior reference to the controlling authority. Extant instructions stipulate an Administrative Clearance for issue of BGs for a period in excess of 18 months. However, in cases where requests are received for extension of the period of BGs as long as the fresh period of extension is within 18 months. No bank guarantee should normally have a maturity of more than 10 years. Bank guarantee beyond maturity of 10 years may be considered against 100% cash margin with prior approval of the controlling authority.

More than ordinary care is required to be executed while issuing guarantees on behalf of customers who enjoy credit facilities with other banks. Unsecured guarantees, where furnished by exception, should be for a short period & for relatively small amounts. All deferred payment guarantee should ordinarily be secured.

Appraisal of Bank Guarantee Limit

Proposals for guarantees shall be appraised with the same diligence as in the case of fund-base limits. Branches may obtain adequate cover by way of margin & security so as to prevent default on payments when guarantees are invoked. Whenever an application for the issue of bank guarantee is received, branches should examine & satisfy themselves about the following aspects:

a) The need of the bank guarantee & whether it is related to the applicants normal trade/business.

b) Whether the requirement is one time or on the regular basis

c) The nature of bank guarantee i.e., financial or performance

d) Applicants financial strength/ capacity to meet the liability/ obligation under the bank guarantee in case of invocation.

e) Past record of the applicant in respect of bank guarantees issued earlier; e.g., instances of invocation of bank guarantees, the reasons thereof, the customers response to the invocation, etc.

f) Present o/s on account of bank guarantees already issued

g) Margin

h) Collateral security offered

Format of Bank Guarantees

Bank guarantees should normally be issued on the format standardized by Indian Banks Association (IBA). When it is required to be issued on a format different from the IBA format, as may be demanded by some of the beneficiary Government departments, it should be ensured that the bank guarantee is

a) for a definite period,

b) for a definite objective enforceable on the happening of a definite event,

c) for a specific amount

d) in respect of bona fide trade/ commercial transactions,

e) contains the Banks standard limitation clause

f) not stipulating any onerous clause, &

g) not containing any clause for automatic renewal of the bank guarantee on its expiry

Specimen of the First Page of Bank Guarantee

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

STATE BANK OF INDIA

.Branch (Stamp)

Form No. .

.

.

.

Dear Sir,

Guarantee No.

Amount of Guarantee Rs.

Guarantee cover from 1.1.20*0 to 31.3.20*1

Last date for lodgement of claim 31.3.20*1

This Deed of guarantee executed by the State Bank Of India constituted under the State Bank of India Act, 1955 having its Central Office at Nariman Point, Mumbai & amongst other places, a branch at.(hereinafter referred to as the Bank) in favour of(hereinafter referred to as the Beneficiary) for an amount not exceeding Rs..(Rupees ..only) at the request of.(hereinafter referred to as the Contractor/(s)).

This guarantee is issued subject to the condition that the liability of the bank under this Guarantee is limited to a maximum of Rs. (Rupees..only) & the Guarantee shall remain in full force up to 31.3.20*1 (date of expiry) & cannot be invoked otherwise than by a written demand or claim under this Guarantee served on the Bank on or before the 31.3.20*1, last date of claim).

SUBJECT TO AS AFORESAID

(Main Guarantee matter may be typed hereafter)

CREDIT APPRAISAL PROCESS

Receipt of application from applicant

|

Receipt of documents

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

|

Pre-sanction visit by bank officers

|

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

|

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

|

Valuation reports of the properties to be obtained from empanelled valuer/engineers

|

Preparation of financial data

|

Proposal preparation

|

Assessment of proposal

|

Sanction/approval of proposal by appropriate sanctioning authority

|

Documentations, agreements, mortgages

|

Disbursement of loan

|

Post sanction activities such as receiving stock statements, review of accounts, renew of accounts, etc

(on regular basis)

CHAPTER-3

RESEARCH METHODOLOGY

INTRODUCTION TO CREDIT APPRAISAL:

Credit appraisal means an investigation/assessment done by the bank prior before providing any loans & advances/project finance & also checks the commercial, financial & technical viability of the project proposed its funding pattern & further checks the primary & collateral security cover available for recovery of such funds.

PROBLEM STATEMENT:

To study the Credit Appraisal System in SME sector, at State Bank of India (SBI), Ahmedabad.

OBJECTIVES

To study the Credit Risk Assessment Models. To observe the movements to reduce various risk parameters which are broadly categorized into financial risk, business risk, industrial risk & management risk. To check the commercial, financial & technical viability of the project proposed & its funding pattern. To check the primary & collateral security cover available for recovery of

such funds.

RESEARCH DESIGN - Analytical in nature

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

DATA COLLECTION Secondary Data

Books & magazines

Database at SBI

Library research

Websites

E-circulars of SBI

LIMITATION OF STUDY Due to the constraint limited study on the project has been done

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

EXPECTED CONTRIBUTION OF THE STUDY:

This study will help in understanding the credit appraisal system in banks & to reduce various risk parameters, which are broadly categorized into financial risk, business risk, industrial risk & management risk associated in providing any loans or advances or project finance.

CHAPTER-4

INTRODUCTION OF SME

SME

4.1 Concept:

The small-scale industries (SSI) produce about 8000 products, contribute 40% of the industrial output and offer the largest employment after agriculture. The sector, therefore, presents an opportunity to the nation to harness local competitive advantages for achieving global dominance.

4.2 From SSI to SME:

Defining the New Paradigm2.1 Government policy as well as credit policy has so far concentrated on manufacturing units in the small-scale sector. The lowering of trade barriers across the globe has increased the minimum viable scale of enterprises. The size of the unit and technology employed for firms to be globally competitive is now of a higher order. The definition of small-scale sector needs to be revisited and the policy should consider inclusion of services and trade sectors within its ambit. In keeping with global practice, there is also a need to broaden the current concept of the sector and include the medium enterprises in a composite sector of Small and Medium Enterprises (SMEs). A comprehensive legislation, which would enable the paradigm shift from small-scale industry to small and medium enterprises under consideration of Parliament. The Reserve Bank of India had meanwhile set up an Internal Group which has recommended: Current SSI/tiny industries definition may continue. Units with investment in plant and machinery in excess of SSI limit and up to Rs.10 crore may be treated as Medium Enterprises (ME). The definition may be reviewed after enactment of the Small and Medium Enterprises Development Bill.

4.3Definition of SMEs- At present, a small scale industrial unit is an undertaking in which investment in plant and machinery, does not exceed Rs.1 crore, except in respect of certain specified items under hosiery, hand tools, drugs and pharmaceuticals, stationery items and sports goods, where this investment limit has been enhanced to Rs 5 crore. Units with investment in plant and machinery in excess of SSI limit and up to Rs. 10 crore may be treated as Medium Enterprises (ME).

The Government of India has enacted the Micro, Small and Medium Enterprises Development (MSMED) Act 2006 which was notified on October 2, 2006. The definition of the small and medium enterprises as provided in the Act (Annex VII) will have immediate effect.

4.4 Eligibility criteria(i) These guidelines would be applicable to the following entities, which are viable or potentially viable:

a) All non-corporate SMEs irrespective of the level of dues to banks.

b) All corporate SMEs, which are enjoying banking facilities from a single bank, irrespective of the level of dues to the bank.

c) All corporate SMEs, which have funded and non-funded outstandingup toRs.10 crore under multiple/ consortium banking arrangement.

(ii) Accounts involving willful default, fraud and malfeasance will not be eligiblefor restructuring under these guidelines.

(iii) Accountsclassified by banks as Loss Assets willnot be eligible forrestructuring.

(iv)In respect of BIFR cases banks should ensure completion of allformalities in seeking approval from BIFR before implementing the package.

SME: At present, a small scale industrial unit is an industrial undertaking in which investment in plant and machinery, does not exceed Rs.1 crore except in respect of certain specified items under hosiery, hand tools, drugs and pharmaceuticals, stationery items and sports goods where this investment limit has been enhanced to Rs.5 crore. A comprehensive legislation which would enable the paradigm shift from small scale industry to small and medium enterprises is under consideration of Parliament. Pending enactment of the above legislation, current SSI/tiny industries definition may continue. Units with investment in plant and machinery in excess of SSI limit and up to Rs.10 crore may be treated as Medium Enterprises (ME). Only SSI financing will be included in Priority Sector.

All banks may fix self-targets for financing to SME sector so as to reflect a higher disbursement over the immediately preceding year, while the sub-targets for financing tiny units and smaller units to the extent of 40% and 20% respectively may continue. Banks may arrange to compile data on outstanding credit to SME sector as on March 31, 2005 as per new definition and also showing the break up separately for tiny, small and medium enterprises.

Banks may initiate necessary steps to rationalize the cost of loans to SME sector by adopting a transparent rating system with cost of credit being linked to the credit rating of enterprise.

SIDBI has developed a Credit Appraisal & Rating Tool (CART) as well as a Risk Assessment Model (RAM) and a comprehensive rating model for risk assessment of proposals for SMEs. The banks may consider to take advantage of these models as appropriate and reduce their transaction costs.

In order to increase the outreach of formal credit to the SME sector, all banks, including Regional Rural Banks may make concerted efforts to provide credit cover on an average to at least 5 new small/medium enterprises at each of their semi urban/urban branches per year.

A debt restructuring mechanism for nursing of sick units in SME sector and a One Time Settlement (OTS) Scheme for small scale NPA accounts in the books of the banks as on March 31, 2004 are being introduced.

4.5 CHALLENGES FACED BY SME:The challenges being faced by the small and medium sector may be briefly set out as follows-

a) Small and Medium Enterprises (SME), particularly the tiny segment of the small enterprises have inadequate access to finance due to lack of financial information and non-formal business practices. SMEs also lack access to private equity and venture capital and have a very limited access to secondary market instruments.

b) SMEs face fragmented markets in respect of their inputs as well as products and are vulnerable to market fluctuations.

c) SMEs lack easy access to inter-state and international markets.

d) The access of SMEs to technology and product innovations is also limited. There is lack of awareness of global best practices.

e) SMEs face considerable delays in the settlement of dues/payment of bills by the large scale buyers. With the deregulation of the financial sector, the ability of the banks to service the credit requirements of the SME sector depends on the underlying transaction costs, efficient recovery processes and available security. There is an immediate need for the banking sector to focus on credit and SMEs.

CHAPTER-5

CREDIT RISK ASSESSMENT

FOR A BANK, WHAT IS RISK?

Risk is inability or unwillingness of borrower-customer or counter-party to meet their repayment obligations/ honor their commitments, as per the stipulated terms.

LENDER TASK

Identify the risk factors, and

Mitigate the risk

HOW DOES RISK ARISE IN CREDIT?

In the business world, Risk arises out of

Deficiencies / lapses on the part of the management (Internal factor)

Uncertainties in the business environment (External factor)

Uncertainties in the industrial environment (External factor)

Weakness in the financial position (Internal factor)

To put in another way, success factors behind a business are: -

Managerial ability

Favorable business environment

Favorable industrial environment

Adequate financial strength

As such, these are the broad risk categories or risk factors built into our CRA models. CRA takes into account the above types of risks associated with the borrowal unit. The eventual CRA rating awarded to a unit (based on a score of 100) is a single-point risk indicator of an individual credit exposure, & is used to indentify, to measure & to monitor the credit risk of an individual proposal. At the corporate level, CRA is also used to track the quality of Banks credit portfolio.

CREDIT & RISK

Go hand in hand.

They are like twin brothers.

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

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

LENDING DESPITE RISKS:

So, risk should not deter a Banker from lending. A bankers task is to identify/ assess the risk factors/ parameters & manage / mitigate them on a continuous basis.

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

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

Importance of CREDIT RISK ASSESSMENT

Credit is a core activity of banks & an important source of their earnings, which go to pay interest to depositors, salaries to employees & dividend to shareholders

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

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

Moreover, with the implementation of Basle-II accord4, capital has to be allocated for loan assets depending on the risk perception/ rating of respective assets. It is, therefore, extremely important for every bank to have a clear assessment of risks of the loan assets it creates, to become Basle-II compliant.

That is why Credit Risk Assessment (CRA) system is an essential ingredient of the Credit Appraisal exercise.

INDIAN SCENARIO:

In Indian banks, there was no systematic method of Credit Risk Assessment till late 1980s/ early 1990s. Health Code System (1985) / IRAC norms (1993) are Asset (loan) classification systems, not CRA systems.

RBI came out with its guidelines on Risk Management Systems in Banks in 1999 & Guidance Note on Management of Credit in October, 2002.

SBI SCENARIO:

However, like in many other fields, in the field of Credit Risk Assessment too, our Bank played a proactive & pioneering role. We had our Credit Rating System (CRA) in 1988. Then, the CRA system was introduced in the Bank in 1996. The first CRA model was rolled out in 1996 to take care of exposures to the C & I (Manufacturing) segment. Thereafter, separate models for SSI & AGL segments were introduced in 1998, when the C&I (Mfg) CRA model was developed for Non Banking Finance Companies (NBFCs).

As of now, in SBI, CRA is the most important component of the Credit Appraisal exercise for all exposures > 25 lacs & a very important tool in decision-making (a Decision Support System) as well as in pricing. The review of the existing CRA Model for NBFCs is under process.

CREDIT RISK ASSESSMENT (CRA) MINIMUM SCORES / HURDLE RATES

1. The CRA models adopted by the Bank take into account all possible factors which go into appraising the risks associated with a loan. These have been categorized broadly into financial, business, industrial & management risks and are rated separately. To arrive at the overall risk rating, the factors duly weighted are aggregated & calibrated to arrive at a single point indicator of risk associated with the credit decision.

2. Financial parameters: The assessment of financial risk involves appraisal of the financial strength of the borrower based on performance & financial indicators. The overall financial risk is assessed in terms of static ratios, future prospects & risk mitigation (collateral security / financial standing).3. Industry parameters: The following characteristics of an industry which pose varying degrees of risk are built into Banks CRA model: Competition

Industry outlook

Regulatory risk

Contemporary issues like WTO etc.

4. Management parameters: The management of an enterprise / group is rated on the following parameters: Integrity (corporate governance) Track record

Managerial competence / commitment

Expertise

Structure & systems

Experience in the industry

Credibility : ability to meet sales projections

Credibility : ability to meet profit (PAT) projections

Payment record

Strategic initiatives

Length of relationship with the Bank

5. The risk parameters as mentioned above are individually scored to arrive at an aggregate score of 100 (subject to qualitative factors negative parameters). The overall score thus obtained (out of a max. of 100) is rated on a 8 point scale from SB1/SBTL1 to SB 8 /SBTL8.

SALIENT FEATURES OF CRA MODELS:

(a) Type of Models

S.

No.Exposure Level (FB + NFB Limits )Non Trading Sector

(C&I , SSI , AGL) Trading Sector

( Trade & Services)

(i)Over Rs. 5.00 croreRegular ModelRegular Model

(ii)Rs 0.25 crore to Rs. 5.00 croreSimplified ModelSimplified Model

(b) Type of Ratings

S. No. Model Type of Rating

(i) Regular Model Borrower Rating

Facility Rating

(ii) Simplified Model Borrower Rating

New Rating Scales Borrower Rating: 16 Rating Grades

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

S. No.

Borrower RatingRange of scoresRisk levelComfort Level

1SB194-100Virtually Zero riskVirtually Absolute safety

2SB290-93Lowest RiskHighest safety

3SB386-89Lower RiskHigher safety

4SB481-85Low RiskHigh safety

5SB576-80Moderate Risk with Adequate CushionAdequate safety

6SB670-75Moderate RiskModerate Safety

7SB764-69

8SB857-63Average riskAbove Safety Threshold

9SB950-56

10SB1045-49Acceptable Risk

(Risk Tolerance Threshold)Safety Threshold

11SB1140-44Borderline riskInadequate safety

12SB1235-39High RiskLow safety

13SB1330-34Higher riskLower safety

14SB1425-29Substantial riskLowest safety

15SB15

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