ASSIGNMENT OF BANKING

Steps in Credit Appraisal and disbursal

Submitted By:

Nitika Sharma

FC11150

OVERVIEW OF CREDIT APPRAISAL

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

It is the process of appraising the credit worthiness of a Loan applicant. Factors like age, income, number of dependents, nature of employment, continuity of employment, repayment capacity, previous Loans, credit cards, etc. are taken into account while appraising the credit worthiness of a person. Every bank or lending institution has its own panel of officials for this purpose.

However the 3 ‘C’ of credit are crucial & relevant to all borrowers/ lending, which must be kept in mind, at all times.

Character Capacity Collateral

If any one of these are missing in the equation then the lending officer must question the viability of credit. There is no guarantee to ensure a Loan does not run into problems; however if proper credit evaluation techniques and monitoring are implemented then naturally the Loan loss probability / problems will be minimized, which should be the objective of every lending Officer.Credit is the provision of resources (such as granting a Loan) by one party to another party where that second party does not reimburse the first party immediately, thereby generating a debt, and instead arranges either to repay or return those resources (or material(s) of equal value) at a later date. The first party is called a creditor, also known as a lender, while the second party is called a debtor, also known as a borrower.

Credit allows you to buy goods or commodities now, and pay for them later. We use credit to buy things with an agreement to repay the Loans over a period of time. The most common way to avail credit is by the use of credit cards. Other credit plans include personal Loans, home Loans, vehicle Loans, student Loans, small business Loans, trade. A credit is a legal contract where one party receives resource or wealth from another party and promises to repay him on a future date along with interest. In simple Terms, a credit is an agreement of postponed payments of goods bought or Loan. With the issuance of a credit, a debt is formed.

Basic types of credit

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

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

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

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

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

Brief overview of Loans

Loans can be of two types fund base & non-fund base:

Fund Base includes:

Working Capital Term Loan

Non-fund Base includes:

Letter of Credit Bank Guarantee Bill Discounting

Credit Appraisal Process

Receipt of application from applicant

Receipt of documents

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

Pre-sanction visit by bank officers

Check for RBI defaulters list, willful defaulters list, CIBIL data, ECGC, Caution list etc

Title clearance reports of the properties to be obtained from empanelled

Advocates

Proposal preparation

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

Preparation of financial data

Assessment of proposal

Documentations, agreements, mortgages

Sanction/approval of proposal by appropriate sanctioning authority

Disbursement of Loan

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

(On regular basis)

Loan administration pre- sanction process

Appraisal, Assessment and Sanction functions

1. Appraisal

A. Preliminary appraisal

Sound credit appraisal involves analysis of the viability of operations of a business and the capacity of the promoters to run it profitably and repay the bank the dues as and when they fall

Towards this end the preliminary appraisal will examine the following aspects of a proposal.

Bank’s lending policy and other relevant guidelines/RBI guidelines, Prudential Exposure norms, Industry Exposure restrictions, Group Exposure restrictions, Industry related risk factors, Credit risk rating, Profile of the promoters/senior management personnel of the project, List of defaulters, Caution lists, Acceptability of the promoters, Compliance regarding transfer of borrower accounts from one bank to

another, if applicable; Government regulations/legislation impacting on the industry; e.g., ban on

financing of industries producing/ consuming Ozone depleting substances; Applicant’s status vis-à-vis other units in the industry, Financial status in broad Terms and whether it is acceptable The Company’s

Memorandum and Articles of Association should be scrutinized carefully to ensure (i) that there are no clauses prejudicial to the Bank’s interests, (ii) no limitations have been placed on the Company’s borrowing powers and operations and (iii) the scope of activity of the company.

Further, if the proposal is to finance a project, the following aspects have to be examined: Whether project cost is prima facie acceptable Debt/equity gearing proposed and whether acceptable

Promoters’ ability to access capital market for debt/equity support Whether critical aspects of project - demand, cost of production,

profitability, etc. are prima facie in order

Required Documents for Process of Loana) Application for requirement of loanb) Copy of Memorandum & Article of Associationc) Copy of incorporation of businessd) Copy of commencement of businesse) Copy of resolution regarding the requirement of credit facilitiesf) Brief history of company, its customers & supplies, previous track records,

orders In hand. Also provide some information about the directors of the company

g) Financial statements of last 3 years including the provisional financial statement for the year 2007-08

h) Copy of PAN/TAN number of companyi) Copy of last Electricity bill of companyj) Copy of GST/CST numberk) Copy of Excise numberl) Photo I.D. of all the directorsm) Address proof of all the directorsn) Copies related to the property such as 7/12 & 8A utara, lease/ sales deed, 2R

Permission, Allotment letter, Possession o) Bio-data form of all the directors duly filled & notarizedp) Financial statements of associate concern for the last 3 years

After undertaking the above preliminary examination of the proposal, the branch will arrive at a decision whether to support the request or not. If the branch (a reference to the branch includes a reference to SECC/CPC etc. as the case may be) finds the proposal acceptable, it will call for from the applicant(s), a comprehensive application in the prescribed proforma, along with a copy of the proposal/project report, covering specific credit requirement of the company and other essential data/ information. The information, among other things, should include: Organizational set up with a list of Board of Directors and indicating the

qualifications, experience and competence of the key personnel in charge of the main functional areas

e.g., purchase, production, marketing and finance; in other words a brief on the managerial resources and whether these are compatible with the size and scope of the proposed activity.

Demand and supply projections based on the overall market prospects together with a copy of the market survey report. The report may comment on the geographic spread of the market where the unit proposes to operate, demand and supply gap, the competitors’ share, competitive advantage of the applicant, proposed marketing arrangement, etc.

Current practices for the particular product/service especially relating to Terms of credit sales, probability of bad debts, etc.

Estimates of sales cost of production and profitability. Projected profit and loss account and balance sheet for the operating years

during the Currency of the Bank assistance. If request includes financing of project(s), branch should obtain

additionallya) Appraisal report from any other bank/financial institution in case appraisal

has been done by them. b) ‘No Objection Certificate’ from Term lenders if already financed by them

andc) Report from Merchant bankers in case the company plans to access capital

market, wherever necessary.

In respect of existing concerns, in addition to the above, particulars regarding the history of the concern, its past performance, present financial position, etc. should also be called for. This data/information should be supplemented by the supporting statementsSuch as:

a) Audited profit loss account and balance sheet for the past three years (if the latest audited balance sheet is more than 6 months old, a pro-forma balance sheet as on a recent date should be obtained and analysed). For non-corporate borrowers, irrespective of market segment, enjoying credit limits of Rs.10 lacs and above from the banking system, audited balance sheet in the IBA approved formats should be submitted by the borrowers.

b) Details of existing borrowing arrangements, if any,c) Credit information reports from the existing bankers on the applicant

Company, and

d) Financial statements and borrowing relationship of Associate firms/Group Companies.

B. Detailed Appraisal

The viability of a project is examined to ascertain that the company would have the ability to service its Loan and interest obligations out of cash accruals from the business. While appraising a project or a Loan proposal, all the data/information furnished by the borrower should be counter checked and, wherever possible, inter-firm and inter-industry comparisons should be made to establish their veracity.

The financial analysis carried out on the basis of the company’s audited balance sheets and profit and loss accounts for the last three years should help to establish the current viability.

In addition to the financials, the following aspects should also be examined:

The method of depreciation followed by the company-whether the company is following straight line method or written down value method and whether the company has changed the method of depreciation in the past and, if so, the reason therefore;

Whether the company has revalued any of its fixed assets any time in the past and the present status of the revaluation reserve, if any created for the purpose;

Record of major defaults, if any, in repayment in the past and history of past sickness,

If any; The position regarding the company’s tax assessment - whether the

provisions made in the balance sheets are adequate to take care of the company’s tax liabilities;

The nature and purpose of the contingent liabilities, together with comments thereon;

Pending suits by or against the company and their financial implications (e.g. cases relating to customs and excise, sales tax, etc.);

Qualifications/adverse remarks, if any, made by the statutory auditors on the company’s accounts;

Dividend policy; Apart from financial ratios, other ratios relevant to the project; Trends in sales and profitability, past deviations in sales and profit

projections, and estimates/projections of sales values; Production capacity & use: past and projected;

o Estimated requirement of working capital finance with reference to acceptable build up of inventory/ receivables/ other current assets;

Projected levels: whether acceptable; and Compliance with lending norms and other mandatory guidelines as

applicable

Project financing:If the proposal involves financing a new project, the commercial, economic and

Financial viability and other aspects are to be examined as indicated below:

Statutory clearances from various Government Depts. / Agencies Licenses/permits/approvals/clearances/NOCs/Collaboration agreements, as

applicable Details of sourcing of energy requirements, power, fuel etc. Pollution control clearance Cost of project and source of finance Build-up of fixed assets (requirement of funds for investments in fixed assets

to be critically examined with regard to production factors, improvement in quality of products, economies of scale etc.)

Arrangements proposed for raising debt and equity Capital structure (position of Authorized, Issued/ Paid-up Capital,

RedeemablePreference Shares, etc.)

Debt component i.e., debentures, Term Loans, deferred payment facilities, unsecured Loans/ deposits. All unsecured Loans/ deposits raised by the company for financing a project should be subordinate to the Term Loans of the banks/ financial institutions and should be permitted to be repaid only with the prior approval of all the banks and the financial institutions concerned. Where central or state sales tax Loan or developmental Loan is taken as source of financing the project, furnish details of the Terms and conditions governing the Loan like the rate of interest (if applicable), the manner of repayment, etc.

Feasibility of arrangements to access capital market Feasibility of the projections/ estimates of sales, cost of production and

profits covering the period of repayment Break Even Point in Terms of sales value and percentage of installed

capacity under aNormal production year

Cash flows and fund flows Proposed amortization schedule Whether profitability is adequate to meet stipulated repayments with

reference to Debt Service Coverage Ratio, Return on Investment Industry profile & prospects Critical factors of the industry and whether the assessment of these and

management plans in this regard are acceptable Technical feasibility with reference to report of technical consultants, if

available Management quality, competence, track record Company’s structure & systems Applicant’s strength on inter-firm comparisons

For the purpose of inter-firm comparison and other information, where necessary, source data from Stock Exchange Directory, financial journals/ publications, professional entities like CRIS-INFAC, CMIE, etc. with emphasis on following aspects:

o Market share of the units under comparisono Unique featureso Profitability factorso Financing pattern of the businesso Inventory/Receivable levelso Capacity utilizationo Production efficiency and costso Bank borrowings patternso Financial ratios & other relevant ratioso Capital Market Perceptionso Current priceo 52week high and low of the share priceo P/E ratio or P/E Multipleo Yield (%)- half yearly and yearly

Also examine and comment on the status of approvals from other Term lenders, market view (if anything adverse), and project implementation schedule. A pre-sanction inspection of the project site or the factory should be carried out in the case of existing units. To ensure a higher degree of commitment from the promoters, the portion of the equity / Loans which is proposed to be brought in by

the promoters, their family members, friends and relatives will have to be brought upfront. However, relaxation in this regard may be considered on a case to case basis for genuine and acceptable reasons. Under such circumstances, the promoter should furnish a definite plan indicating clearly the sources for meeting his contribution. The balance amount proposed to be raised from other sources, viz., debentures, public equity etc., should also be fully tied up.

C. Present relationship with Bank:

Compile for existing customers, profile of present exposures: Credit facilities now granted Conduct of the existing account Utilization of limits - FB & NFB Occurrence of irregularities, if any Frequency of irregularity i.e., number of times and total number of days the

account was irregular during the last twelve months Repayment of Term commitments Compliance with requirements regarding submission of stock statements,

Financial Follow-up Reports, renewal data, etc. Stock turnover, realization of book debts Value of account with break-up of income earned Pro-rata share of non-fund and foreign exchange business Concessions extended and value thereof Compliance with other Terms and conditions Action taken on Comments/observations contained in RBI Inspection

Reports: CO Inspection & Audit Reports

D. Credit risk rating: Draw up rating for (i) Working Capital and (ii) Term Finance.

E. Opinion Reports: Compile opinion reports on the company, partners/ promoters and the proposed guarantors.

F. Existing charges on assets of the unit: If a company, report on search of charges with ROC.

G. Structure of facilities and Terms of Sanction:

Fix Terms and conditions for exposures proposed - facility wise and overall:

Limit for each facility – sub-limits

Security - Primary & Collateral, Guarantee Margins - For each facility as applicable Rate of interest Rate of commission/exchange/other fees Concessional facilities and value thereof Repayment Terms, where applicable ECGC cover where applicable Other standard covenants

H. Review of the proposal:

Review of the proposal should be done covering (i) strengths and weaknesses of the exposure proposed (ii) risk factors and steps proposed to mitigate them

(ii) Deviations, if any, proposed from usual norms of the Bank and the reasons therefore

I. Proposal for sanction:

Prepare a draft proposal in prescribed format with required backup details and with recommendations for sanction

J. Assistance to Assessment:

Interact with the assessor, provide additional inputs arising from the assessment, incorporate these and required modifications in the draft proposal and generate an integrated final proposal for sanction.

2. Assessment :

Indicative List of Activities Involved in Assessment Function is given below:

Review the draft proposal together with the back-up details/notes, and the borrower’s application, financial statements and other reports/documents examined by the appraiser.

Interact with the borrower and the appraiser. Carry out pre-sanction visit to the applicant company and their

project/factory site. Peruse the financial analysis (Balance Sheet/ Operating Statement/ Ratio

Analysis/ Fund Flow Statement/ Working Capital assessment/Project cost & sources/

Break Even analysis/Debt Service/Security Cover, etc.) to see if this is prima

facie in order. If any deficiencies are seen, arrange with the appraiser for the analysis on the correct lines.

Examine critically the following aspects of the proposed exposure.

o Bank’s lending policy and other guidelines issued by the Bank from time to time

o RBI guidelineso Background of promoters/ senior managemento Inter-firm comparisono Technology in use in the companyo Market conditionso Projected performance of the borrower vis-à-vis past estimates and

performanceo Viability of the projecto Strengths and Weaknesses of the borrower entity.o Proposed structure of facilities.o Adequacy/ correctness of limits/ sub limits, margins, moratorium and

repayment scheduleo Adequacy of proposed security cover o Credit risk ratingo Pricing and other charges and concessions, if any, proposed for the facilitieso Risk factors of the proposal and steps proposed to mitigate the risko Deviations proposed from the norms of the Bank and justifications therefore To the extent the inputs/comments are inadequate or require modification,

arrange for additional inputs/ modifications to be incorporated in the proposal, with any required modification to the initial recommendation by the Appraiser

Arrange with the Appraiser to draw up the proposal in the final form. Recommendation for sanction: Recapitulate briefly the conclusions of the

appraisal and state whether the proposal is economically viable. Recount briefly the value of the company’s (and the Group’s) connections. State whether, all considered, the proposal is a fair banking risk. Finally, give recommendations for grant of the requisite fund-based and non-fund based credit facilities.

3. Sanction:

Indicative list of activities involved in the sanction function is given below:

Peruse the proposal to see if the report prima facie presents the proposal in a comprehensive manner as required. If any critical information is not provided in the proposal, remit it back to the Assessor for supply of the required data/clarifications.

Examine critically the following aspects of the proposed exposure in the light of corresponding instructions in force:

Bank’s lending policy and other relevant guidelines RBI guidelines Borrower’s status in the industry Industry prospects Experience of the Bank with other units in similar industry Overall strength of the borrower Projected level of operations Risk factors critical to the exposure and adequacy of safeguards proposed There against Value of the existing connection with the borrower Credit risk rating Security, pricing, charges and concessions proposed for the exposure and

covenantso Stipulated vis-à-vis the risk perception.

Accord sanction of the proposal on the Terms proposed or by stipulating modified or additional conditions/ safeguards, or Defer decision on the proposal and return it for additional data/clarifications, or Reject the proposal, if it is not acceptable, setting out the reasons.

Loan administration - Post sanction Credit process.Need

Lending decisions are made on sound appraisal and assessment of credit worthiness. Past record of satisfactory performance and integrity are no guarantee for future though they serve as a useful guide to project the trend in performance. Credit assessment is made based on promises and projections. A loan granted on the basis of sound appraisal may go bad because the borrower did not carry out his promises regarding performance. It is for this reason that proper follow up and supervision is essential. A banker cannot take solace in sufficiency of security for his loans. He has to -

a) Make a proper selection of borrower

b) Ensure compliance with terms and conditionsc) Monitor performance to check continued viability of operationsd) Ensure end use of funds.e) Ultimately ensure safety of funds lent.

Stages of post sanction process

The post-sanction credit process can be broadly classified into three stages viz., follow-up, supervision and monitoring, which together facilitate efficient and effective credit management and maintaining high level of standard assets. The objectives of the three stages of post sanction process are detailed below.

Types of Lending Arrangements

IntroductionBusiness entities can have various types of borrowing arrangements. They are

One Borrower – One Bank One Borrower – Several Banks (with consortium arrangement) One Borrower – Several Banks (without consortium arrangements –

Multiple Banking One Borrower – Several Banks (Loan Syndication)

One BankThe most familiar amongst the above for smaller loans is the One Borrower-One Bank arrangement where the borrower confines all his financial dealings with only one bank.

Sometimes, units would prefer to have banking arrangements with more than one bank on account of the large financial requirement or the resource constraint of his own banker or due to varying terms & conditions offered by different banks or for sheer administrative convenience. The advantages to the bank in a multiple banking arrangement/ consortium arrangement are that the exposure to an

individual customer is limited & risk is proportionate. The bank is also able to spread its portfolio. In the case of borrowing business entity, it is able to meet its funds requirement without being constrained by the limited resource of its own banker. Besides this, consortium arrangement enables participating banks to save manpower & resources through common appraisal & inspection & sharing credit information.The various arrangements under borrowings from more than one bank will differ on account of terms & conditions, method of appraisal, coordination, documentation & supervision & control.

Consortium LendingWhen one borrower avails loans from several banks under an arrangement among all the lending bankers, this leads to a consortium lending arrangements. In consortium lending, several banks pool banking recourses & expertise in credit management together & finance a single borrower with a common appraisal, common documentation & joint supervision & follow up. The borrower enjoys the advantage similar to single window availing of credit facilities from several banks. The arrangement continues until any one of the bank moves out of the consortium.The bank taking the highest share of the credit will usually be the leader of consortium. There is no ceiling on the number of banks in a consortium.

Multiple Banking ArrangementMultiple Banking Arrangement is one where the rules of consortium do not apply & no inter se agreement among banks exists. The borrower avails credit facility from various banks providing separate securities on different terms & conditions. There is no such arrangement called ‘Multiple Banking Arrangement’ & the term is used only to denote the existence of banking arrangement with more than one bank. Banking Arrangement has come to stay as it has some advantages for the borrower & the banks have the freedom to price their credit products & non-fund based facility according to their commercial judgment. Consortium arrangement occasioned delays in credit decisions & the borrower has found his way around this difficulty by the multiple banking arrangement. Additionally, when units were not doing well, consensus was rarely prevalent among the consortium members. If one bank wanted to call up the advance & protect the security, another bank was interested in continuing the facility on account of group considerations.

Points to be noted in case of multiple banking arrangements Though no formal arrangement exists among the financing banks, it is

preferable to have informal exchange of information to ensure financial discipline

Charges on the security given to the bank should be created with utmost care to guard against dilution in our security offered & to avoid double financing

Certificates on the outstanding with the other banks should be obtained on the periodical basis & also verified from the Balance sheet of the unit to avoid excess financing

Credit SyndicationA syndicated credit is an agreement between two or more lending institutions to provide a borrower a credit facility using common loan documentation. It is a convenient mode of raising long-term funds.

The borrower mandates a lead manager of his choice to arrange a loan for him. The mandate spells out the terms of the loan & the mandated bank’s rights & responsibilities.The mandated banker – the lead manger – prepares an information memorandum & Circulates among prospective lender banks soliciting their participation in the loan. On the basis of the memorandum & on their own independent economic & financial evolution the leading banks take a view on the proposal. The mandated bank convenes the meeting to discuss the syndication strategy relating to coordination, communication & control within the syndication process & finalizes deal timing, management fees, cost of credit etc. The loan agreement is signed by all the participating banks. The borrower is required to give prior notice to the lead manger about loan withdrawls to enable him to tie up disbursements with the other lending banks.

Features of syndicated loans Arranger brings together group of banks Borrower is not required to have interface with participating banks, thus

easy & hassle fee Large loans can be raised through syndication by accessing global markets For the borrower, the competition among the lenders leads to finer terms Risk is shared Small banks can also have access to large ticket loans & top class credit

appraisal & management

Advantages

Strict, time-bound delivery schedule & withdrawals

Streamlined process of documentation with clearly laid down roles & responsibilities

Market driven pricing linked to the risk perception Competitive pricing but scope for fee-based income is also available Syndicated portions can be sold to another bank, if required Fixed repayment schedule & strict monitoring of default by markets which

punish indiscipline