8/7/2019 An Introduction to Bank Credit
1/22
An Introduction to Bank Credit
8/7/2019 An Introduction to Bank Credit
2/22
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
8/7/2019 An Introduction to Bank Credit
3/22
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.
8/7/2019 An Introduction to Bank Credit
4/22
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
8/7/2019 An Introduction to Bank Credit
5/22
Other sectors :-
Services sectors
Personal Business segment : HL, EL
Consumer durable finance,
Retail Finance
Market share and credit portfolio makes the difference.
8/7/2019 An Introduction to Bank Credit
6/22
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.
8/7/2019 An Introduction to Bank Credit
7/22
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%
8/7/2019 An Introduction to Bank Credit
8/22
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.
8/7/2019 An Introduction to Bank Credit
9/22
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.
8/7/2019 An Introduction to Bank Credit
10/22
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
8/7/2019 An Introduction to Bank Credit
11/22
Credit Process :
8/7/2019 An Introduction to Bank Credit
12/22
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.
8/7/2019 An Introduction to Bank Credit
13/22
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?
8/7/2019 An Introduction to Bank Credit
14/22
Broad steps to Credit analysis :
8/7/2019 An Introduction to Bank Credit
15/22
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.
8/7/2019 An Introduction to Bank Credit
16/22
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.
8/7/2019 An Introduction to Bank Credit
17/22
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.
8/7/2019 An Introduction to Bank Credit
18/22
Due Diligence :
CPV
RCU
PI with borrower Checking the technology, Internal management control and
information systems, Industrial Relations, Employeecompensation and benefits, Environmental audit, etc.
8/7/2019 An Introduction to Bank Credit
19/22
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.
8/7/2019 An Introduction to Bank Credit
20/22
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.
8/7/2019 An Introduction to Bank Credit
21/22
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.
8/7/2019 An Introduction to Bank Credit
22/22