Ibsar summer project

A Project Report on

MSME CREDIT OPERATIONS & OVERVIEW OF FOREIGN EXCHANGE

Submitted to theMumbai University

In partial fulfillment of the requirements for the award of the Degree of

MASTERS of MANAGEMENT STUDIES( M.M.S.)

Submitted by:SUSHILKUMAR SHANKAR GUPTA

(Roll No.10)

Project Guide:

Prof. Amit Raut

IBSAR® Institute of Management Studies, Karjat

May-June 2011

DECLARATION

I hereby declare that the Project Report on “MSME Credit operations & Overview

of Foreign Exchange” submitted for the Master’s of Management Studies

(M.M.S.) Degree at Mumbai University’s IBSAR® Institute of Management

Studies, Karjat, is my original work and the dissertation has not formed the basis

for the award of any degree, associate ship, fellowship or any other similar titles.

Place: Karjat

Date:

Signature of the Student

2

Certificate

This is to certify that the Project Report entitled “MSME Credit operations &

Overview of Foreign Exchange” is the bonafide Project work carried out by Mr.

SUSHILKUMAR SHANKAR GUPTA student of MMS, at IBSAR® Institute of

Management Studies, Karjat during the year 2010 -2012, in partial fulfillment of

the requirements for the award of the Degree of Master of Management Studies

and that the dissertation has not formed the basis for the award previously of any

degree, diploma, associateship, fellowship or any other similar title.

(Dr. Jayanti Gokhale

Dy. Director

IBSAR® Institute of Management Studies, Karjat)

(Dr. M.L.Monga,

Director,

IBSAR® Institute of Management Studies, Karjat)

Place: Karjat

Date:

3

KHAND BAZAR – MUMBAI Branch

109, Kazi Sayed Street, Khand Bazar, Mumbai, Maharashtra – 400003Tel No: 022-23422390

Ref. No.: KBZ/506/2011 Date: 30/06/2011

TO WHOMSOEVER IT MAY CONCERN

This is to state that Mr. Sushilkumar Shankar Gupta of IBSAR Institute of

Management Studies, Karjat has undergone training at our Khand Bazar Branch,

Union Bank of India (UBI) from May 2, 2011 to June 30, 2011 on MSME Credit

Operations & Overview of Foreign Exchange.

The trainee has a sound knowledge, good aptitude to learn & has successfully

completed the 2 months internship at our Khand Bazar Branch, UBI.

Mr. S.K. Jain

(Asst. Gen. Manager

Khand Bazar Branch, UBI)

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Certificate from Summer Project Guides

This is to certify that Mr. Sushilkumar Shankar Gupta, a student of the Masters of

Management Studies, has worked under our guidance and supervision. This Summer

Project Report has the requisite standard and to the best of our knowledge no part of it has

been reproduced from any other summer project, monograph, report or book.

Faculty Guide - Organizational Guide - Mr. Amarnath MishraDesignation - Designation - Sr. Manager (Loans & Advances)IBSAR Institute of Management Studies, Organization – UBIKarjat Address – Khand BazarDate - Date – 30.06.2011

Organizational Guide – Mr. Sanjeev Kulkarni Designation – Manager (Foreign Exchange)Organization - UBIAddress – Khand BazarDate-30.06.2011

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ACKNOWLEDGEMENTS

I would like to express my sincere thanks to Prof. Amit Raut, IBSAR® Institute of

Management Studies, Karjat for guiding me during the course of my internship at

UBI. Without her help it would have been impossible for me to complete the project.

I would like to extend my sincere thanks to the Asst. Gen. Manager of UBI, Khand

Bazar branch, Mr. S.K.Jain for allowing me to have a learning experience in

foreign exchange and Advances department of Khand Bazar Branch of UBI. Also I

am thankful to him, for all the co-operation and support, he provided to me during

the internship. I would like to thank Mr. Amarnath Mishra and Mr. Gautam

Sharma for providing me with practical knowledge and a great learning experience

at Union Bank, Khand bazaar branch, in the loans & advances department. I

would also like to thank Mr. Sanjeev Kulkarni, for giving me learning opportunity

and all needed assistance in understanding the functioning of foreign exchange

department at UBI. Also, I am thankful to all the staff and non-staff members of UBI

Khand Bazar Branch, for their helpful and kind approach.

I would be failing in my duty if I do not acknowledge with a deep sense of gratitude

the sacrifices made by my parents and thus have helped me in completing the

project work successfully.

Place: Karjat

Date:

Signature of the student.

6

TABLE OF CONTENTS

Chapter No TitlePage No

A   LIST OF TABLES 9

B   LIST OF FIGURES 9

C   LIST OF ABBREVIATIONS 10

D   EXECUTIVE SUMMARY 11

    Objective of the Study 12

E RESEARCH METHODOLOGY 12

1   INTRODUCTION 13

  1.1 Indian Banking Industry a brief overview 13

  1.2 Introduction to MSME 14

  1.3 UBI- Brief Introduction 17

2 TYPES OF CREDIT 19

  2.1 Fund Based 19

  2.2 Non-Fund Based 20

3 CREDIT APPRAISAL PROCESS 22

3.1 Credit Appraisal 22

3.2 Credit Appraisal process 22

4METHODS FOR DETERMINING THE CREDIT LIMIT 25

4.1 Turnover Method 25

4.2Maximum Permissible Bank Finance Method (MPBF) 26

5TYPES OF SECURITIES PROVIDED AGAINST ADVANCES 28

6 CREDIT RATING 30

6.1 Rate of Interest 33

6.2 CIBIL 34

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TABLE OF CONTENTS (Contd)

Chapter No TitlePage No

7 CASE STUDY: M/S ABC CHEMICALS 35

7.1 Preparation of the Proposal 37

7.2 Documentation Process 53

7.3 Disbursement of credit 54

7.4 Follow-Up/Monitoring 54

8 INTRODUCTION TO FOREIGN EXCHANGE 55

9ROLE OF BANKS IN FOREIGN EXCHANGE TRANSACTIONS 56

10 EXPORT FINANCE 57

10.1 Pre-Shipment Finance 57

10.2 Post-Shipment Finance 58

10.3FDBP (Foreign Document Bill Purchased) & PC (Packing Credit) 59

10.4 ECGC 60

11 IMPORT FINANCE 63

11.1 Letter of Credit 63

11.2 L/C Mechanism 65

11.3Uniform Customs and Practices for Documentary Credit (UCPDC) 66

11.4 Types of Documentary Credit 67

11.5 Risks associated with Opening Import L/C 68

12 REMITTANCES 70

12.1 Inward remittances 70

12.2 Outward remittances 70

12.3 SWIFT 70

13 CONCLUSION 72

14 BIBLIOGRAPHY 73

A. LIST OF TABLES 8

Table 1 Classification of MSME for Manufacturing & Service Sector 15Table 2 Credit Rating 33Table 3 Break up of Balance Sheet 37-38

B. LIST OF FIGURES

Figure1 Types of credit 19

Figure 2 Credit Appraisal Process 22

Figure 3 Types of security provided 28Figure 4 Credit Rating Modules 30Figure 5 LC Mechanism 65

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C LIST OF ABBREVIATIONS

CAGR Compounded Annual Growth RateMSME Micro, Small & Medium EnterpriseCRISIL Credit Rating Information Services of India LimitedNPA Non Performance AssetLC Letter of CreditLIBOR London Inter-Bank Offered RateFBF Flexible Bank FinanceCMA Credit Monitoring Analysis DataFDR Fixed Deposit ReceiptCIBIL Credit Information Bureau India LimitedBR Based RateBPLR Benchmark Prime Lending RateQPR Quarterly Performance ReportECGC Export Credit Guarantee Corporation of India Ltd CC Cash creditCID Credit Information DepartmentDP/DA Document Purchase / Document AcceptanceRO Regional officeLSR Legal Search ReportCPA Credit Process AuditDP Demand Promissory NoteSOD Secured OverdraftFEMA Foreign Exchange Management ActUCPDC Uniform customs & practices of documentary creditICC International Chamber of CommerceDGFT Director General of Foreign TradeFDBP Foreign Document Bill PurchasePC Packing CreditSWIFT Society World Wide for Inter-bank Financial TelecommunicationAD Authorized DealerICRA Investment Information and Credit Rating Agency of India LimitedMPBF Maximum Permissible Bank finance UBI Union Bank Of IndiaRBI Reserve Bank of IndiaFOREX Foreign ExchangeDOP Delegation Of Power

D. EXECUTIVE SUMMARY

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The Indian banking sector has been an integral part of the overall economy growing

with and supporting the growth of other sectors. The sector has withstood the

global financial turmoil with little disruption and continued to grow at a healthy pace.

The RBI has been actively encouraging financial inclusion.  Only 40% of the India’s

total population has been connected to banking system. Hence, there is vast scope

for banking industry to grow, and explore the unexplored.

The banking system in India primarily consists of state-owned banks (PSB’s),

private banks & foreign banks. Union bank of India also known as UBI is one

of India's largest state-owned banks (the government owns 55.43% of its share

capital).

This report does an in depth study and analysis of the various credit facilities for

working capital requirements of MSME facilitated by UBI. This report also gives

brief insights about the operations of foreign exchange at UBI which would further

help in understanding the credit provided by UBI.

There two major topics covered in this project viz. Credit appraisal of MSME

working capital credit and a brief overview of foreign exchange operations at Union

bank, Khand Bazar branch. This branch is located at Masjid Bunder, Mumbai,

which is famous market of whole sellers, stockiest and traders of various goods. At

Khand Bazar branch, most of the customers are business customers, more

specifically chemical traders. This report contains a case study of a chemical

trading firm, seeking working capital credit for foreign trade. Also, report explains

the various factors to be considered while appraising the credit to a business

customer, like credit rating, determining credit limit, types of credits, etc.

The another section i.e. an overview of foreign exchange, provides an idea, as how

a foreign trade takes place between an importer and exporter, and roles of banks in

it. It throws a light on the three major aspects of foreign exchange functions viz.

Export finance, import finance and remittances (inward & outward).

OBJECTIVES

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1. Learn about the various Credit facilities provided by Union Bank.

2. Analyse Balance Sheet of the clients, calculation of credit rating and

verify their creditworthiness.

3. Gain knowledge about the methods used for limit calculation & the

various ratios used in the banks.

4. Learn about the basic operations of foreign exchange department.

E.RESEARCH METHODOLOGY

Primary data:

This data was collected purely on the basis of interaction with the branch

manager, and associates at Union bank of India.

Secondary data:

The sources of secondary data were a combination of information from the

Internet, periodicals and newspapers.

1.0 INTRODUCTION

1.1 Indian Banking Industry a brief overview

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The Indian banking sector has been an integral part of the overall economy

growing with and supporting the growth of other sectors. The sector has

withstood the global financial turmoil with little disruption and continued to

grow at a healthy pace.

The RBI has been actively encouraging financial inclusion. There are around

72,315 villages, with a population of over 2000 (as per the 2001 census), that

are yet unbanked and which need to be brought under the banking net. Only

40% of the India’s total population has been connected to banking system.

Hence, there is vast scope for banking industry to grow.

The banking sector business has grown at a CAGR of around 23% between

FY05 to FY10. On account of lower capital expenditure by the industry,

coupled with the apprehension of the banking sector to issue credit the sector

witnessed a slightly modest growth in FY10 y-o-y of around 16.7%. However,

the same has witnessed a pickup in the current financial year, with a growth of

around 20% y-o-y as of October 2010. With the overall economy expected to

grow at around 8.8% for FY11, and services and industry expected to grow at

a faster pace of around 10.3% and 9.5% respectively, bank credit is expected

to continue at a healthy pace.

New trends in Banking

Consolidation the way forward for the banking sectors; would help banks

finance larger transactions. Eg: ICICI & The Sangli Bank, ICICI & bank of

Rajasthan, etc.

Mobile technology to drive the next leg of the banking sector growth; would

also support financial inclusion.

Core banking to solution to speed up the transactions and customer

orientation.

Investments in commercial papers to rise given the shift to the base rate

system.

1.2 Introduction to MSME

Worldwide, the micro small and medium enterprises (MSMEs) have been

accepted as the engine of economic growth and for promoting equitable

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development. The major advantage of the sector is its employment potential

at low capital cost. The labour intensity of the MSME sector is much higher

than that of the large enterprises.  In India, the MSMEs play a pivotal role in

the overall industrial economy of the country. In recent years the MSME

sector has consistently registered higher growth rate compared to the overall

industrial sector. It is estimated that in terms of value, MSME sector accounts

for about 45% of the manufacturing output and around 40% of the total export

of the country.

As per MSMED Act 2006 the MSME segment has broadly been classified into

Manufacturing Enterprises & Service Enterprises. 

i) A Manufacturing Sector Enterprise is one, which is engaged in the

manufacturing or production, processing or preservation of goods.

Investment in plant & machinery is the criterion for classifying a

manufacturing enterprise into Micro, Small and Medium Manufacturing

Sector Enterprise. 

ii) A Service Sector Enterprise is one, which is engaged in providing or

rendering of services. Investment in equipments is the criterion for

classifying a service enterprise into Micro, Small and Medium Service

Sector Enterprise.

The following table reflects the investment ceilings for classifying Micro, Small

and Medium sector enterprises: 

Micro and small enterprises are to be treated as priority sectors as per the

rules of Reserve bank of India. It means 18% of the net bank credit (NBC) of

the bank should be advanced to the micro and small enterprises i.e. priority

sector. Investments made by the banks in special bonds issued by the

specified institutions could be reckoned as part of priority sector advances.

These institutions are National Housing Corporation, NABARD, SIDBI, etc.

ClassificationManufacturing Sector

(Investment in P & M)

Service Sector

(Investment in

Equipments)

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Micro

Enterprise Upto Rs 25.00 Lacs Upto Rs 10.00 Lacs

Small

EnterpriseMore than Rs 25.00 Lacs

upto Rs 5.00 Crores.

More than Rs 10.00 Lacs

upto Rs 2.00 Crores

Medium

Enterprise

More than Rs. 5.00 crores

upto Rs. 10.00 crores

More than Rs. 2.00 crores

upto Rs. 5.00 crores

Table 1: Classification of MSME for Manufacturing & Services

Industry

Following activities are also falling under Service Enterprises:

Consultancy Services including Management Services

Composite Broker Services in Risk and Insurance Management

Third Party Administration (TPA) Services for Medical Insurance Claims of

Policy Holders

Seed Grading Services

Training-cum-Incubator Center

Educational Institutions

Training Institutes

Retail Trade

Practice of Law i.e. legal services

Trading in medical instruments (brand new)

Placement and Management Consultancy Services

Advertising agency and Training centers

Benefits of MSME Registration-

MSME Registration is pre-requisite for several schemes of Government of

India. MSME Registration provides following benefits to the company-

Credit Linked capital subsidy scheme for Technology Upgradation -

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Priority Sector

The scheme was launched at facilitating technology upgradation of micro

and small enterprises by providing 15% capital subsidy (12% prior to

2005) on institutional finance availed by them for induction of well

established and improved technology in approved sub-sector/products.

The admissible capital subsidy under the revised scheme is calculated

with reference to purchase price of Plant & Machinery. Maximum limit of

eligible loan for calculation of subsidy under the revised scheme is also

been raised from Rs. 40 lakh to Rs. 100 lakh.

Credit Guarantee scheme-

The credit Guarantee Fund Scheme for Micro & Small Enterprises

(CGMSE) was launched by the Government of India to make available

collateral-free credit to the micro & small enterprise sector. Both the

existing and the new enterprises are eligible to be covered under the

scheme. The collateral free loan can be availed by micro & small

enterprises.

Performance and Credit Rating scheme for MSMEs-

Government of India provides subsidy for the rating of micro & small

enterprises on the basis of their MSME Registration. The subsidy is up to

75% of the total rating fees. MSMEs can avail the rating from Rating

Agency CRISIL Ltd.

1.3 UBI- Brief Introduction

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Union Bank of India was established on Nov 11, 1919 and is head quartered

in Mumbai. The registered Office of the Bank was inaugurated by Mahatma

Gandhi, father of the Nation in the year 1921.

After Independence, UBI accelerated its growth and by the time the

government nationalized it, along with 13 other banks in 1969, it had grown to

240 branches in 28 states. Shortly after nationalization, Belgaum Bank, a

private sector bank merged in UBI. Then in 1985 UBI merged in Miraj State

Bank. In the year 1999, UBI acquired Sikkim Bank on the request of Reserve

Bank of India.

UBI began its international expansion in 2007 with the opening of

representative offices in Abu Dhabi, United Arab Emirates, and Shanghai,

Peoples Republic of China. The next year, UBI established a branch in Hong

Kong, its first branch outside India. In 2009, UBI opened a representative

office in Sydney, Australia.

VISION: To become the Bank of first choice in our chosen area by building

beneficial & lasting relationship with customers through the process

of continuous improvement.

MISSION: Corporate mission to gain market recognition in chosen area by

building effective strategies.

Bank has a network of more than 3100 service outlets which includes

specialized branches for MSME (SME SARALS), corporate credit, Union Loan

points for Retail Products etc. Union Bank is the first large bank to achieve

100% CBS roll out.

Through its large network of authorized branches, the bank caters to the

foreign exchange needs of its clientele engaged in export and import trade

and the Treasury provides rates for conversion of all major world currencies

like U S Dollar, Sterling Pounds, Euro, Swiss Francs, Japanese Yen and other

currencies. The services to the customers of the Bank include hedging of

foreign currency risks by providing forward covers and various derivative

products.

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Union bank has been performing well since its inception, as per its financials.

The bank showed a Y-o-Y growth in net profits of 0.34%, 20.15% & 24.51%

for the FY-2011, FY-2010 & FY-2009 respectively. The actual net profit stood

at Rs.20.82 billion, Rs.20.75 billion & Rs.17.27 billion for the FY-2011, FY-

2010 & FY-2009 respectively.

The net NPA has been consistently increasing for the bank from 0.34% in FY-

2009 to 0.84% in FY-2010 to 1.19% in FY-2011. Although, the net NPA for

FY-2011 is quite acceptable, still bank needs to take certain measures to

bring this indicator down in the subsequent years.

The bank had a capital adequacy ratio of 12.95% as on March 31 as against

12.51% previous year & deposits as on March 31, 2011 were at Rs 2.02

trillion, more than the Rs 1.70 trillion a year earlier.

The major competitors of Union Bank of India:

2.0 TYPES OF CREDIT

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To meet the working capital requirements of the firm, banks provide two types

of credit facilities.

Figure 1: types of Credit

Fund based limit also includes term loan which is required by the

borrower/company for meeting long-term requirements.

2.1 Fund Based Credit

Fund Based credit is a facility in which the company/borrower gets funds from

banks to meet its business requirements.

2.1.1 Cash Credit

Cash credit is short-term working capital provided by the bank to the borrower,

to carry out its day-to-day functioning of his business activities. This credit

facility is sanctioned by the bank for 1 year which needs to be renewed after

that every year. This facility is provided by the bank against hypothecation of

stock and book debts by the borrower.

It runs like a current account except that the money that can be withdrawn

from this account will depend on the drawing power sanctioned by the bank.

This calculation of drawing capacity or power of the borrower will be explained

in the subsequent section.

2.1.2 Overdraft

The word overdraft means the act of overdrawing from a bank account. An

overdraft occurs when withdrawals from a bank account exceeds the available

balance. In this situation a client is said to be "overdrawn".

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If there is a prior agreement with the bank for an overdraft protection plan, and

the amount overdrawn is within this authorized overdraft limit, then interest is

normally charged at the agreed rate. OD account holder is allowed to exceed

10% of the total OD limit sanctioned provided it is approved by the competent

authority of the bank, for the period not more than 3 months. If the balance

exceeds the agreed terms, then higher interest rates will be applicable.

Eg – SOD (secured over-draft), TOD (temporary over-draft), clean overdrafts.

Clean overdrafts are granted against the perceived “worth” of an individual.

Difference between Cash credit & Overdraft

The difference is very subtle and relates to the operation of the account. In the

case of Cash Credit, a proper limit is sanctioned which normally is a certain

percentage of the value of the inventories/book-debts hypothecated by the

account holder with the Bank. Overdraft, on the other hand, is allowed against

a host of other securities including financial instruments like shares, units of

mutual funds, surrender value of LIC policy and debentures, FD etc.

2.1.3 Export Credit

Export Credit consists of -

a) Pre-shipment Credit (Packing Credit)

b) Post-Shipment Credit

These are available to the exporters, for financing purchase, processing,

manufacturing or packing of goods prior to shipment & after shipment of

goods to the importer.

2.2 Non-fund Based Credit

Non-fund based credit is a facility given by the banks where actual bank funds

are not involved. Generally, banks stand as a guarantor instead of giving

money as in the case of fund -based credit to the borrower.

2.2.1 Letter Of Credit

A letter of credit (L/C) can be defined as an arrangement where in a bank

guarantees, on behalf of its importer, to make payment to the exporter upon

presentation of documents specified in the credit. In other words, it is an

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undertaking by a bank to pay or accept bills provided the beneficiary of the

credit fulfils the terms and conditions set forth in the L/C document.

2.2.2 Bank Guarantee

A guarantee is provided by a lending institution ensuring that the liabilities of a

company/institution would be met. In other words, if the debtor fails to settle a

debt, the bank will cover it.

2.2.3 Buyer’s Credit

Exporter prefers to sell merchandise on sight terms or a maximum usance

period of 90/180 days from date of shipment. However, importers prefer to buy

on a usance terms and at times, beyond 90/180 days depending on the cash

flow position. This cash flow mismatch need can be taken care by the banks

through an import buyers credit offering. The local bank through their offshore

offices arranges foreign currency financing to pay off the exporter on due date

of the transaction. Buyer’s credit is the credit availed by an Importer (Buyer)

from overseas Lenders i.e. Banks and Financial Institutions for payment of his

Imports on due date. The overseas Banks usually lend the Importer (Buyer)

based on the letter of Credit (a Bank Guarantee) issued by the Importers

(Buyer’s) Bank. In fact the Importers Bank brokers between the Importer and

the overseas lender for arranging buyers credit by issuing its Letter of Comfort

for a fee. Buyer’s credit helps local importers access to cheaper foreign funds

close to LIBOR rates as against local sources of funding which are costly

compared to LIBOR rates. Maximum allowed rate of interest on buyer’s credit

is (LIBOR + 2) %, as per RBI guidelines.

3.0 CREDIT APPRAISAL PROCESS

3.1 Credit Appraisal

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Before going to credit appraisal process, first let us see what credit appraisal

is. Credit appraisal is the step which decides if the applicant can avail the

credit or not. Credit Appraisal is the process by which a lender appraises the

creditworthiness of the prospective borrower. It is a very important step in

determining the eligibility of a loan borrower for a loan. Every potential

borrower has to go through the various stages of a credit appraisal process of

the bank, which might include an interview with the bank officials.

However, just like every bank charges different rates for different loans from

different customers based on the credit rating mechanism, in the same way,

each bank has its own set criteria that one must satisfy to qualify as a certified

borrower of money/assets from the bank. All banks have their own rules to

decide the credit worthiness of their borrowers.

Credit appraisal process refers to the steps that the loan application goes

through in order to get it converted into loan approval letter. Following is the

process of the credit appraisal that contains six basic steps, starting from loan

application till disbursement of the credit.

3.2 Credit Appraisal Process

Figure 2: Credit Appraisal Process

Step 1. Application

In this first step for credit appraisal or extension process, an applicant applies

for loan as per his needs and requirements. He is asked to submit various 22

necessary documents like: Address proof, identity proof, balance sheet of the

firm, personal balance sheet of the individual proprietor or partners or

directors as the case may be, Income tax return, CMA data etc. Depending

upon the information gathered from the party, by all verbal and non verbal

communication, credit appraisal officer fills the client information form along

with his own comments.

Step 2. Analysis

This is very crucial step in the entire credit appraisal process. In this step, the credit

appraisal officer scrutinizes and critically evaluates the documents furnished by the

party.

Step 3. Processing

After the critical evaluation of the financial statements and other documents,

credit appraisal office calculates important ratios like current ratio, debt-equity

ratio (with and without quasi capital), etc and prepares a proper proposal for

further sanctioning by higher authority like AGM of a branch.

The details of processing will be explained in detail in upcoming chapters of

the project.

Step 4. Sanctioning

The bank keeps the following things in mind while discussing/sanctioning the

request namely: The kind of person being dealt with, the business, the

industry and economic conditions in general. A complete analysis of the

strengths and weaknesses of an advance as a whole should be made. The

Bank should not commit itself without adequately examining all the aspects of

the advance including banking and legal points of view. The Bank should

make certain that at each stage of discussion with the borrower all the facts

are correctly put. As far as possible dealings should be straightforward leaving

little room or no room for misinterpretation, whether the advance is granted or

rejected.

Step 5. Documentation

Once the loan is sanctioned by the higher authority then next step of

documentation starts. In this step various documents have to be prepared by

the branch Viz. agreement, terms and conditions, necessary legal

documents, proposal duly signed and accepted by the party, documents

pertaining to mortgage or hypothecation of the property documents, etc.

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Step 6. Disbursement

Now, the last step in credit appraisal is disbursement. After completing all the

documentation formality the bank remits the funds to the client’s account or

issues the pay order as per the request made by the client.

4.0 METHODS FOR DETERMINING THE CREDIT LIMIT

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A unit needs working capital funds mainly to carry its day-to-day operations.

Inadequate levels of Working Capital may result in under-utilization of capacity

and serious financial difficulties. Similarly, excessive levels may lead to

unproductive use of credit and unnecessary interest burden on the unit. With

the withdrawal of the mandatory requirement on the MPBF method by the

Tandon Committee in 1997, RBI has given freedom to the Banks to assess

the Working capital needs of their Borrower, however under certain prudential

guidelines and norms.

4.1 Turnover Method

Under this method, the working capital limit shall be computed at 20% of the

projected sales turnover accepted by the bank. In the case of MSME borrower

seeking fund based working capital up to Rs. 500.00 lacs, the limits shall be

assessed on the basis of turnover method.

The Turnover method shall be applied for sanction of fund based working

capital limit to the non-MSME borrowers requiring working capital facility upto

Rs. 100.00 Lacs from the banking system. This system shall be made

applicable to the traders, merchants, exporters who are not having a

predetermined manufacturing/ trading cycle. Under this method, branches

shall ensure maintenance of a minimum margin on the projected annual sales

turnover. In other words, 25% of the estimated sales turnover value shall be

considered as working capital limit, of which, at least 20% shall be provided by

the bank and the balance 5% shall be by way of promoter’s contribution

towards margin money. However, if the available net working capital is more,

the same shall be reckoned for assessing the extent to which the bank will

finance the borrower and the lower limit would be considered.

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Calculation of credit limit under turnover method

Particulars Amount

A) Net Sales XXX

B) 25% of Net Sales XXX

C) 5% of Net Sales XXX

D) Net Working Capital

(CA-CL)XXX

E) Net Eligibility

(B – Higher of C and D)XXX

4.2 Maximum Permissible Bank Finance Method (MPBF)

In 1974, Reserve bank of India appointed a study group with Shr P. L. Tandon, then chairman Punjab National bank as the chairman for “framing Guidelines for the follow up of the bank credit”. A “working Group” to review the system in April 1979 under the chairmanship of Mr. K. B. Chore Chief officer DBCOD, Reserve Bank of India. RBI had appointed Tandon committee and Chore committee, which recommended that businesses should try to improve their liquidity position and firstly they should try to improve their current ratio to the level of 1.33:1 and thereafter should try to achieve a current ratio of 2:1The desired current ratio suggested by Tandon and Chore committee was never attainable by business, practically. Now the desired current ratio for businesses is 1.80:1.

Second method i.e. 0.75 CA-CL is generally used all over for determining the

Maximum Permissible Bank Finance (MPBF)

Instead of using the MPBF method to determine the eligibility of the borrower,

Union Bank of India uses Flexible Banking Finance (FBF) method.

26

FBF method is an extension of MPBF method, with customer friendly

approach in as much as the scope of the current assets is made broad based

and for evaluating projected liquidity, acceptable level of current ratio is taken

at 1.17:1 against benchmark level of 1.33:1.

FBF method is applicable for account with credit limit of above Rs. 1.00 crore

for other advances and above Rs. 5.00 crore for MSME advances.

Under the FBF system, a uniform classification for current assets and current

liabilities shall be adopted on the terms given in CMA data format.

The assessment of credit requirement of a party shall be made based on the

projected study of the borrower’s business operations via-a-via the

production/processing cycle of the industry.

The projected level of inventory and receivables shall be examined in relation

to the past trend, market developments and industry trend.

Calculation of eligibility under FBF method

Particulars Amount

A. Total current assets XXX

B. Current Liabilities Excluding Bank Borrowings XXX

C. Net Working Capital Gap (A-B) XXX

D. Net Working Capital (CA-CL) XXX

E. Flexible Bank Finance (C-D) XXX

5.0 TYPES OF SECURITIES PROVIDED AGAINST ADVANCES

After the bank decides on granting an advance to a borrower, whether in the

form of a Cash Credit, or Overdraft, they keep in mind against what security

the funds will be granted. This is very important aspect in granting or refusing

27

any advance, as for the bank, that security will be the only means to recover

any dues from the borrower at the time of default.

At time of over-draft facility of secured nature, the bank provides credit to the

borrower against fixed deposit receipt (FDR). A right to lien for FDR is created

in a secured over draft facility. A lien is a right to retain property till the debt is

repaid. It is a legal claim on the securities which come in to the hands of the

bank in the ordinary course of business.

In the case of a cash credit facility given to the company to meet its working

capital requirements, the firm needs to provide the following:

Figure 3 Types of Security

As the name suggests, the primary security is the basis on which the cash

credit is being given to the firm. The primary security is generally the

hypothecation of stocks & book debts. Hypothecation is the pledge provided

by the borrower in the form of movable property just like stocks & book

debts. In hypothecation, possession of the movable property remains in the

hands of the borrower. The calculation of the drawing limit for the cash

credit is based on the amount of hypothecation of stocks & book debts

(sundry debtors). Banks calculate the drawing limit every month based on

the stock & book debts statements submitted by the firm. In other words, the

margin to be provided is also based on stock & book debts. In general, the

margin required is –

25% of stocks

28

40% of book debts

The margin may be reduced at the discretion of the bank depending upon

the financial stability of the borrower.

The firm needs to submit the stock & book debts statements before the 15 th

of next month. Ex: for month of June, the stock & book debts statements

should be submitted before 15th of July. Also, the stock & book debts should

be insured by 110% of the total value of the security.

Collateral security or secondary security is the additional protection provided

by the borrower in case, borrower fails to pay back the amount & interest

under the term of the cash credit facility. The collateral security can be in the

form of mortgaged house property (immovable property), pledging of shares,

lien of FDR, assignment of LIC policy etc. In banking terms, the above

mentioned examples are termed as charge creation. In case of house

property (immovable property) given as collateral, it needs to be valued by a

valuation-firm which is authorized by the bank. The valuation-firm will

provide the market value & distress market value of the property. The

valuation of the house property is done in every 3 years which is as per RBI

guidelines.

6.0 CREDIT RATING

Union bank of India, for credit appraisal, has its own credit rating models, in

order to determine the creditworthiness of the applicant. Once the applicant

29

has applied for the loan, and has submitted all the above mentioned

necessary documents, processing officer undertakes the deep study of the

financial statements, bio data of the company and owner or partners or

directors as the case may be, and other essential documents which are

submitted by the applicant. After studying the documents, he has to do credit

rating as per appropriate UBI model.

UBI has four credit rating models depending upon the total credit requirement

of the applicant i.e. both fund based and non fund based. Those are as under:

Figure 4 Credit Rating Models

As mentioned in the above diagram, considering the credit need of the

applicant, an appropriate credit rating model is used by the processing

officer and applicant’s total score is calculated.

In all the above mentioned four models, credit rating is done on four

parameters, what differs in these models is the weight given to each

parameter. Total score of each model is 100. Four broad parameters are as

under:

I. Rating of the borrower

Rating of the borrower is the first and foremost segment in the credit

rating model of UBI. Under rating of the borrower, UBI has three sub-

30

2 Lacs to 10 Lacs 10 Lacs to 100 Lacs

100 Lacs to 1000 Lacs1000 lacs and above

Credit Rating Model1

Credit Rating Model2

segments viz. financial risk, management risk and Market or

industry risk.

a) Financial aspects

In financial risk analysis, assessment of Financial Standing should

be on the basis of "Soundness" of the company. The general

parameters, which are pertinent from the banking point of view, are

quantum of owned funds, policy followed by the company in retaining

part/full of the profits, debt equity ratio, funded debt equity ratio

(TOL/TNW) and more importantly current ratio. Capacity of the

company for raising resources (including margin contribution) for

expansion/modernization is also to be counted, while judging this

aspect.

In case of fund based and non fund based limits are more than

Rs.1000 lacs, additional sub-parameter of ‘Cash Flow Related

Parameters’ is included under ‘rating of the borrower.

b) Management risk

On the other hand in management risk segment, bank examines the

Company's management set up, the composition of the Board and the

Chief Executive in charge of day-to-day operations. Ascertain whether

the company is well versed in all functional areas of purchase,

production, marketing, finance and personnel administration. Take an

overall view on the "Management" of the unit, its reputation and

allocate the marks accordingly.

c) Market / industry risk

In market risk the processing officer, studies the market conditions or

industry prospects in order to check the external risk factors. Under

this head, officer, checks details of following:

Demand and supply situation

Geographical spread of the business and customers

Competitive situation, number of competitors, nature of market,

etc.

Availability of the raw materials and their costs

Location issues like, availability of infrastructure facilities, proximity

to the market place

31

Technology: not to be changed in immediate future, availability of

R&D facilities, etc.

Manufacturing capacity utilization: more than 90% is good, 75%-

90% is satisfactory, 50%-75% is average, and below 50% is

considered as below average.

II. Rating of the facility

A company can start functioning only after completing statutory

obligations laid down by the governing authority. Such statutory

obligation involves obtaining licenses, permits for ensuring smooth

operations. Preparation and submission of financial statements, stock

statements in the standard format within the given time schedule.

Presently, the entire ‘facility rating’ is treated as ‘NOT APPLICABLE’ for

new borrowers.

III. Risk mitigators

Risk mitigators refer to the availability of the collateral security and the

quality of the collateral. Availability of the guarantor, proprietor or

partners or directors as the case may be, is to be taken into

consideration along with the personal means of the guarantor.

IV. Business aspects

The length of the relationship with bank enables the lender to assess the

previous performance of the account holder. A good track record acts in

the favour of the borrower; however underperformance makes the lender

more vigilant. The income value to the bank is also considered.

Based on the points obtained by the borrower under the four different

heads mentioned above, the total score is calculated out of 100.

Depending on the percentage of total score obtained, the borrower is

classified into 9 different categories. Also, depending on the rating of the

borrower, bank decides the lending rate of interest

Credit Quality Rating Numeric

Lowest Risk CR-1

Minimal Risk CR-2

Moderate Risk CR-3

Satisfactory Risk CR-432

Acceptable Risk CR-5

Watch List CR-6

Risk Prone CR-7

High Risk CR-8

Sub-standard CR-9

Doubtful CR-10

Loss CR-11

Table 2 Credit Rating

Minimum Credit Rating required for considering a new proposal is CR-5 and

for takeover proposal is CR-4 at present. The cut-off point is changed from

time to time depending on bank’s requirements by the management.

In addition to the UBI credit rating model, if the credit limit given by the bank

is more than 1 crore i.e. for all credit facility greater than rating model-III of

UBI an additional rating needs to be done. The additional rating model could

be of CRISIL, ICRA, Moody etc.

6.1 Rate of Interest

Interest on any type of advance is applied on daily debit balances standing at

the close of the day. The rate of interest applicable to the borrower is based

on the credit rating obtained. Banks may charge the borrowers at their own

discretion. At UBI, the rate applicable is –

Base Rate (BR) + Additional rate according to credit rating of the borrower

Thus, the minimum rate of interest at UBI is the base rate. The current base

rate (BR) is 10%. Also, the rate of interest may vary according to the collateral

(greater than 75%) provided by the borrower & industry in which the borrower

operates. The rate of interest may change if the business of the borrower

belongs to the priority sector.

6.2 CIBIL

Credit Information Bureau (India) Limited (CIBIL) was incorporated in 2000.

The establishment of CIBIL is an effort made by the Government of India and

the Reserve Bank of India to improve the functionality and stability of the

Indian financial system by containing NPAs while improving credit grantors’

33

portfolio quality. CIBIL provides a vital service, which allows its Members to

make informed, objective and faster credit decisions.

The CIBIL gives a score to every borrower on a total score of 1100. Before

granting any credit facility to the borrower, the bank needs to review the score.

Although, Union bank doesn’t advocates a minimum score requirement in the

CIBIL report but generally a score in the range of 800 is considered good.

7.0 CASE STUDY: M/S ABC CHEMICALS

I, have completed an internship with Union Bank of India, Khand Bazar

branch, Mumbai, Masjid 400 003. I got to work practically on a proposal of

34

M/s ABC Chemicals, which is a proprietorship firm. Following are the details of

the case:

M/s ABC Chemicals is a sole proprietorship firm which is controlled by Mr.

DEF. He is having a rich experience of around 25 years in the same field of

chemical industry. Prior starting his own firm he worked as a commission

agent which helped him to gain knowledge about the different functionality of

chemical industry. He also takes assistance of intermediaries, who constantly

keep him informed & updated about the new products & changing market

conditions.

Mr. DEF, Owner of M/s ABC chemicals has applied for following limits:

Particulars Amount

Fund Based (Cash Credit ) Rs. 1 crore

Non Fund Based (L/C

limit)Rs. 2 crore

Total Limit Rs. 3 Crore

Mr. DEF has submitted following documents on behalf M/s ABC Chemicals

Personal Bio data of both the firm and proprietor himself

Audited balance-sheets of 2008, 09 & 10 and provisional B/S (2011) and

projected B/S of 2012.

CMA data (if the limit is above Rs. 1.00 crore.)

Credit Information Form of the firm & proprietor duly filed in and signed

by the proprietor

List of sundry creditors and debtors along with break-up of debtors

(below and above 180 days)

Details of collateral, sister concerns, if any. Etc.

Following will be the working of the processing of the working capital

application

Balance sheet break-up as per Union bank model

35

Current assets: Assets if satisfies following two conditions, it will be

treated as current asset:

a. It should be business related.

b. It should be convertible in cash within 1 year.

For sundry debtors, the break-up needs to be done for less than 180

days & greater than 180 days. Sundry debtors below 180 days are

treated as is taken into current assets & above 180 days are taken into

miscellaneous assets.

Examples: Cash and bank balance, sundry debtors (below 180 days),

stock, loans & advances & deposits.

Loans & advances & deposits should be related to business activity.

Current liabilities: Liabilities that need to be paid off with in 1 year.

Examples: Other bank borrowings, sundry creditors, outstanding

liabilities, etc.

Fixed Assets: Fixed assets are the assets of the company which are held

for long term purpose and not liquidated within 1 year.

Examples: Land and building, plant & machinery, equipment etc.

Long Term Liabilities: It includes secured and unsecured liabilities, quasi

capital, etc.

Quasi capital is the capital which is contributed by the friends, relatives

and family members of the proprietor.

Miscellaneous Assets: Assets not included in current assets are included

in miscellaneous assets.

Examples: sundry debtors more than 180 days, advances given to

friends, etc.

Net Worth: It is the personal capital contributed by the proprietor.

Examples: Paid up capital, general reserve, retained profits of the

previous years, etc.

7.1 Preparation of the Proposal

BREAK-UP OF BALANCE SHEET: Rs. In Lacs

M/s ABC Chemicals

As at 31st March 2008 2009 2010 2011 2012

36

Aud Aud Aud. Prov. Proj.

CURRENT ASSETS

Cash & bank balance 0.74 33.20 24.07 43.93 54.90

margin money on LC

Book Debts376.5

7402.23

711.12

727.83 1056.91

Inventory 86.71 118.95108.5

8260.04 275.00

a) Raw Materials

b) Work in progress

c) Finished Goods

d) Consumables stores & Spares

Taxes paid in advance

advance to suppliers 1.49

Other Current Assets 1.66 1.08 1.08 6.31 7.55

TOTAL CURRENT ASSETS465.6

8556.95

844.85

1038.11 1394.36

CURRENT LIABILITIES:

Bank Borrowings (Short Term) 50

Bank Borrowings (Short Term) -other bank

Sundry Creditors Expenses 6.40 7.77 13.16 13.00

Loans from others 3.00 1.50

Sundry Creditors373.7

4458.64

689.38

878.33 1196.37

Intt./Other ch.accrued but not due for payment

Provision for taxation 0.62 3.82

Other Provisions

Installments due in 12 months on Term Loans

Other Current Liabilities 0.13 1.58 1.24 1.18 5.25

Advance from Customers 6.54 0.08

Deposit against sales

TOTAL CURRENT LIABILITIES:390.4

3469.57

707.60

892.51 1251.62

CURRENT RATIO 1.19:1 1.18:1 1.19:1 1.16:1 1.11:1

FIXED ASSETS:

Land

Building

Plant and Machinery

Other Fixed Assets 2.26 1.84 1.80 0.70 0.38

Furniture and Fixtures

Constn.waiting for completion

OTHERS

TOTAL FIXED ASSETS; 2.26 1.84 1.80 0.70 0.38

LONG TERM LIABILITIES:

Deferred Tax Liability

Redeemable Pref.Shares

Term Loan - car loan from HDFC bank

Term Loan – Others 29.00 34.50 53.20 19.84 20

Term Loan - UNION BANK

Other Term Liabilities

37

Unsecured Loans from FRIENDS & RELATIVES 24.00 24.70 31.85 59.52 60

TOTAL LONG TERM LIABILITIES: 53.00 59.20 85.05 79.36 80.00

MISCELLANEOUS ASSETS:

Deferred Tax Assets

Bals/Dep with P.Trust/Customs

Other Loans & Advances

Unquoted Investments

Non.Consumable Stores/Spares

Other Miscellaneous Assets-deposits 0.02 0.03 0.02

Book Debts older than 6 months 8.01 11.53 14.25 22.51 32.69

SecuritY DEPOSITS

TOTAL MISCELLANEOUS ASSETS: 8.03 11.56 14.27 22.51 32.69

NET WORTH:

Paid Up Capital 32.54 41.58 68.27 89.45 95.81

Prop. Current account

General reserves & Surplus

Other Reserves- subsidy

Balance of Profit

TOTAL NET WORTH 32.54 41.58 68.27 89.45 95.81

TOTAL ASSETS:475.9

7570.35

860.92

1061.32 1427.43

TOTAL LIABILITIES:475.9

7570.35

860.92

1061.32 1427.43

Table 3 Break up Balance sheet

From the above break up, credit rating of the borrower is conducted by the

bank, as per the latest audited balance-sheet, i.e. 2010 in this case.

As per the credit rating model of UBI, M/s ABC chemicals gets the CR4 rating

which is satisfactory for further processing of the application.

After the breakup of balance sheet, credit rating, now the proposal is made

and forwarded to the Regional office for the approval and sanction.

38

PROPOSAL of the M/s ABC Chemical

UNION BANK OF INDIAMEMORANDUM TO THE COMPETENT AUTHORITY

FOR APPROVAL

PROPOSAL FOR SANCTION

GROUP -

BANKING Sole

MONTH OF REVIEW New Account

ASSET CLASSIFICATION Standard

INTEREST RATING CR-4 (Aud. 2010)

STATUS OF ACCOUNT

(Please tick appropriate

box)

Regular

Early Alert

System

Special

Mention

Account

1a) NAME OF THE

ACCOUNTM/s ABC Chemicals

b) BRANCH / ZONE Khand Bazar Branch

c) BORROWER

CREDIT

RATING

CR-4 (Aud. 2010)

d) DATE OF

ESTABLISHMENT2005-06

2 CONSTITUTION

(Proprietorship/Partnership/Company)

Sole Proprietorship

3 ADDRESSREGD. AND ADM. OFFICE

XXXX

39

4

NAME OF

PROPRIETOR & HIS

MEANS

ProprietorMeans as of

(31/3/2010)

Mr. DEF 103.72 lacs

5BACKGROUND OF

PROMOTERS

The business is managed by Mr. DEF. He is well

known in trade circles and is reported to be

experienced businessman with satisfactory dealings.

6

CAPITAL STRUCTURE

(Applicable in case of a

company)

N.A (Proprietorship Firm)

6aSHAREHOLDING

PATTERNN.A.

No. Of sharesFace

valueHolding %

- - -

7

IN CASE OF

PARTNERSHIP FIRM

INDICATE CAPITAL

CONTRIBUTED BY

EACH PARTNER

SEPARATELY

NA

8

LINE OF ACTIVITY

(Description of the

business)

Traders & Dealers in chemicals & Solvents

9DUE DILIGENCE

(Reference with the existing parties which have

availed credit facilities by the bank is required given

by the borrower)

40

10

COMMENTS ON

LATEST

CREDIT / SEARCH

REPORT

(CID is the Credit Information department of the

bank which would give brief history & information

about the firm. CID report is required for limit greater

than Rs. 1 Crore)

11

A) DEALING WITH

BANK

SINCE

September 2006

B) CREDIT FACILITIES

SINCE2007

12

WHETHER A/C. IS

TAKEN / TO BE

TAKEN OVER. IF SO

NORMS FOR TAKE

OVER ARE

FULFILLED

(This is applicable in situation where the borrower

has credit facilities with other banks. Credit report by

the other bank is required in this case.)

N.A.

13 FINANCIAL INDICATORS:

(Rs. In lacs)

Year Ending31/03/08

(Aud.)

31/03/0

9

(Aud.)

31/03/10

( Aud.)

31/03/1

1

( Prov.)

31/03/12

(Proj.)

Paid up Capital 32.54 41.58 68.27 89.45 95.81

Reserves & Surplus - - - - -

Tangible Net Worth 32.54 41.58 68.27 89.45 95.81

Long Term Liabilities 53.00 59.20 85.05 79.36 80.00

Capital Employed 85.54 100.78 153.32 168.81 175.81

Net Block 2.26 1.84 1.80 0.70 0.38

Investments - - - - -

Non Current Assets 8.03 11.56 14.27 22.51 32.69

Net Working Capital 75.25 87.38 137.25 145.60 142.74

Current Assets 465.68 556.95 844.85 1038.11 1394.36

41

Current Liabilities 390.43 469.57 707.60 892.51 1251.62

Current Ratio 1.19 1.19 1.19 1.16 1.11

DER 1.63 1.42 1.25 0.88 0.83

DER with quasi capital 0.51 0.52 0.53 0.13 0.13

TOL/TNW 13.63 12.72 11.61 10.86 13.90

TOL/TNW with Quasi

Capital7.42 7.61 7.60 6.12 8.16

Net Sales 1330.69 1849.70 2913.03 3384.11 4230.00

Net Profit Before Tax 9.53 15.11 48.63 42.86 52.95

Provision for Tax - - - - -

Net Profit After Tax 9.53 15.11 48.63 42.86 52.95

Depreciation 0.51 0.42 0.42 0.54 0.34

Cash Accruals 10.04 15.53 49.05 43.4 53.29

COMMENTS ON FINANCIAL INDICATORS

Based on Audited financial statements as of 31/03/2010:-

Capital/TNW

Total net worth of the M/s Veer chemicals has been rising since last 3

years. Capital/TNW improved from `41.58 lacs in 2008-09 to `68.27 lacs

in 2009-10 due to induction of additional capital by the proprietor and

plough back of the entire profit. As per the provisional balance sheet as

of March 2011 the capital is increased to `89.45 lacs & `95.81 lacs as of

March 2012.

Current Ratio

Current Ratio is constant for both the F.Y 2009 & 2010 i.e. at 1.19. It

was marginally above the acceptable level of 1.17. In 2010-11 (Prov.),

the same is at 1.16 due to increase in sundry creditors and increase in

non-current assets (Debtors older than 180 days). In the year 2011-12

the same is estimated at 1.11.

DER ( TL/TNW)

The DER (Debt-to-Equity Ratio) is reduced from 1.42:1 as of March 2009

to 1.25:1 as of March 2010, due to increase in the capital. It further

reduced to 0.88:1 as of March 2011(Prov.), which is due to increase in

capital. It is further reduced to 0.83:1 as of March 2012. However,

considering the unsecured loan as quasi capital the DER is of 0.52:1,

42

0.53:1, 0.13:1 as of March 2009, March 2010 & March 2011 respectively,

which is reasonable.

TOL/TNW.

TOL/TNW (Total Outstanding Liability/Total Net Worth) of the firm

reduced from 12.72:1 as of March 2009 to 11.61:1 as of March 2010,

due to increase in capital. It is further reduced to 10.86:1 as of March

2011(Prov.) followed by increase to 13.90:1 as of March 2012. However

by considering the quasi capital the ratio will be 7.61:1, 7.60:1 & 6.12:1

as of March 2009, March 2010 & March 2011(Prov.) respectively, As on

30/05/2011 the party has further introduced under quasi capital from

`59.20 lacs to `86.91 lacs which has reduced TOL/TNW in quasi capital

to 5.17:1.

Sales:

Net sales have been consistently increasing from the year 2007-08. The

performance of the firm in the year 2009-10 is encouraging. The firm has

recorded a growth of 57.48% over the last year 2008-09 from `1849.70

lacs to `2913.03 lacs. In the year 2010-11(Prov.), it grew by 16.17%. The

projected growth of the sales for the year 2011-12 has been pegged at

25% and value of the net sales expected to be `4230.00 lacs.

Profitability:

FY 2008-09 FY 2009-10 FY 2010-11 FY 2011-12

PBT 15.11 48.63 42.86 52.95

Sales 1849.70 2913.03 3384.11 4230.00

PBT/Sales

(%)0.82 1.67 1.27 1.25

The profit of the firm has increased `15.11 lacs to `48.63 lacs as of March

2010. It is marginally reduced to `42.86 lacs as of March 2011(Prov.). For

the year 2011-12 it is estimated to `52.95 lacs.

Overall financial statement of the firm is satisfactory.

AUDIT NOTES IN BALANCE SHEET NO

(IF ANY, TO BE SPECIFIED)

COMMENTS ON FINANCIAL INDICATORS ON CASH BASIS

43

The firm has earned the cash accruals of `25.53 lacs as of March 2009,

`49.05lacs as of March 2010 and `43.40 lacs as of March 2011 respectively.

14. EVALUATION OF MANAGEMENT

M/s ABC Chemicals is a sole proprietorship firm which is controlled by Mr.

DEF. He is having a rich experience of around 25 years in the same field of

chemical industry. Prior starting his own firm he worked as a commission agent

which helped him to gain knowledge about the different functionality of

chemical industry. He also took assistance of intermediaries, who constantly

keep him informed & updated about the new products & changing market

conditions.

15. EVALUATION OF INDUSTRY

The chemical industry is highly versatile segment in the overall industrial

economy of India. It has a linkage of almost every other industrial activity,

textiles, rubber etc. There is in fact hardly any segment where chemicals do not

feature. The industry has remained amongst the fastest growing sector except

for slow-down witnessed in the early 90’s which was attributed primarily to the

economic liberalization policies ushered in the early 90’s.

16. EVALUATION OF BUSINESS RISK

There are a number of competitors in the chemical market. The firm mainly

deals with established & reputed companies. Hence, the risk in payment default

is minimal. In 2010-11, the demand for chemicals is likely by 6-8% on account

of improvement in demand from end user segments. Margins of players in the

chemical industry are sensitive to raw material as it constitutes nearly 65-70%

of the total cost.

In the year 2011-12, we expect margins to shrink on account of higher in the

feed-stock prices (in line with the anticipated rise in crude oil prices) as

compared to product prices. As per the union budget 2010-11, the excise &

custom duty remains unchanged except carbon black which in our case the

firm doesn’t import.

17A. CONDUCT OF THE ACCOUNT

a) Regularity in submission of:

44

Stock Statements / Book Debt statement New Account

QPR statements / Half Yearly statement New Account

Financial Statements SubmittedCMA Data Submitted

(QPR stands for Quarterly Performance report.

CMA stands for Credit monitoring analysis report.

All the above statements have to be submitted in case of limit more than Rs.1

Crore)

17B. COMMENTS ON OPERATIONS/ OVERDUES: New Account

18. COMPLIANCE TO TERMS OF SANCTION: New Account

a)Completion of Mortgage

formalitiesNew Account

b)Registration of Charges

with ROC

(ROC stands for Registrar of

Companies)

(Applicable in case of company)

NA

c)Whether documents valid

and in forceNew Account

d)Whether all other terms and

conditions complied withNew Account

e)Compliance of RBI

guidelinesNew Account

f)

Whether consortium meetings held at prescribed periodic intervals where the

Bank is the leader

(Consortium is applicable when a group of banks in collaboration are providing the credit facility to the

borrower)NA

19a

DATES OF INSPECTION

DURING THE FINANCIAL

YEAR

(Inspection to be done by bank

officials)

Done by the bank.

19bNATURE & VALUE OF

COLLATERAL SECURITY

Nature / Description of

Value

(in lacs)

Date of

valuation

Insuranc

e Amt Remarks

45

collateral security

indicating area and location of

property

along with

name of

valuer

and

Date of

Expiry

PQR flats

Ghatkopar (E)

Mumbai –

400077

150.00

Valuation done by Yardi

Prabhu Consultants

Dtd 30/04/2011

LIC Policy 5.00

FDR 10.00

TOTAL 165.00

19c) PERSONAL GUARANTEE OF PROPRIETOR & FAMILY(WITH MEANS)

(fig in lacs)

Name Means as on 31/03/2010 (fig in lacs)

Mr. DEF 103.72

Wife of Mr. DEF 24.86Total 128.58

20

a)

WHETHER THE NAME OF THE COMPANY / DIRECTORS FIGURES IN RBI DEFAULTER’S / CAUTION LIST / WILFUL DEFAULTERS / ECGC. IF YES PLEASE FURNISH DETAILS

No

b)WHETHER DIRECTOR / PARTNER / PROPRIETOR IS A DIRECTOR IN OUR / OTHER BANK OR IS RELATED TO THEM IF YES

No

c)ANY LITIGATION IN FORCE AGAINST THE FIRM / No

46

(Valuation is to be done by the recognized company dealing in valuation of the real estate property. The valuation should include the market value & distress value.)(FDR stands for fixed deposit receipt)OUR ASSESSMENT:(Verification needs to be as to whether the property given as collateral has already been mortgaged.)Deducting twice the outstanding amount from the valuation, we are left with 80.00 lacs which the party has proposed to add as collateral for the proposed credit facility. Thus, the total collateral coverage for the total limit of 175.00 lacs becomes 54.28%.

COMPANY OR AGAINST THE PARTNERS / DIRECTORS IF SO, MENTION DETAILS & PRESENT POSITION

21)AUDIT OBSERVATIONSa) Internal

(Done by bank auditors)New Account

b) Concurrent (Done by external auditors)c) Statutory (Done by external auditors)d) RBI Inspectione) Stock Audit (Done by bank auditors)

22)ANY IRREGULAR FEATURE OBSERVED IN THE MONITORING REPORT

NA

23a) EXPOSURE DETAILS FROM OUR BANK

Nature of facility LimitsExisting

Limits Recom- mended

D.P O/s. as on

ValueOf Securities

A) FUND BASED LIMITS CC ( HYP. ) New 50.00 - -

SOD FDR 9.50 --Sub Total [A] 9.50 50.00B) NON FUND BASED LIMITImp./Inl./ L/CW/wBuyers Credit

New 125.00

(50.00)Sub Total [B] - 125.00C) TERM LOAN/ DPGL LIMITSOther term loans New NilSub Total [C] - NilGRAND TOTAL [A+B+C] 9.50 175.00

(SOD FDR stands for Secured over-draft against the fixed deposit receipt.)

(The borrower is already enjoying the SOD against FDR.)

23. b) DETAILS OF EXCESSES ALLOWED DURING THE YEAR

No. of occasions excesses allowed Maximum Excess allowedNil Nil

(Excesses are allowed in the case where the borrower is given credit above the limit which has been sanctioned by the bank.) 23.c OTHER EXPOSURE , IF ANY, NO

47

INCLUDING INVESTMENTS23.d

OTHER LIABILITIES OF DIRECTORS / PARTNERS (IN THEIR INDIVIDUAL CAPACITY)

NO

24.a

EXPOSURE DETAILS FROM BANKING SYSTEM (INCL. OUR BANK)

Name of the Bank Fund Based Non-Fund Based Comments on the

conduct of the account % Share

Amt. % share Amt.

UBI(SOD/FDR) 100 9.50 Nil Nil SatisfactoryTotal 100 9.50

(100% share means bank has solely funded the SOD amount. In case of consortium, the bank has to specify the percentage of amount it has funded.)

24. b) CONDUCT OF THE ACCOUNT : Satisfactory

& EXPOSURE DETAILS FROM

FINANCIAL INSTITUTIONS

24. c) VALUE OF ACCOUNT – ( Applicable in the case of existing account.) New Account. (Since, this is a new account it is not applicable in this case.) i) Advances 01/04/2009 to 31/03/10 01/04/10 to 31/03/2011- Interest Income- Fee based Incomeii) Retail / Consumer / Finance (to employees associates)

iii) Deposits Amount Tenor & due dateOwn & family members

24.d)

DETAILS OF THE FOREIGN CURRENCY

EXPOSURE COMMITMENTS &

UNHEDGED PORTION IF ANY

NA

25.a)

OPERATIONAL EXPERIENCE WITH

REGARD TO SISTER / ALLIED

CONCERNS

NA

48

25.b)

COMMENTS ON OTHER BANK’S /

CREDIT REPORT ON SISTER CONCERN

NA

(Applicable in the case where the borrower has a sister concerned company.)

26 PRUDENTIALEXPOSURE NORMSWithin the prudential risk exposure

ceiling of the bank

27COMMENTS ON ASSESSMENT OF

LIMITS

a) PROJECTED LEVEL OF SALES

(Rs. in lacs)

PERIOD 07-08

(Aud)

08-09

(Aud)

09-10

(Aud)

10-11

(Prov.)

11-12

(Proj.)

Sales 1330.69 1849.70 2913.03 3384.11 4230.00

% growth -- 39 57.48 16.17 25

b) COMMENTS ON INVENTORY RECEIVABLE

(Rs. in lacs)

Particulars Mar. 09

(Aud.)

Mar. 10

(Aud.)

Mar. 11

(Prov.)

Mar. 12

(Proj.)

Finished goods

(Month’s cost of sales)

118.95

(0.78)

108.58

(0.47)

260.04

(0.91)

275.00

(0.80)

Receivables

(Month’s sales)

402.23

(2.61)

711.12

(2.93)

727.83

(2.58)

1056.91

(3.00)

Other currents assets 33.77 25.15 50.26 62.45

Sundry Creditors

(Month’s purchases)

458.64

(3.02)

689.38

(2.96)

878.33

(3.07)

1196.37

(3.48)

Advance from customers 0.08 - - -

Finished Goods: As per Aud B/S of 2009 stock of finished goods is at 0.78

month cost of sales and it is reduced to 0.47 months as of March 2010. It is

increased to 0.91 months in 2011 (Prov) and projected at 0.80 months cost of

sales as of March 2012, which is reasonable and acceptable.

Receivables: As per Aud B/S of 2009 the credit given to customers was 2.61

months sales and it is marginally increased to 2.93 months as of March 2010.

It is reduced to 2.58 months sales in 2011 (Prov) and projected at 3.00 months

as of March 2012, which is in line with past trend hence acceptable.

49

Sundry Creditors: As per Aud B/S 2009 the credit available from the supplier is for 3.02 months and it is at 2.96 months credit in 2010. It is increased to 3.07 months purchase as of March 2011 (Prov) and projected at 3.48 months as of March 2012, which is in line with past trend and reasonable and hence acceptable.

c) WORKING CAPITAL ASSESSMENT

Based on the built up of current assets and current liabilities and its accepted

levels, working capital assessment for F.Y 2011-12 is arrived as:

(Amount in Lacs)

(Aud.) (Prov.) (Est.) PARTICULARS 2009-10 2010-11 2011-12

A. Net Sales 2913.03 3384.11 4230.00B. 25% of Net Sales 728.25 960.275 1057.5C. Margin 5% of Net sales 145.65 192.055 211.5D. Net Working Capital 137.25 145.60 142.74E. Net Eligibility 528.6 768.22 846.00

The working capital assessment is being done by the turnover method.

COMMENTS ON ASSESSMENT

Based on the projected sales, the assessment of Working capital limit, the firm is

eligible for Cash Credit limit of Rs. 50.00 lacs.

d) TERM LOAN: NA

(Applicable in the case where the borrower has applied for any term loan related to

business activity)

e) NON FUND BASED LIMIT

The company is engaged in import of chemicals for which they have requested

for Imp L/C (DP/DA upto 120 days) limit of 125.00 lacs. The assessment of L/C

limit is as under

(Rs. in lacs)

A Projected Total PurchasesB Projected Import Purchases ( 2011-12) 975.00C Less: Custom Duty 20% 195.00D Net Import Purchases 780.00E Average L/C Period 90 daysF Lead Period 30 days

50

G L/C requirement on Usance Terms (780 x 120/365) 256.44

H Total L/C requirement 256.44

COMMENTS ON ASSESSMENTImport L/C limit is assessed at Rs. 125.00 lacs as above.

BUYERS CREDIT

The firm has also requested for the buyers credit limit of 50.00 lacs as sub limit of

L/C (DP/DA upto 120 days) limit of 125.00 lacs. The total period of buyers credit

and L/C usance period should not be more than 120 days.

28. CREDIT RATING

Parameters

Marks obtained F.Y. 2009-10

Borrower Rating 44/57Facility Rating N.A

Risk Mitigators 2/5

Business Aspects ½

Total Marks 47/64

Grade 73.44%

RECOMMENDATIONS

In view of satisfactory financials of the firm we recommend sanction of credit facility

as under: - (Rs. in lacs)

Nature of facility

Limits Existing

LimitsReco--mend

MarginInt /Com

Security

FUND BASED

New 50.00St-25%Bd-40%

BR + 6.25=16.25

Hypothecation of stock & book debts duly insured with the bank clause

CC( Hyp.)Stock & Book DebtNONFUND BASED DA= Hyp. of goods

51

Year Current Year 31/3/2010Total Score obtained 73.44%Grade CR-4

New125.00

(50.00)

10+15=25%

Usual

received under L/C duly insured with usual bank clause & BDs created out of sell of such goods plus pledge of deposits receipt.

L/C(DP/DA upto 120 days)W/wBuyers CreditTOTAL New 175.00

(The margin for the fund based limit i.e. CC limit are as follows:

1) Stock – 25%

2) Book debts – 40%

The above mentioned margin requirement is at the discretion of the bank & varies

as per bank requirement. The margin has to be calculated every month based on

stock & book debts value as submitted by the borrower. The rationale behind the

stock & book debts value is that it gives us a proper indication of the business done

by the firm in the month. The drawing power during a period cannot be greater than

the total credit limit sanctioned by the bank.

The margin for the Non-fund based limit i.e. L/C limit are as follows:

1) For sight L/C, the margin to be provided is 10% of the total value of sight

L/C. The margin to be provided is required in the form of FDR.

2) For usance L/C, the margin to be provided is 25% of the total value of

usance L/C. As stated above, the margin needs to be provided in the form of

FDR.) Again, the margin requirement at the discretion of the bank.

(As this proposal is greater than Rs. 50 lacs, the proposal is required to be

submitted at the credit grid of RO, Branch along with all the necessary documents

for their approval.)

Branch power for sanctioning credit limit –

Particulars Amount

Fund Based Rs. 4.50 crore

Non Fund Based Rs. 1.50 crore

For limits under the Branch DOP (Delegation of Power) is appraised & sanctioned

in the Branch. Also, the limits under the Branch DOP are sent for grid approval

department for further verification provided the amount is greater than Rs.50 lacs.

If limits to be appraised & sanctioned are above the mentioned limits in the above

table i.e. above the branch DOP, the branch doesn’t have the power to sanction the 52

proposal. The branch needs to submit all the relevant documents to the Regional

office which will further process the application of the borrower.

After such preparation of the proposal, the proposal is sent to Grid department at

RO. Grid then verifies the proposal, and then sends it back to the branch with or

without its recommendations. If Grid approves the proposal, branch then prepares

the sanction advice in duplicate. One copy is handed over to the applicant &

another one is retained by the bank.

Borrower, if agrees and accepts the sanction advice, bank then goes ahead with

procedure of documentation. Applicant has to borne documentation charges and

processing charges.

7.2 Documentation Process

The documentation process will vary & change as per the limit sanctioned for

the borrower/firm. After the proposal for the working capital credit has been

sanctioned by the branch heads/regional branch and sanction advice

accepted by the borrower than the documentation process start, the following

documents are required before the final disbursement -

1.) DP (Demand promissory) note – The DP note needs to be separately

submitted for all the different limits which the applicant has applied for.

2.) Letter of Continuity (AD-09) – Similar to the DP note, the Letter of

continuity needs to be separately submitted for different limits. Generally,

the number of DP note should be equal to Letter of continuity.

3.) Hypothecation of Stocks & Book-debts (SD-06) – The borrower needs to

submit the document. The value of this letter is generally 0.2% of the limit

sanctioned by the bank.

(These above mentioned documents are mandatory documents for any

borrower.)

4.) Declaration of Partnership (AD-07) – Applicable in the case of partnership

firms.

5.) Letter of undertaking not to alienate Hypothecated goods (AD-12) – The

borrower needs to submit a letter of undertaking stating that they won’t

isolate their hypothecated goods

53

6.) Letter of guarantee (SD-01) – The applicant needs to submit a letter of

guarantee to the bank. The value of this letter is generally 0.2% of the limit

sanctioned by the bank.

7.) LSR report – This is the legal search report of the property which is being

conducted to know the complete details of the property which is being

mortgaged.

8.) Memorandum of Title deeds

9.) Declaration & Affidavit - The borrower needs to submit a declaration that

he is availing a credit facility. Also, affidavit needs to be submitted which is

generally done 1 day after the Declaration by the borrower. Also,

declaration & affidavit needs to be notarized.

Finally, Vetting of the documents needs to be done by the lawyer. Also, a

Credit Process audit (CPA) is required by the internal bank official who will

check into the complete credit process done by the bank for the borrower. If

any irregularities are found by the bank official, then it needs to be reported to

higher authorities. CPA is the process followed by UBI which may vary from

bank to bank. The above two process of vetting & CPA will be applicable only

when the credit application process is above 10 lacs & 1 Cr respectively.

7.3 Disbursement of credit

Once the documentation process is done then bank disburses the credit.

Under this disbursement stage, bank provides the limit raised for the borrower

as per the agreement. In case of non-fund based credit, L/C limit is created by

the bank, and for fund based credit, the amount is credited in the borrower’s

bank account.

Interest is chargeable only for that portion of the limit, which is actually being

used by the borrower.

Borrowers, if has availed short-term limit, it needs to be renewed every year.

For such renewal of the short-term limit, bank every year has to calculate

credit rating and again has to renew the short-term limit, after inspecting the

stock and book debts of the borrower of the projected year.

7.4 Follow-Up/Monitoring

54

Bank has to undertake regular follow-up/monitoring steps, to check, if the

party is properly utilizing the limit i.e. it checks whether the party has utilized

the sanctioned limit & it should be used for the business purposes. If within 3

months of the sanctioned credit limit, the borrower/company doesn’t avail

complete the process then the bank has the right to reject the sanction limit.

Party, each month has to submit the statements of stock and book debts,

before 15th of next month.

8.0 INTRODUCTION TO FOREIGN EXCHANGE

Foreign trade takes place between different sovereign countries having different

monetary units, different rules and regulations governing foreign trade, different

legal system. Hence, exporters and importers participating in trade have their own

compulsions. Thus, the exporters want money for the goods exported or services

provided in the currency of the country he resides, the importer on the other hand

can pay for the goods imported in the currency of the country .This is where foreign

exchange comes into play and helps convert one currency into another and

smoothen the flow of international trade and monetary resources.

Foreign exchange is a mechanism by which the currency of one country is

converted into currency of another country.

Forex operation is a very critical and important for a country so the

government has developed a systematic process for its operation &

regulation. The regulatory authority for the Indian forex market is RBI whereas

FEMA [Foreign Exchange Management Act] is the law which regulates the

forex market. RBI issues Guidelines/regulations/instructions from time to time

which govern the functioning of the market .Only A.D’s (Authorised Dealers)

licensed by the RBI can participate directly in the forex market. These are

usually the commercial banks which operate in India.

Foreign exchange operations can be regulated and controlled by following

guidelines:

1. Trade & Exchange Management- This is managed by the ministry of

finance with the help of the DGFT Import & Export, Foreign trade policy of

the government, RBI & authorized dealers.

55

2. UCPDC – UCPDC stands for Uniform customs & practices of documentary

credit. It is managed by International Chambers of Commerce (ICC) which

defines set of rules governing Letter of Credit (L/C).

3. ECGC – ECGC stands for Exchange credit Guarantee Corporation of India

Ltd. ECGC is controlled by the ministry of Commerce through board of

directors representing Government, banking, trade & industry.

4. Bank Policies – Bank policies includes service charge, internal

documentation, margin required etc. These policies vary from bank to

bank as banks are at their own discretion to decide matters related to

service charge, margin requirement etc.

9.0 ROLE OF BANKS IN FOREIGN EXCHANGE TRANSACTIONS

Banks also play a vital role in forex operations .They perform many functions

but the most important one is that they are the intermediaries through whom

documents are exchanged for money between exporters and importers.

Banks also assist RBI in the administration of FEMA.

Every commercial bank deals in foreign exchange since it is an activity with

good potential for profits. But, broadly we would classify the functions into:

1. Finance of exports

2. Finance of import, letters of credits

3. Remittances and other miscellaneous services like traveler’s cheque,

currency encashment, credit card transactions, etc.

Accounts Used By Banks in FOREX

To facilitate dealings in foreign exchange, a bank in India maintains accounts

with banks abroad to facilitate the foreign transaction. Similarly, some foreign

banks may maintain accounts with bank of India. In banking terminology these

are known as Nostro account & Vostro account.

a. Nostro Account:

An account that bank in our case Union bank of India holds with a foreign

bank.

Nostro accounts are always in the legal currency of the foreign country.

This helps the banks in better cash management as there is no need to

convert the currency.

56

e.g.: Union Bank of India maintains an account with Bank of China or Bank

of New York.

b. Vostro Account:

The account opened by a foreign bank in Indian rupee with an Indian bank

would be referred by all correspondence by Indian banks as vostro

account, meaning foreign bank account with our bank.

e.g.: Bank of China having its account in domestic currency with our Union

Bank.

10.0EXPORT FINANCE

Export finance is a short term, working capital finance allowed to an exporter.

An exporter may avail financial assistance from any bank provided following

two requirements are satisfied.

1) Timely availability of credit:

Funds should be available to the exporter at the required time to ensure

the availability of the funds to eligible borrowers.

2) Cost of fund should be affordable:

In order to compete in the international market, exporter requires funding

at cheaper cost.

Export financing is loan made for the shipping of products outside a country.

As the name suggests, export finance is divided into financing activities and

other export related activities. The financing activities are further sub-divided

into

a. Pre-shipment finance &

b. Post-shipment finance

10.1 Pre-Shipment Finance

57

EXPORT FINANCE

Pre-shipment Finance

Post-shipment finance

Pre-shipment is also referred as “packing credit”. It is working capital

finance provided by commercial banks to the exporter prior to shipment of

goods. The finance required to meet various expenses before shipment of

goods is called pre-shipment finance or packing credit. The exporter requires

finance for procuring of raw material, manufacturing and packaging of goods.

Forms or Methods of Pre-Shipment Finance

a) Cash Packing Credit Loan:

In this type of credit, the bank normally grants packing credit advantage

initially on unsecured basis. Subsequently, the bank will always ask for

security.

b) Advance Against Hypothecation

Packing credit is given to process the goods for export. The advance is

given against security and the security remains in the possession of the

exporter. The exporter is required to execute the hypothecation deed in

favour of the bank.

c) Advance Against Pledge

The bank provides packing credit against security. The security remains in

the possession of the bank. On collection of export proceeds, the bank

makes necessary entries in the packing credit account of the exporter.

d) Advance Against Exports Through Export Houses

Manufacturer, who exports through export houses or other agencies can

obtain packing credit, provided such manufacturer submits an undertaking

from the export houses that they have not or will not avail of packing credit

against the same transaction.

e) Advance Against Duty Draw Back (DBK)

DBK means refund of customs duties paid on the import of raw materials,

components, parts and packing materials used in the export production. It

also includes a refund of central excise duties paid on indigenous

materials. Banks offer pre-shipment as well as post-shipment advance

against claims for DBK.

10.2 Post-Shipment Finance

Post shipment finance is provided to meet working capital requirements after

the actual shipment of goods. It bridges the financial gap between the date of

58

shipment and actual receipt of payment from overseas buyer thereof.

Whereas the finance provided after shipment of goods is called post-shipment

finance.

Forms/Methods of Post Shipment Finance

a) Export bills negotiated under L/C

The exporter can claim post-shipment finance by drawing bills or drafts

under L/C. The bank insists on necessary documents as stated in the L/C.

If all documents are in order, the bank negotiates the bill and advance is

granted to the exporter.

b) Purchase of export bills drawn under confirmed contracts:

The banks may sanction advance against purchase or discount of export

bills drawn under confirmed contracts. If the L/C is not available as

security, the bank insists on ECGC cover to be obtained by the exporter.

c) Advance against bills under collection:

In this case, the advance is granted against bills drawn under confirmed

export order L/C and which are sent for collection. They are not purchased

or discounted by the bank. However, this form is not as popular as

compared to advance purchase or discounting of bills.

d) Advance against claims of Duty Drawback (DBK):

DBK means refund of customs duties paid on the import of raw materials,

components, parts and packing materials used in the export production. It

also includes a refund of central excise duties paid on indigenous

materials. Banks offer pre-shipment as well as post-shipment advance

against claims for DBK.

e) Advance against goods sent on Consignment basis:

The bank may grant post-shipment finance against goods sent on

consignment basis.

f) Advance against Undrawn Balance of Bills:

Importer normally does not make the entire payment at a time. He retains

a part of it, and releases the same after confirming the quality of the goods

supplied by the exporter. So, such bills, which are due but against which

payment is yet to receive, are called undrawn bills. And bank may provide

advance to the exporter against such bills.

59

10.3 FDBP (Foreign Document Bill Purchased) & PC (Packing

Credit)

FDBP is type of Post shipment finance offered by the bank to the exporter.

Under the mechanism of FDBP, exporter’s bank provides the facility of

purchasing the bills of the exporter. This will help the exporter to have the

funds available in hand immediately after the shipment of goods. This facility

provides exporter with the immediate availability and liquidity of funds to carry

on the further export or inland order processing. Also, after availing the FDBP

facility, exporter parts with the risk of non-payment by the importer, or any

other uncertain event. Bank, for this facility charges some commission to the

exporter. FDBP can be availed by the exporter provided a L/C is present or

not i.e. it can availed even if the exporter has the export order for shipment of

the goods to the importer.

Packing credit (PC) is a pre-shipment working capital finance made available

to the exporter. This credit limit is usually included in FDBP limit. Bank

provides the packing credit to the exporter to fund his initial production,

processing or packing activities, for export order.

An exporter who has availed the packing credit has to present his export bill to

the bank.

Eg: Exporter A has availed the FDBP limit of Rs. 15 lacs, within which packing

credit of Rs. 5 lacs. Exporter A has used packing credit of Rs. 3 lacs for his

export order of Rs. 10 lacs. After availing the packing credit, he undertakes

the production of goods as per export order, and finally ships the consignment

for delivery to the importer. Now, he has with him the Bill of Rs. 10 lacs. Since,

he has availed packing credit the Bank will buy the export bill of the exporter.

Bank purchases his bill of Rs. 10 lacs. Exporter actually gets Rs. 10 lacs

minus some commission charges of the bank & packing credit he has already

availed (Rs. 3 lacs in this case).

This means, bank first gets its loan recovered along with its commission

charges for bill purchase, from the bill amount and then credits the exporter’s

account by the remaining amount. Now, the Packing credit limit of exporter is

again Rs. 5 lacs, but FDBP limit reduces to Rs. 5 Lacs.

Finally, when the Bank actually receives the payment from the importer on

behalf of the bill purchased the FDBP limit will be re-instated to Rs.15 lacs.

60

10.4 ECGC

Export Credit Guarantee Corporation of India Ltd (ECGC), was established in

the year 1957 by the government of India to strengthen the export promotion

drive by covering the risk of exporting on credit. Being essentially an export

promotion organization, it functions under the administrative control of the

Ministry of Commerce & Industry, Department of Commerce, Government of

India. It is managed by a Board of Directors comprising representatives of the

Government, RBI, banking, insurance & exporting community. ECGC is the 5th

largest credit insurer of the world in terms of coverage of national exports.

ECGC Cover is issued to the exporter and guarantees are issued to the Bank

(Exporter’s Bank). It is a type of insurance policy but it covers only the losses.

ECGC guarantees protect the bank from losses on account of their lending to

exporters. These guarantees have been designed to encourage banks to give

adequate credit & other facilities for exporters both at pre-shipment & post-

shipment stages.

Bank provides the funds to the exporter to carry out his export order, but for

that bank asks for ECGC cover obtained by the exporter in order to reduce the

risk. In ECGC cover if either importer or his bank or both decline to make any

payment to the exporter, then in this case the ECGC makes payment to the

ultimate beneficiary, provided he has complied with all the necessary

requirements and has paid the regular premiums.

When L/C is obtained by the exporter, it is not mandatory for the exporter to

procure ECGC cover also. But in case L/C is not obtained or it does not cover

pre-shipment guarantee, then exporter’s bank before providing any financial

assistance to the exporter insists upon ECGC cover that is to be obtained by

the exporter.

Eg. When L/C is issued by the importer which would reach the exporter after

he has started with the production as per the specifications of the importer,

then to start with such production activities he needs funds to be supplied by

the banker. Banker without any L/C in the possession of the exporter will not

part with funds to provide assistance to the exporter. For this bank will seek

ECGC cover to be taken by the exporter for his banker. In case, if the goods

produced for the export purpose are unable to be exported due to reasons like

unstable political conditions, weather conditions, etc that are beyond the

61

control of the exporter, then ECGC will compensate the exporter’s bank who

has already provided advances to the exporter.

Eg. An exporter of perishable goods like onions etc from India enters into

contract for exporting onions to an importer in the foreign country. Exporter

has obtained the ECGC cover. Exporter as per specific requirements of the

importer has shipped the onions. Due to unfavourable weather conditions,

onions were not in consumable conditions. Importer therefore refuses to

accept the goods and also, denied to make the payment. ECGC thereby,

makes the payment to the exporter’s bank, as the loss of quality of onions was

due to the unfavourable weather conditions. Such importer parties which

refuse to pay for the goods are then black-listed by the ECGC & future trades

with these parties is restricted. Trade with these parties in future will be

curtailed.

As per the mechanism of ECGC, exporter obtained such insurance cover to

protect his banker from any unpredicted financial loss due to export trade. The

payment of the insurance premium is to be borne by the exporter.

Difference between ECGC cover & insurance cover -

The difference between a regular insurance policy and an ECGC policy is

that, under ECGC if the payment later realized by the exporter, then such an

exporter’s bank which has already recovered the same from ECGC, has to

remit back the funds to the ECGC, which is not so in case of regular insurance

policy.

62

11.0IMPORT FINANCE

The import department does all the banking activities pertaining to the import

of goods to India. This includes opening of import letter of credit, retirement of

bills under letter of credit and collection bills.

11.1 Letter of Credit

A letter of credit (L/C) can be defined as an arrangement where in a bank

guarantees, on behalf of its customers, to make payment to the beneficiary

upon presentation of documents specified in the credit. In other words it is an

undertaking by a bank to pay or accept bills provided the beneficiary of the

credit fulfils the terms and conditions set forth in the L/C document.

Parties involved in a L/C

1. Applicant (Opener): Applicant which is also referred to as account party

is normally a buyer or customer of the goods, who has to make payment to

63

IMPORT FINANCE

Letter of Credit Inward collection bill Other import related services:1. Guarantees2. Import loans etc

beneficiary. L/C is initiated and issued at his request and on the basis of

his instructions.

2. Issuing Bank (Opening Bank): The issuing bank is the one which create

a letter of credit and takes the responsibility to make the payments on

receipt of the documents from the beneficiary or through their banker. The

payment has to be made to the beneficiary within seven working days from

the date of receipt of documents at their end in case of sight L/C, provided

the documents are in accordance with the terms and conditions of the

letter of credit. If the documents are discrepant one, the rejection thereof to

be communicated within seven working days from the date of receipt of

documents at their end.  

3. Beneficiary: Beneficiary is normally stands for a seller of the goods, who

has to receive payment from the applicant. A credit is issued in his favour

to enable him or his agent to obtain payment on surrender of stipulated

document and comply with the term and conditions of the L/C.

4. Advising Bank: An Advising Bank provides L/C advice to the beneficiary

which provides the authenticity to the document. Advising bank is normally

located in the country of the beneficiary.

5. Confirming Bank: Confirming bank adds its guarantee to the credit

opened by another bank, thereby undertaking the responsibility of

payment/negotiation acceptance under the credit, in additional to that of

the issuing bank. Confirming bank is liable to make the necessary payment

to the exporter in case both importer and issuing bank fail to make the

payment.

6. Negotiating Bank:  The Negotiating Bank is the bank who negotiates the

documents submitted to them by the beneficiary under the credit either

advised through them or restricted to them for negotiation. On negotiation

of the documents they will claim the reimbursement under the credit and

makes the payment to the beneficiary provided the documents submitted

are in accordance with the terms and conditions of the letters of credit. 

7. Reimbursing Bank: Reimbursing Bank is the bank authorized to honour

the reimbursement claim in settlement of negotiation/acceptance/payment

lodged with it by the negotiating bank. It is normally the bank with which

issuing bank has an account from which payment has to be made.

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11.2 L/C Mechanism

Figure 5 L/C Mechanism

Explanation of L/C Mechanism:

1. Contract between exporter & importer.

2. Buyer applies for issue of L/C.

3. Buyers bank issues L/C.

4. Issuing bank communicates issue of L/C to the advising and negotiating

bank.

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Exporter’s Bank (advising &

negotiating Bank)Buyer’s Bank (Issuing Bank)

1. Export contract

2. Request to issue

L/C

3. L/C

4. L

/C

5. Export Goods

11. P

aym

ent

10. Payment

9. P

aym

ent

6. D

ocu

men

t

8. D

ocu

men

t

7. Document

5. Advising & negotiating bank communicate issue of L/C to beneficiary.

6. Advising bank adds its own confirmation, if required.

7. Beneficiary receives L/C.

8. Seller exports the goods.

9. Presentation of documents to negotiating bank.

10.Scrutiny of documents.

11.Discrepancies in documents.

12.Dispatch of documents to issuing bank

13.Presentation of the documents to the applicant and acceptance of the

same by him.

14.Delivery of documents to the applicant by the issuing bank.

15.Payment by the buyer to the issuing bank.

16.Negotiating bank receives the payment & pays the money to the seller

along with the commission to the bank.

11.3 Uniform Customs and Practices for Documentary Credit

(UCPDC)

The Uniform Customs and Practices for Documentary Credit (UCPDC) were

evolved by the International Chamber of Commerce to define a set of rules

governing letters of credit which can be universally accepted by all the

participating countries.

In a purchase and sale transaction, the essence of the agreement is the

confidence and trust that seller must have vis-à-vis the buyer. A business deal

is usually completed in following steps -

Buyer places he order for the goods with the seller after negotiating the

price and terms.

Seller executes the order and supplies the goods ordered.

The buyer effects the payment to the seller after being satisfied that the

goods that he has received are the ones that he had ordered.

This cycle is complete once the seller receives his payment from the buyer. In

a sale and purchase transaction in international business, geographical

distances separate the seller and the buyer, and it is really difficult for the

buyer & seller to have complete confidence in each other. To avoid these

uncertainties the bank steps into the picture by providing a guarantee for this

trade. 66

In short a “Documentary Credit is an undertaking issued by a bank, on behalf

of the buyers (importers), to seller(exporter), to pay goods and /or services,

provided that the seller presents documents which comply fully with the terms

and conditions of the credit.”

These are advantages to both the buyer and seller when settlement is

arranged by documentary letter of credit. Firstly, the buyer knows that

payment will only be made if the documents received comply strictly with the

terms and conditions of the credit as stipulated by the buyer. Secondly, the

seller knows that payment will be received provided the terms and conditions

of the credit are strictly complied with.

The main aims of the International Chamber of Commerce in adopting a

universal standard for documentary credit were to:

Reduce misinterpretations

Reduce the number of articles by clubbing them and deleting the repetitive

ones.

Define the articles in much clearer and simplified language

Take advantage of technology.

11.4 Types of Documentary Credit

a) Revocable letter of credit

A revocable credit is one, which can be amended or cancelled at any time

without prior notice or warning to the seller. It involves risks to the

beneficiary, as the credit may be amended or cancelled while the goods

are in transit and before correct documents are presented. The seller of

goods would face the problem of obtaining payment directly from the

buyer. A revocable credit gives the buyer maximum flexibility ,as it can be

amended or cancelled without prior notice to the seller up to the moment of

presentation of documents to the bank at which the issuing bank has made

the credit available for payment.

b) Irrevocable letter of credit:

An irrevocable credit cannot be amended or cancelled without the

agreement of the issuing bank, the confirming bank (if the credit is

confirmed) and the seller (beneficiary).An irrevocable credit gives the seller

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great comfort of payment but is really only dependent upon undertaking of

bank abroad.

c) Unconfirmed letter of credit:

Advising Bank has no engagement or responsibility as regard payment,

even conforming document are presented. The Advising Bank will make a

decision on ability to effect payment at the time of presentation of

documents. The beneficiary will need to assess the country risk concerned

before continuing with handling of the credit .It should always be

remembered that whilst a bank has issued credit it might not be able to

secure the foreign exchange in order to meet its obligation

d) Confirmed letter of credit:

The confirmation constitutes the undertaking of that bank in addition to that

of the issuing bank, to effect payment upon presentation at its counter of

conforming documents. Therefore, in the event the issuing bank to effect

payment upon presentation at its counter of conforming documents.

Therefore, in the events of the issuing bank not being in a position to

honour its obligation, the confirming bank will effect payment to beneficiary

as prescribed in the credit terms.

e) Sight Credit:

A credit available by sight payment usually allows the nominated bank to

debit account of the issuing bank on the presentation of the conforming

document. A draft payable sight may be called for, drawn on the

nominated bank. In the case of a confirmed credit, the nominated bank is

nearly always the confirming bank.

f) Usance credit:

It calls for drawing of drafts at a stated usance period requiring acceptance

and /or payment by drawee at the end of such usance period. This type of

credit is also referred as “term credit”.

In other words, the buyer is given a time-period over which he has to make

the payment of the goods that he has bought from the exporter.

11.5 Risks associated with Opening Import L/C

The basic risk associated with an issuing bank while opening an import L/C

are:

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1. The financial standing of the importer - As the bank is responsible to

pay the money on the behalf of the importer, thereby the bank should

make sure that it has the proper funds to pay.

2. The goods - Bankers need to do a detailed analysis against the risks

associated with perishability of the goods, possible obsolescence, import

regulations packing and storage, etc. Price risk is another crucial factor

associated with all modes of international trade.

3. Exporter Risk - There is always the risk of exporting inferior quality goods.

Banks need to be protective by finding out as much possible about the

exporter using status report and other confidential information.

4. Country Risk - These types of risks are mainly associated with the

political and economic scenario of a country. To solve this issue, most

banks have specialized unit which control the level of exposure that that

the bank will assumes for each country.

5. Foreign exchange risk - Foreign exchange risk is another most sensitive

risk associated with the banks. As the transaction is done in foreign

currency, the traders depend a lot on exchange rate fluctuations.

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12.0REMITTANCES

Remittances department would deal with the issuance and payment of foreign

currency, telegraphic transfers, mail transfers, issuance and encashment of

travellers’ cheque, sale and encashment of foreign currency notes,

maintaining non-resident accounts, etc.

Remittances are of two types:

Inward remittances.

Outward remittances.

12.1 Inward remittances:

Inward remittances may arise out of:

Export from India.

Remittances into India by non residents for investment.

Foreign travellers/tourists spending their exchange in India.

12.2 Outward remittances:

Outward remittances may arise out of:

Imports.

Travel of residents outside India.

Remittances by foreigners employed/settled in India.

Other remittances like gift, medical expenses, subscription to magazines,

examination fees etc.

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12.3 SWIFT:

The SWIFT system of transmitting messages is widely used throughout the

world. SWIFT stands for Society World Wide for Inter-bank Financial

Telecommunication is a co-operative society registered in Brussels.

The transmission of messages takes place in seconds therefore this method

is economical and time saving. The greatest advantage is that SWIFT

message has is that the communications are sent using pre-defined

structured format, hence there is no ambiguity of any sort, since these formats

are used all over the world on a standardized basis for conducting all types of

banking transactions.

For communication between banks, each bank has its own swift code. The

standardized format used for nomenclature the bank consists of 11 alphabets.

The break-up of these alphabets is as follows –

The first 4 alphabets are used for the banks name.

The next 2 alphabets are used for the origin country of the bank.

The next 2 alphabets are used for the specific city of the branch.

The final 3 alphabets are used for the appropriate branch name.

Eg. – The SWIFT code for the UBI Bank at Khand Bazar which is located in

Mumbai is UBIN-IN-BB-KBZ.

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13.0CONCLUSION

This report highlights the importance and the impact of working capital finance to

any Company/borrower. After all, working capital finance is a segment of finance

which deals with the decisions taken by the different corporations & borrowers.

The report discusses about the different types of credit facilities provided by the

bank and the complete process involved in the bank for granting capital to the

borrower. It also studies and analyses the tools & methods that are mandatory in

arriving at such decisions of giving capital.

The report also gives a brief introduction about the foreign exchange in reference to

the various types of facilities provided both to the firm where they may be

exporter/importer. This report describes about the various ways in which banks are

involved & the roles played by banks in the foreign exchange transactions of the

importer & exporter.

Banks by providing all these facilities to the company/borrower earn money in the

form of either interest on cash credit, overdraft & guarantees & commission on

facilities extended to the importer/exporter.

Thus, the final objective of this study is to help in the maximization of firm’s value &

assist them in the wealth creation process by providing the much required

assistance to meet their day-to-day credit requirement in the business & to help

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them in conducting their foreign exchange transactions in an efficient & effective

manner by acting as the much needed facilitator.

14.0BIBLIOGRAPHY

www.rbi.org.in

www.unionbankofindia.co.in

www.ecgc.in

www.statebankofindia.com

www.fedai.org.in

www.iibf.org.in

www.investopedia.com

www.bankofbaroda.com

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