An Introduction to Bank Credit

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An Introduction to Bank Credit


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Why Bank Gives Credit : -

Prime Factor of Modern Economy is to meet the

consumption demand of vast population as well as the

supplymachineries. Source of supply not always confined to the are of demand.

Industrial and Non industrial sector needs financial support

to meet the demand.

Commercial Banks provides credit to boost economy andthe objective is Welfare of the society at Large


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History of Bank Credit : -

Individuals and Families traditionally engaged in banking

business and they used to provide credit .

Post Independence commercial Banks were owned /controlled by large business houses .

Bank credit mostly directed towards production sector I.e

manufacturing industries.

Credit were generally given to few business houses /Influential person or groups.

Credit portfolio of many banks suffered high concentration

of risk and became unviable.


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Primary sector lending :

1. RBI Directives : 40% of net bank credit to prioritysector and out of this 10% to be delivered to weakersection.

2. DRI scheme : 1% of previous year total advance to begiven in DRI scheme.

Primary sectors and sub sectors :1. Agriculture

2. SSI, Financing industrial estate, Khadi & villageindustries

3. Retail traders, Small business, professionals & selfemployed persons, small road and water transportoperators, etc

4. Education,Housing , Pure consumption loan, Loans toSelfhelp group

5. Food and Agro based industries


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Other sectors :-

Services sectors

Personal Business segment : HL, EL

Consumer durable finance,

Retail Finance

Market share and credit portfolio makes the difference.


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Loan Policy and exposure Norms:

Asset Liability Match

Funds received by Bank in term of deposits are invested in

securities, Investments and Loans.

Banks to examine the inherent risk elements involved in

the credit proposal before disbursing.

Every bankhas a loan policy documents which contains

ceiling level, standard of appraisal, the decision making

power at different level ofhierarchy, documentation

standard, etc.


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Capital Adequacy Ratio(CAR):

Capital Adequacy Ratio = Total Capital(Tier I Capital+Tier II

Capital)/ Market Risk+ Credit Risk + Operation Risk

Tier I Capital = Ordinary Capital+Retained Earnings& SharePremium - Intangible assets.Tier II Capital = Undisclosed Reserves+General Bad Debt

Provision+ Revaluation Reserve + Subordinate debt+Redeemable Preference shares

Under Basel II norms,8% is the prescribed Capital Adequacy

Norm.In case of Scheduled Commercial Banks CAR= 9%For New Private Sector Banks CAR = 10%For Banks undertaking Insurance Business CAR = 10%and For Local Area Banks CAR =15%


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The exposure ceiling is linked to the capital fund of thelanding bank.

Exposure ceiling is 15% of capital fund in case of Single

borrower and 40% in case of group borrower

10% addition exposure to group of borrower on infra.Projects.


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Lending Rates : -Base Rate : -

From July 01, 2010 the new Base rate system replace theexisting system of benchmark prime lending rates (BPLR).

The formula for calculating the base rate will take into accountthe cost of deposits, cost of complying with CRR and SLR

requirements, and the need to retain a profit margin. Plus there will be a markup depending on the cost of operation

for a particular type of product and premiums for credit risk andtenor of loans. This need not raise rates for small loans as thenew base rates are likely to be lower than BPLRs. More

important, it is argued that as non-bank credit is invariablycostlier, making small loans affordable for banks will raise thesupply of such credit and thus be beneficial on the balance tosmall borrowers. To set floating rate loans, the new base rates asalso external benchmarks can be used, though the rate should not

fall below the base rate.


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The Security Aspect of Lending :

Basic purpose of of Charging security is to ensure that the

outstanding balance in the bank loan account can beliquidated at any point of time out of their proceeds of sales /

Disposal of the security in the event the borrower does notrepay the loan as per the contracted terms.

Primary Securities, Collateral Securities


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Credit Process :


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Business Development and Initial Recommendation :

Market research and credit investigation by Bank

Annual Business Plan of the bank defined industries and to

the extent to which bank would like exposure to eachindustry.

Campaign to attract target customers.

Collection of application file with financial statements,credit reports, relevant project reports.


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Credit appraisal points :-

Risk involved in the borrowers business. Risk like Marketrisk, technological risk, Environmental related risk , etc.

What are the antecedent of the borrower ? His reputationand integrity? What is his track record?

What are the financial risk involved in the borrowerbusiness ? Is the project economically viable ? Is theproject financially feasible?

What Risk are inherent in the operation of the business?

What have the managers of the borrower firm done to

mitigate these risk? Does the bank wants to borrow? Ifyes, what steps bank

need to take to get his money back?


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Broad steps to Credit analysis :


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Building the credit file : -

1. Gathering of Information.

2. Borrowers financial and managerial capacity

3. Existing credit history

4. Past and present financial statement, Cash flow

projection, Insurance detail, assets detail, collateraldetail,debtor and creditor detail, etc

These information helps to examine theborrowers track record in repayment and help to

make an opinion about the borrowers futurerepayment intention and potential.


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Project and financial appraisal :

Management integrity and capability, company performance, marketvalue and industry characteristics are evaluated.

Past Financial statement

Cash flow statement which revels the use of own and borrowed fund

by the borrower.

Analysis of the liquidity of the borrower / Firm. Removal of ageingreceivables or slow moving / obsolete inventory from the current assetsto revel the true picture of the financial statement.

Analysis of cash flow projection esp. the sales projections.

Evaluation of the strength of collateral securities for worst possiblescenario.


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Qualitative Analysis :

Integrity of the borrower to be measured.

For corporate borrower rating agencies like CRISIL,CARE & ICRA provides short term and long term rating to

bank loans.


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Due Diligence :

CPV

RCU

PI with borrower Checking the technology, Internal management control and

information systems, Industrial Relations, Employeecompensation and benefits, Environmental audit, etc.


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Risk assessment :

Identification of all potential internal and external risks andtheir severity accessed and their impact on borrowersfuture cash flow and debt service capacity.

Structuring the credit facility and finalization of terms ofloan agreement.


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Making the recommendation :

Credit officer make his recommendation with terms andconditions.

If no, then the credit officer ask for the revised creditproposal with different credit term, loan amount, maturity,pricing, description of prime collateral securities , etc.


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Credit Delivery and Administration :

Who takes the decision to lend?

Discretionary Limits with organizational hierarchy withaccountability.

Top management committee , board to take largeexposures.

Centralized underwriting department process the creditrequest and conveys approval in principle.


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Documents

An Introduction to Bank Credit