A STUDY ON RISK INVOLVED IN CREDIT MANAGEMENT

OF SBI KOCHI, 2013-14

CHAPTER 1INTRODUCTION

Background of topic

Credit risk is defined as the potential that a bank borrower or counterparty will fail to

meet its obligations in accordance with agreed terms, or in other words it is defined as

the risk that a firm’s customer and the parties to which it has lent money will fail to

make promised payments is known as credit risk

The exposure to the credit risks large in case of financial institutions, such commercial

banks when firms borrow money they in turn expose lenders to credit risk, the risk that

the firm will default on its promised payments. As a consequence, borrowing exposes

the firm owners to the risk that firm will be unable to pay its debt and thus be forced to

bankruptcy.

Banking in our country is already witnessing the sea changes as the banking sector

seeks new technology and its applications. The best port is that the benefits are

beginning to reach the masses. Financial Institutions mainly Banks play a pivotal role in

matching a depositor and lenders and channeling money and making the economy more

efficient. Although there are different types of banks specialized for different purposes

and with different brands and capital structure, they are regulated by standards such as

the BASEL standards (to keep a minimum amount of capital) BASEL II etc.

Currently (2007), the overall banking in India is considered as fairly mature in terms of

supply, product range and reach - even though reach in rural India still remains a

challenge for the private sector and foreign banks. Even in terms of quality of assets and

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Capital adequacy, Indian banks are considered to have clean, strong and transparent

balance sheets - as compared to other banks in comparable economies in its region.

Credit risk (or counterparty risk) is increasingly faced by banks in their product

assortment (not only lending) and can be considered as the oldest and largest risk in

banking. Important in a bank relationship is the “know your client principle”, by

becoming familiar with the borrower and/or credit base. It is important that banks deal

with customers with sound reputation and creditworthiness. Therefore, banks need not

only manage the credit risk in their credit portfolio but also that in any individual credit

or transaction.

The relationship between credit risk and other risks should also be considered by banks.

The effective management of credit risk is a critical component of a comprehensive

approach to risk management and important to the long-term success of any banking

organization. Effective credit risk management process is a way to manage portfolio of

credit facilities.

Credit risk management encompasses identification, measurement, monitoring and

control of the credit risk exposures. The effective management of credit risk is a critical

component of comprehensive risk management and essential for the long term success

of a banking organisation.

The objectives of credit risk management are to:

Evolve an integrated framework for charting/categorising various types of loans

and

advances, and determine implications on quality of credit and risk.

Draw up suitable strategies at the corporate level to attain the prescribed

levels/quality of exposure and issue guidelines to Strategic Business Units

(SBUs). Benchmarks could be in term of recovery percentages, NPA levels,

volume of exposure, etc.

Review the exposures and performance periodically.

2

Devise suitable control/monitoring mechanisms.

Evolve and refine analytical tools to assess risk profiles, for ensuring healthy

portfolios and guarding against sickness.

Commercial banking plays a dominant role in commercial lending. Commercial banks

routinely perform investment banking activities in many countries by providing new

debt to their customers. The credit creation process works smoothly when funds are

transferred from ultimate savers to borrower. There are many potential sources of risk,

including liquidity risk, credit risk, interest rate risk, market risk, foreign exchange risk

and political risks. However, credit risk is the biggest risk faced by banks and financial

intermediaries. The credit risk’s indicators include the level of non- performing loans,

problem loans or provision for loan losses. Credit risk is the risk that a loan which has

been granted by a bank will not be either partially repaid on time or fully and where

there is a risk of customer or counterparty default. Credit risk management processes

enforce the banks to establish a clear process in for approving new credit as well as for

the extension to existing credit. These processes also follow monitoring with particular

care, and other appropriate steps are taken to control or mitigate the risk of connected

lending.

Credit granting procedure and control systems are necessary for the assessment of loan

application, which then guarantees a bank’s total loan portfolio as per the bank’s overall

integrity. It is necessary to establish a proper credit risk environment, sound credit

granting processes, appropriate credit administration, measurement, monitoring and

control over credit risk, policy and strategies that clearly summarize the scope and

allocation of bank credit facilities as well as the approach in which a credit portfolio is

managed i.e. how loans are originated, appraised, supervised and collected, a basic

element for effective credit risk management. Credit scoring procedures, assessment of

negative events probabilities, and the consequent losses given these negative migrations

or default events, are all important factors involved in credit risk management systems.

Most studies have been inclined to focus on the problems of developing an effective

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method for the disposal of these bad debts, rather than for the provision of a regulatory

and legal framework for their prevention and control.

The management of credit risk should receive the top management’s attention and the

process should encompass:

Measurement of risk through credit rating/scoring;

Risk pricing on a scientific basis;

Controlling the risk through effective Loan Review Mechanism and portfolio

management; and

Quantifying the risk through estimating expected loan losses i.e. the amount of loan

losses that bank would experience over a chosen time horizon (through tracking

portfolio behaviour over 5 or more years) and unexpected loan losses i.e. the

amount by which actual losses exceed the expected loss (through standard deviation

of losses or the difference between expected loan losses and some selected target

credit loss quantile).

A survey conducted in the United States found credit risk management as the best

practice in bank and above 90% of the bank in country have adopted the best practice.

Inadequate credit policies are still the main source of serious problem in the banking

industry as result effective credit risk management has gained an increased focus in

recent years. The main role of an effective credit risk management policy must be to

maximize a bank’s risk adjusted rate of return by maintaining credit exposure within

acceptable limits. Moreover, banks need to manage credit risk in the entire portfolio as

well as the risk in individual credits transactions.

Credit risk consists of primarily two components, viz, quantity of risk, which is nothing

but the outstanding loan balance as on the date of default and the quality of risk, viz, the

severity of loss defined by both probability of default as reduced by the recoveries that

could be made in the event of default. Thus credit risk is a combined outcome of

Default Risk and Exposure Risk.

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RBI expects that banks take specific measures, mainly at the Corporate Level, for

implementing appropriate Credit Risk Management Systems in the bank. The policy

will involve the following:

Policy framework

Credit rating framework

Credit risk models

Portfolio management and Risk Limits

Managing Credit Risk in Inter-Bank Exposure

Credit Risk in Off-Balance Sheet Exposure

Country Risk

Loan Review Mechanism/Credit Audit

RAROC(Risk adjusted return on capital) pricing/Economic profit

Basel II Accord: Implications for Credit Risk Management

The banks are required to

Ensure that their Risk Management functions considers the above issues as

applicable to the bank and put in place appropriate structures/systems. This will

ensure that Risk Based Supervision (RBS) is effective.

Each bank must have a Credit Rating Framework to suit their requirements.

To implement effective credit risk management practice private banks are more serious

than state owned banks. A survey conducted by Kuo & Enders (2004) of credit risk

management policies for state banks in China and found that mushrooming of the

financial market; the state owned commercial banks in China are faced with the

unprecedented challenges and tough for them to compete with foreign bank unless they

make some thoughtful change. In this thoughtful change, the reform of credit risk

management is a major step that determines whether the state owned commercial banks

in China would survive the challenges or not.

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1.1 LITERATURE REVIEW

Commercial banking plays a dominant role in commercial lending (Allen and Gale

20114). Commercial banks routinely perform investment banking activities in many

countries by providing new debt to their customers (Gande 2008). The credit creation

process works smoothly when funds are transferred from ultimate savers to borrower

(Bernanke 1993). There are many potential sources of risk, including liquidity risk,

credit risk, interest rate risk, market risk, foreign exchange risk and political risks

(Campbell, 2007). However, credit risk is the biggest risk faced by banks and financial

intermediaries (Gray, Cassidy, & RBA., 1997). The credit risk’s indicators include the

level of non- performing loans, problem loans or provision for loan losses (Jimenez &

Saurina, 2006). Credit risk is the risk that a loan which has been granted by a bank will

not be either partially repaid on time or fully and where there is a risk of customer or

counterparty default. Credit risk management processes enforce the banks to establish a

clear process in for approving new credit as well as for the extension to existing credit.

These processes also follow monitoring with particular care, and other appropriate steps

are taken to control or mitigate the risk of connected lending (Basel,1999).

Credit granting procedure and control systems are necessary for the assessment of loan

application, which then guarantees a bank’s total loan portfolio as per the bank’s overall

integrity (Boyd, 1993). It is necessary to establish a proper credit risk environment,

sound credit granting processes, appropriate credit administration, measurement,

monitoring and control over credit risk, policy and strategies that clearly summarize the

scope and allocation of bank credit facilities as well as the approach in which a credit

portfolio is managed i.e. how loans are originated, appraised, supervised and collected,

a basic element for effective credit risk management (Basel, 1999). Credit scoring

procedures, assessment of negative events probabilities, and the consequent losses

given these negative migrations or default events, are all important factors involved in

credit risk management systems (Altman, Caouette, & Narayanan, 1998). Most studies

have been inclined to focus on the problems of developing an effective method for the

6

disposal of these bad debts, rather than for theprovision of a regulatory and legal

framework for their prevention and control (Campbell, 2007). Macaulay (1988)

conducted a survey in the United States and found credit risk management is best

practice in bank and above 90% of the bank in country have adopted the best practice.

Inadequate credit policies are still the main source of serious problem in the banking

industry as result effective credit risk management has gained an increased focus in

recent years. The main role of an effective credit risk management policy must be to

maximize a bank’s risk adjusted rate of return by maintaining credit exposure within

acceptable limits. Moreover, banks need to manage credit risk in the entire portfolio as

well as the risk in individual credits transactions. To implement effective credit risk

management practice private banks are more serious than state owned banks. A survey

conducted by (Kuo & Enders 2004) of credit risk management policies for state banks

in China and found that mushrooming of the financial market; the state owned

commercial banks in China are faced with the unprecedented challenges and

tough for them to compete with foreign bank unless they make some thoughtful change.

In this thoughtful change, the reform of credit risk management is a major step that

determines whether the state owned commercial banks in China would survive the

challenges or not. Research however faults some of the credit risk management policies

in place the broad framework and detailed guidance for credit risk assessment and

management is provided by the Basel New Capital Accord which is now widely

followed internationally (Campbell, 2007)

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1.2 THEORETICAL BACKGROUND

CREDIT

The word ‘credit’ comes from the Latin word ‘credere’, meaning ‘trust’. When sellers

transfer his wealth to a buyer who has agreed to pay later, there is a clear implication of

trust that the payment will be made at the agreed date. The credit period and the amount

of credit depend upon the degree of trust.

Credit is an essential marketing tool. It bears a cost, the cost of the seller having to

borrow until the customers payment arrives. Ideally, that cost is the price but, as most

customers pay later than agreed, the extra unplanned cost erodes the planned net profit.

RISK

Risk is defined as uncertain resulting in adverse outcome, adverse in relation to planned

objective or expectation. It is very difficult o find a risk free investment. An important

input to risk management is risk assessment. Many public bodies such as advisory

committees concerned with risk management. There are mainly three types of risk they

are follows:

• Market risk • Credit Risk • Operational risk

Risk analysis and allocation is central to the design of any project finance, risk

management is of paramount concern. Thus quantifying risk along with profit

projections is usually the first step in gauging the feasibility of the project. Once risks

have been identified they can be allocated to participants and appropriate mechanisms

put in place.

MARKET RISK

Market risk is the risk of adverse deviation of the mark to market value of the trading

portfolio, due to market movement, during the period required to liquidate the

transactions.

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OPERATIONAL RISK

Operational risk is one area of risk that is faced by all organizations. More complex the

organization more exposed it would be operational risk. This risk arises due to deviation

from normal and planned functioning of the system procedures, technology and human

failure of omission and commission. Result of deviation from normal functioning is

reflected in the revenue of the organization, either by the way of additional expenses or

by way of loss of opportunity. Technical breakdown and change in staff also account

for the operational risk.

CREDIT RISK

Credit risk is defined as the potential that a bank borrower or counterparty will fail to

meet its obligations in accordance with agreed terms, or in other words it is defined as

the risk that a firm’s customer and the parties to which it has lent money will fail to

make promised payments is known as credit risk.

The exposure to the credit risks large in case of financial institutions, such commercial

banks when firms borrow money they in turn expose lenders to credit risk, the risk that

the firm will default on its promised payments. As a consequence, borrowing exposes

the firm owners to the risk that firm will be unable to pay its debt and thus be forced to

bankruptcy.

CONTRIBUTORS OF CREDIT RISK • Corporate assets • Retail assets • Non-SLR portfolio • In case of guarantees, Letter of credit and Letter of comfort • Securities trading business • Treasury operations • Derivatives • Cross border exposure • Collaterals accepted by the bank • Settlement, etc

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KEY ELEMENTS OF CREDIT RISK MANAGEMENT 1.2 Establishing appropriate credit risk environment 1.3 Operating under sound credit granting process 1.4 Maintaining an appropriate credit administration, measurement & Monitoring 1.5 Ensuring adequate control over credit risk 1.6 Banks should have a credit risk strategy which in our case is

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Credit rating

Definition

Credit rating is the process of

assigning a letter rating to

borrower indicating that

creditworthiness of the borrower.

Rating is assigned based on the

ability of the borrower

(company).To repay the debt and

his willingness to do so.The higher

rating of company the lower the

probability of its default.

Use in decision making Credit rating helps the bank in making several key decisions regarding credit including

1. whether to lend to a particular

borrower or not; what price to

charge?

2. what are the product to be offered

to the borrower and for what

tenure?

3. at what level should sanctioning be

done, it should however be noted

that credit rating is one of inputs

used in credit decisions.

There are various factors (adequacy of

borrowers, cash flow, collateral provided,

and relationship with the

borrower).Probability of the borrowers

default based on past data.

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Main features of the rating tool:-

comprehensive coverage of

parameters extensive data

requirement mix of subjective

and objective parameters

includes trend analysis

parameters are benchmarked

against other players in the

segment captions of industry

outlook grade ratings broadly

mapped with external rating

agencies prevailing data.

Rating tool for SME

Internal credit ratings are the summary

indicators of risk for the bank’s individual

credit exposures. It plays a crucial role in

credit risk management architecture of any

bank and forms the cornerstone of

approval process.

Based on the guidelines provided by

Boston Consultancy Group (BCG), SBI

adopted credit rating tool.

The rating tool for SME borrower assigns

the following Weight ages to each one of

the four main categories i.e

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(i) Scenario (I) : without monitoring tool

S No Parameters Weightages (%)

1 financial performance XXXX

2 operating performance XXXX

3 quality of management XXXX

4 industry outlook XXXX

(ii). Scenario (II): with monitoring tool

[conduct of account]:- the weight age

would be conveyed separately on roll out

of the tool. In the above parameters first

three parameters used to know the

borrower characteristics. In fourth

encapsulates the risk emanating from the

environment in which the borrower

operates and depends on the past

performance of the industry its future

outlook and macro economic factors.

Operating performance

S No Sub parameters

1. credit period allowed

2. credit period availed

3. working capital cycle

4. Tax incentives

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5. production related risk

6. product related risk

7. price related risk

8. client risk

9. fixed asset turnover

Total

Quality of management

S No sub parameters

1. Hy / Track record of industrial unrest

2 market report of management reputation

3 history of FERA violation / ED enquiry

4 Too optimistic projections of sales and other financials

5 technical and managerial expertise

6 capability to raise money

Total

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IN STATE BANK OF INDIA

DFFERENT PARAMETERS USED TO

GIVE RATINGS AREAS FOLLOWS:-

FINANCIAL PARAMETERS

S.NO Indicator/ratio

F1(a) Audited net sales in last year

F2(b) Audited net sales in year before last

F1(c) Audited net sales in 2 year before last

F1(d) Audited net sales in 3 year before last

F1(e) Estimated or projected net sales in next year

F2 NET SALES GROWTH RATE(%)

F3 PBDIT growth rate(%)

F4 Net sales(%)

F5 ROCE(%)

F6 TOL/TNW

F7 Current ratio

F8 DSCR

F9 Interest coverage ratio

F10 Foreign exchange risk

F11 Reliability of debtors

F12 Operating cash flow

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F13 Trend in cash accruals

BUSINESS PARAMETERS

S.NO Indicator/ratio

B1 Credit period allowed(days)

B2 Credit period availed(days)

B3 Working capital cycle(times)

B4 Production related risks

B5 Product related risks

B6 Price related risks

B7 Fixed assets turnover

B8 No. of yeas in business

B9 Nature of clientele base

MANAGEMENT PARAMETERS

SR. NO INDICATOR/RATIO

M1 HR policy

M2 Track record in payment of statutory and other dues

M3 Market report of management reputation

M4 Too optimistic projections of sales and other financials

M5 Capability to raise resources

M6 Technical and managerial expertise

M7 Repayment track record

CONDUCT PARAMETERS

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A1 Creation of charges on primary security

A2Creation of charges on collateral and execution of personal orcorporate guarantee

A3 Proper execution of documents

A4 Availability of search report

A5 Other terms and conditions not complied with

A6 Receipt of periodical data

A7 Receipt of balance sheet

B1Negative deviation in half yearly net sales vis-à-vis proportionateEstimates

B2 Negative deviation in annual net sales vis-à-vis estimates

B3Negative deviation in half yearly net profit vis-à-vis proportionateEstimates

B4Adverse deviation in inventory level in months vis-à-vis estimateLevel

B5Adverse deviation in receivables level in months vis-à-visestimated level

B6 Quality of receivable assess from profile of debtors

B7Adverse deviation in creditors level in months vis-à-vis estimatedLevel

B8 Compliance of financial covnants

B9 Negative deviation in annual net profit vis-à-vis estimates

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C1 Audit report internal/statutory/concurrent/RBI

C2Conduct of account with other banks/lenders and information onconsortium

D1 Routing of proportionate turnover/business

D2 Utilization of facilities(not applicable for term loan)

D3Over due discounted bills during the period under review within thesanctioned terms then not applicable

D4Devolved bill under L/c outstanding during the period under review

D5Invoked BGs issued outstanding during the period under review

D6Intergroup transfers not backed by trade transactions during the periodunder review

D7Frequency of return of cheques per quarter deposited by borrower

D8Frequency of issuing cheques per quarter without sufficient balance andreturned

D9 Payment of interest or instalments

D10Frequency of request for AD HOC INCREASE OF LIMIS during the lastone year

D11 Frequency of over drawings CC account

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E1Status of deterioration

in value of primary security or stock depletion

E2Status of deterioration in value of collateral security

E3 Status of deterioration in personal net worth and TNW

E4 Adequacy of insurance for the primary /collateral security

F1 Labor situation/industrial relations

F2 Delay or default in payments of salaries and statutory dues

F3 Non co-operation by the borrower

F4 Intended end-use of financing

F5Any other adverse feature/snon financial including corporate governanceissues suchasadverse publicity, strictures from regulators, pitical risk andadverse trade environment not covered

Difficulty of measuring credit risk

Measuring credit risk on a

portfolio basis is difficult. Banks and

financial institutions traditionally

measure credit exposures by obligor and

industry. They have only recently

attempted to define risk quantitatively in

a portfolio context e.g., a value-at-risk

(VaR) framework. Although banks and

financial institutions have begun to

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develop internally, or purchase, systems

that measure VaR for credit, bank

managements do not yet have confidence

in the risk measures the systems produce.

In particular, measured risk levels

depend heavily on underlying

assumptions and risk managers often do

not have great confidence in those

parameters. Since credit

derivatives exist principally to allow for

the effective transfer of credit risk, the

difficulty in measuring credit risk and the

absence of confidence in the result of risk

measurement have appropriately made

banks cautious about the use of banks and

financial institutions internal credit risk

models for regulatory capital purposes.

Credit Risk

The most obvious risk derivatives

participants’ face is credit risk. Credit

risk is the risk to earnings or capital of an

obligor’s failure to meet the terms of any

contract the bank or otherwise to perform

as agreed. For both purchasers and sellers

of protection, credit derivatives should be

fully incorporated within credit risk

management process. Bank management

should integrate credit derivatives activity

in their credit underwriting and

20

administration policies, and their

exposure measurement, limit setting, and

risk rating/classification processes. They

should also consider credit derivatives

activity in their assessment of the

adequacy of the allowance for loan and

lease losses (ALLL) and their evaluation

of concentrations of credit.

There a number of credit risks for

both sellers and buyers of credit

protection, each of which raises separate

risk management issues. For banks and

financial institutions selling credit

protection the primary source of credit is

the reference asset or entity.

APPRAISAL OF THE FIRMS

POSITION ON BASIS OF OTHER

PARAMETERS

1. Managerial Competence

2. Technical Feasibility

3. Commercial viability

4. Financial Viability

Managerial Competence

Back ground of promoters Experience

Technical skills, Integrity & Honesty

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Technical Feasibility

Location

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Size of

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Commercial Viability

23

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Pricing policies Competition

Export policies

Financial Viability

Whether adequate funds are

available at affordable cost to

implement the project Whether

sufficient profits will be

available

Whether BEP or margin of safety are

satisfactory

What will be the overall financial position

of the borrower in coming years.

Credit investigation report

Branch prepares Credit

investigation report in order to avoid

25

consequence in later stage Credit

investigation report should be a part of

credit proposal. Bank has to submit the

duly completed credit investigation reports

after conducting a detailed credit

investigation as per guidelines.

Some of the guidelines in this regards as

follow:

Wherever a proposal is to be considered

based only on merits of flagships concerns

of the group, then such support should also

be compiled in respect of subject flagship

in concern besides the applicant company.

In regard of proposals falling beyond

the power of rating officer, the branch

should ensure participation of rating

officer in compilation of this report.

The credit investigation report should

accompany all the proposals with the

fund based limit of above 25 Lakhs and

or non fund based of above Rs. 50

Lakhs.

The party may be suitably kept

informed that the compilation of this

report is one of the requirements in the

connection with the processing for

consideration of the proposal.

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The branch should obtain a copy of

latest sanction letter by existing banker

or the financial institution to the party

and terms and conditions of the

sanction should

studied in detail.

Comments should be made wherever

necessary, after making the

observations/lapses in the following

terms of sanction.

Some of the important factors like

funding of interest, re schedule of loans

etc terms and conditions should be

highlighted.

Copy of statement of accounts for the

latest 6 months period should be

obtained by the bank. To get the

present condition of the party.

Remarks should be made by the bank

on adverse features observed. (e.g.,

excess drawings, return of cheques

etc).

27

Personal enquiry should be made by

the bank official with responsible

official of party’s present / other

bankers and enquiries should be made

with a elicit information on conduct of

account etc.

Care should be taken in selection of

customers or creditors who acts as the

representative. They should be

interviewed and compilation of opinion

should be done.

Enquiries should be made regarding the

quality of product, payment

terms, and period of overdue which

should be mentioned clearly in the

report. Enquiry should be aimed to

ascertain the status of trading of the

applicant and to know their capability to

meet their commitments in time.

To know the market trend branch

should enquire the person or industry

that is in the same line of business

activity.

In depth observation may be made of the

applicant as to :

- whether the unit is working in full

swing

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- number of shifts and number of

employees

- any obsolete stocks with the unit

- capacity of the unit

- nature and conditions of the machinery

installed

- Information on power, water and

pollution control etc.

- information on industrial relation and

marketing strategy

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CRA Proposal

The proposal is made considering

3 years balance sheet of a company to

arrive at a pricing based on its current

rating. It includes many parameters.

Illustration: A model of a CRA

proposal

Memorandum for the committee of CRA

validation

1. CRA model used: Choose one form

a. Trading

b. Non – trading ( Regular)

c. Non – trading regular

( Diamond)

2. Borrower details (Name)

3. Particulars of CRA

a. Borrower Rating

i. Before country risk

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ii. Final after country

risk

b. External Rating

4. Proposal for validation of

a. Borrower rating

b. Facility rating

5. Credit limits

6. Brief particulars of the borrower

a. Age, Succession planning

b. Collateral, Management

c. Name of the directors

d. Associate / Sister / Group

company

7. Validation

a. Performance and financial

indicators

b. Comments on variance in

values

c. Performance under other

relevant factors

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i. Net Sales as a

percentage of

estimated net sales

ii. Profit as a

percentage of

estimated net profit

d. Moving average of

company’s last 3 years ratio

e. Details in terms of loan.

8. Quarterly Sales

a. Growth %

b. Average Growth

9. Comments on

a. Financial flexibility of the

company

i. Raise funds through

internal sources like

internal accruals,

scalable assets.

ii. Raise resources

through external

sources based on

the relationship

32

with banker,

liquidity back up

etc.

iii. Record in raising funds from capital market.

iv. Flexibility to defer its capex in case of weakening financial position etc.

b. Forex business details

c. Country risk

d. Justification for giving abnormal high or low

10.Conduct of Account ( Last 12 months)

11.Future Prospects

12.Entry Barriers

13.Details of security available

14.CRMD guidelines on industry

outlook

15. Non – compliance with

regulation to bank’s laid down

instruction with regard to loan

policy guidelines / Earlier

prescription of sanctioning

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authority / RMD exposure norms /

Figuring in RBI / ECGC defaulters

list / Major I & A audit

irregularities / Other risk factors etc.

16. Qualitative factors

17. Hurdle scores comparison

18.Risk Score

19.Certificate

20.Recommendation

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CHAPTER 2

RESEARCH METHODOLOGY

The research was taken in the light to

study the risk involved in credit

management in SBI Kochi. The research

was undertaken with the aim of getting an

eagle’s view of how SBI manage the credit

risk.

OBJECTIVES OF THE STUDY

To study the credit policies of SBI

To compare the loans and advances

of SBI with other public and

private sector banks

To analyze the credit recovery

management of SBI

To study the priority sector

advances of SBI in comparison

with other public sector banks

SCOPE AND LIMITATIONS

SCOPE

35

It covers the key performing

banks in the public and private

banking sectors.

The project has been from the

angle of SBI Bank.

The study only covers SBI

branch in Cochin.

LIMITATIONS

Only secondary data was used.

Study was limited to Kochi city

Only few banks were considered

The major limitation was time

constraint which was only one

months, but still efforts have been

made to put the picture as clear and

candid as possible.

Type of research:

We would select the conclusive method in

which we would go for descriptive

research design.

Descriptive research design is more

structured and formal in nature. The

objective of these studies is to provide a

comprehensive and detailed explanation of

the phenomena under study. Descriptive

research, used often in social sciences and

market research, is the study of how a

particular group, person, or thing behaves.

Observations are noted without influence.

36

Data Requirement:

We would consider secondary data.

Secondary data:

Secondary data is data collected by

someone other than the user. Common

sources of secondary

data include censuses, organizational

records and data collected through

qualitative methodologies or qualitative

research. The investigator conducting the

research collects primary data. Secondary

data analysis saves time that would

otherwise be spent collecting data and,

particularly in the case of quantitative data,

provides larger and higher-

quality databases that would be unfeasible

for any individual researcher to collect on

their own.

Types of data:

We would select only qualitative data.

Qualitative data: Dept interview

Data collection Plan:

By telephonic interview with the

AGM of SBI

By visiting websites like

www.sbi.co.in, www.rbi.org,

37

moneycontrol.com and

www.indiainfoline.com

Sampling Plan:

Target population:

Top level officers and bank managers.

Sampling technique:

We are planning to go for convenience

sampling technique.

Convenience sampling technique:

Convenience sampling is a non-probability

sampling technique where subjects are

selected because of their convenient

accessibility and proximity to the

researcher.

38

CHAPTER 3

COMPANY PROFILE

3.1 STATE BANK OF INDIA

State Bank of India (SBI) is a multinational banking and financial services company based in

India. It is a government-owned corporation with its headquarters in Mumbai, Maharashtra. As

of December 2013, it had assets of US$388 billion and 17,000 branches, including 190 foreign

offices, making it the largest banking and financial services company in India by assets. The

bank traces its ancestry to British India, through the Imperial Bank of India, to the founding in

1806 of the Bank of Calcutta, making it the oldest commercial bank in the Indian Subcontinent.

Bank of Madras merged into the other two presidency banks—Bank of Calcutta and Bank of

Bombay—to form the Imperial Bank of India, which in turn became the State Bank of

India. Government of India owned the Imperial Bank of India in 1955, with Reserve Bank of

India taking a 60% stake, and renamed it the State Bank of India. In 2008, the government took

over the stake held by the Reserve Bank of India.SBI is a regional banking behemoth and has

20% market share in deposits and loans among Indian commercial banks.

SBI has five associate banks, all use the State Bank of India logo, which is a blue circle, and all

use the "State Bank of" name, followed by the regional headquarters' name:

State Bank of Bikaner & Jaipur

State Bank of Hyderabad

State Bank of Mysore

State Bank of Patiala

State Bank of Travancore

State Bank of India is the largest state-owned banking and financial services company in India.

The Bank provides banking services to the customer. In addition to the banking services, the

39

Bank through their subsidiaries, provides a range of financial services, which include life

insurance, merchant banking, mutual funds, credit card, factoring, security trading, pension fund

management and primary dealership in the money market. The Bank operates in four business

segments, namely Treasury, Corporate/ Wholesale Banking, Retail Banking and Other Banking

Business. The Treasury segment includes the investment portfolio and trading in foreign

exchange contracts and derivative contracts. The Corporate/ Wholesale Banking segment

comprises the lending activities of Corporate Accounts Group, Mid Corporate Accounts Group

and Stressed Assets Management Group. The Retail Banking segment consists of branches in

National Banking Group, which primarily includes personal banking activities, including lending

activities to corporate customers having banking relations with branches in the National Banking

Group. SBI provides a range of banking products through their vast network of branches in India

and overseas, including products aimed at NRIs. The State Bank Group, with over 16,000

branches, has the largest banking branch network in India. The State bank of India is the 10th

most reputed company in the world according to Forbes. The bank has 156 overseas offices

spread over 32 countries. They have branches of the parent in Colombo, Dhaka, Frankfurt, Hong

Kong, Johannesburg, London and environs, Los Angeles, Male in the Maldives, Muscat, New

York, Osaka, Sydney, and Tokyo. They have offshore banking units in the Bahamas, Bahrain,

and Singapore, and representative offices in Bhutan and Cape Town. State Bank of India was

incorporated in the year 1955.

In 2000 the Bank has embarked upon the expansion of its ATM network in the twin cities of

Hyderabad and Secunderabad. The Bank has become the first government owned financial

institution to join the rank of companies declaring interim dividend. The Bank has proposed to

come out with an issue under private placement of unsecured, non-convertible, subordinated

bonds in the nature of promissory notes of Rs 1 lakh each aggregating Rs 600 crores with an

option to retain oversubscription of up to Rs 40 crores.

SBI provides easy access to money to its customers through more than 8500 ATMs in India. The

Bank also facilitates the free transaction of money at the ATMs of State Bank Group, which

includes the ATMs of State Bank of India as well as the Associate Banks – State Bank of

40

Bikaner & Jaipur, State Bank of Hyderabad, State Bank of Indore, etc. You may also transact

money through SBI. Commercial and International Bank Ltd by using the State Bank ATM-cum-

Debit (Cash Plus) card.

The demographic profile of select customers of State Bank of India reveals that, 67.2 percent of

them are male. In term of age, it is evident that 27.6 percent of the customers are falling in the

age group ranging between 31-40 years. Graduates accounted for 37.6 percent. Business and

profession people dominated the sample with 44.8 percent and 22 percent respectively. In term

of marital status, 87.2 percent of the respondents were married. The income statistics revealed

that 32.8 percent of the customers were earning their income between Rs.2,50,001-

Rs.5,00,000 yearly.

The Banking profile of the customers reveals that 53.2 percent of the select customers maintain

current account in State Bank of India. 53.6 percent of them are having banking experience

ranging between 6-10 years. The convenience of all the customers would be greatly enhanced by

an electronic, 24 hour branch. As a result 90.4 percent of the respondents prefer e-banking rather

then conventional banking system. 59.2 percent of the respondents have e-banking experience

ranging between 1-3 years. 41.6 percent of the respondents use e-banking channels

41

ABOUT LOGO

THE PLACE TO SHARE THE NEWS ...……

SHARE THE VIEWS ……

Togetherness is the theme of this corporate loge of SBI where the world of banking services

meet the ever changing customers needs and establishes a link that is like a circle, it indicates

complete services towards customers. The logo also denotes a bank that it has prepared to do

anything to go to any lengths, for customers.

The blue pointer represent the philosophy of the bank that is always looking for the growth and

newer, more challenging, more promising direction. The key hole indicates safety and security.

42

MISSION, VISION AND VALUES

MISSION STATEMENT:

To retain the Bank’s position as premiere Indian Financial Service Group, with world class

standards and significant global committed to excellence in customer, shareholder and employee

satisfaction and to play a leading role in expanding and diversifying financial service sectors

while containing emphasis on its development banking rule.

VISION STATEMENT:

¨ Premier Indian Financial Service Group with prospective world-class

Standards of efficiency and professionalism and institutional values.

¨ Retain its position in the country as pioneers in Development banking.

¨ Maximize the shareholders value through high-sustained earnings per

Share.

¨ An institution with cultural mutual care and commitment, satisfying and

Good work environment and continues learning opportunities.

43

VALUES:

¨ Excellence in customer service

¨ Profit orientation

¨ Belonging commitment to Bank

¨ Fairness in all dealings and relations

¨ Risk taking and innovative

¨ Team playing

¨ Learning and renewal

¨ Integrity

¨ Transparency and Discipline in policies and systems.

44

CHAPTER 4

ANALYSIS AND INTERPRETATION

Introduction

From this chapter we would be able to analyse and interpret the objectives of the study. The data

like advances amount, loan recovered amount, loan out-standing, etc of different banks in

different years are considered here, which are collected from RBI website, SBI website,

moneycontrol.com website and personally from the branch manager of SBI.

4.1 CREDIT POLICIES OF STATE BANK OF INDIA.

Credit policy:

The credit policy document is a document which carefully specifies the do’s and don'ts

while sanctioning the loan proposals.

As loan proposals differ widely from each other, there cannot be a strict methodology for

accepting or rejecting the proposals.

Instead, guidelines can be given within the credit policy for the decision makers to enable

them to screen out loans, which can be out rightly rejected.

Loans that can be sanctioned without any reference to the top management and proposals

that require a certain amount of top-level decision-making.

The credit policy of a bank consists of five major components.

RBI Guidelines for credit policy:

45

As per RBI’s guidelines at least 40% of the net bank credit should be given to the priority

sector, of which 18% would be for Agriculture and 10% to the weaker sections of the

society.

RBI, NABARD and State Level Bankers Committee (SLBC) govern the credit policy and

procedures with respect to agricultural sector.

Depending on the segments, the policies and procedures could differ substantially.

The introduction of Service Area Approach in 1989 prompted each bank’s branch to

prepare its own Service Area Plan based on the village profile, skills and available

resources. Such Service Area Plans would then be integrated with the annual growth plan

of a bank’s branch.

SBI Credit policy

For the highest rated (AAA) firms, the bank now gives working capital loans at its base

rate, or the minimum lending rate. For the next lot of AA-rated firms, the bank gives

loans at base rate plus 25 basis points, and for BBB-rated loans, the working capital loans

are given at base rate plus 0.65 basis points. A basis point is one-hundredth of a

percentage point.

4.1 THE TABLE BELOW SHOWS ADVANCES OF PUBLIC SECTOR BANKS TO PRIORITY SECTOR PERCENT.

Name of the Bank Percent

Total agricultural advances (%)

Weaker section

(%)

Total priority sector advances

(%)

Canara Bank 15.7 6 48.2

Syndicate Bank 17.4 10.1 39.9

IDBI Ltd. 2.2 0.3 15.2

SBI 12.6 5.4 41

46

Interpretation:

From the above table, we can understand that SBI is complying with the Credit policy guidelines

issued by RBI. The other top performing banks mentioned above like Canara bank is issuing

more credit than the prescribed rate by RBI, which is generating more risk to the bank, whereas

the other two banks are not even withstanding with the credit policy issued by RBI.

4.2 THE BELOW TABLE SHOWS THE COMPARISON OF LOANS &

ADVANCES OF STATE BANK OF INDIA WITH OTHER PUBLIC AND

PRIVATE SECTOR BANKS

Public Sector Banks: Syndicate Bank, Canara Bank, Corporation Bank

Private Sector Banks: HDFC Bank, ICICI Bank, UTI Bank

Criteria for selection: These banks are selected as they are the top performing banks and

they have high loan lending capacity.

Variables: Loan amount of different banks.

Amounts in Million

Name of the Bank 2009 2010 2011 2012 2013

Amount Amount Amount Amount Amount

State Bank Of India 4167681.96 5425032.04 6319141.52 7567194.48 8675788.90

Syndicate Bank 640510.11 815322.69 904063.59 1067819.20 1236201.77

Canara Bank 1072380.40 1382194.00 1693346.30 2112682.92 2324898.18

Corporation Bank 391855.74 485121.60 632025.62 868504.04 1004690.20

HDFC Bank 634268.93 988830.47 1258305.93 1599826.65 1954200.29

ICICI Bank 2256160.82 2183108.49 1812055.97 2163659.01 2537276.57

47

UTI Bank 596611.44 815567.65 1043409.46 1424078.28 1697595.38

Figure 4.1: The loans and advances of SBI and other public and private sector banks

Interpretation:

Considering the above figure we can say that year on year the amount of advances lent by State

Bank of India has increased which indicates that the bank’s business is really commendable and

the Credit Policy it has maintained is absolutely good. Whereas other banks do not have such

good business SBI is ahead in terms of its business when compared to both Public Sector and

Private Sector banks, this implies that SBI has incorporated sound business policies.

48

State

Bank O

f India

Syndica

te Ban

k

Canara

Bank

Corporation Ban

k

HDFC Ban

k

ICICI Ban

k

UTI Ban

k0

5000000

10000000

15000000

20000000

25000000

30000000

35000000

20132012201120102009

4.2 THE TABLE BELOW SHOWS THE CREDIT RECOVERY MANAGEMENT OF

SBI

Variables: Loan issued amount, loan recovered amount and outstanding loan to be

recovered of SBI.

Year Loans Issued Recovered Outstanding

2010 157933.54 91601.4 66332.09

2011 202374.46 120210.43 82164.03

2012 261641.54 163264.32 98377.22

2013 337336.49 263264.32 74072.17

2010 2011 2012 2013

0

50000

100000

150000

200000

250000

300000

350000

400000

SBI loans, recovery and outstanding

Loans IssuedRecoveredOutstandingAxis Title

49

Figure 4.2: The credit risk management of SBI

Interpretation:

From the figure we can say that till the year 2012 outstanding loans had increased up to 30%

but due to the improved credit policy of SBI its outstanding rate decreased to 23% in the year

2013.

4.3 THE TABLE BELOW SHOWS THE PRIORITY SECTOR ADVANCES OF SBI

IN COMPARISON WITH OTHER PUBLIC SETOR BANKS

Public Sector Banks: Syndicate Bank

Canara Bank

Corporation Bank

Criteria for selection: These banks are selected because they are performing with low

NPA.

Varriables: Total Agriculture Advances, Weaker Section Advances, Total

Priority Sector Advances

S.No Name of the Bank

(Amount)

Total Agriculture

Advances (Amount)

Weaker Section

Advances (Amount)

Total

Priority

Sector

Advances

1 STATE BANK OF

INDIA30516 19883 82895

2 SYNDICATE BANK 5870.94 3267.71 14626.62

3 CANARA BANK 12032 4423 30937

50

4 CORPORATION

BANK

1934.80 665.32 9043.74

STATE

BANK OF INDIA

SYNDICATE

BANK

CANARA BANK

CORPORATION BANK

0100002000030000400005000060000700008000090000

Total Agriculture AdvancesWeaker Section AdvancesTotal Priority Sector Advances

Figuer 4.3: The priority sector advances of sbi in comparison with other public sector

banks

4.4 THE BELOW TABLE SHOWS THE PRIORITY SECTOR ADVANCES OF PUBLIC

SECTOR BANKS IN PERCENTAGES ARE AS FOLLOWS:

Name of the BankTotal

Agriculture

Advances

Weaker

Section

Advances

Total

Priority

Sector

Advances

% Net Banks Credit % Net Banks Credit % Net Banks Credit

STATE BANK OF 13.6 8.9 37.0

51

INDIA

SYNDICATE BANK 18.0 10.0 44.9

CANARA BANK 15.7 5.9 41.4

CORPORATION

BANK

9.0 3.1 41.9

STATE

BANK OF INDIA

SYNDICATE

BANK

CANARA BANK

CORPORATION BANK

0

5

10

15

20

25

30

35

40

45

50

Total AgricultureWeaker Section AdvanceTotal Priority Sector Advance

Figure 4.4: Priority sector advances of public sector banks in percentage

Interpretations:

SBI’s total agriculture advances as compared to other banks is 13.6% of the Net Bank’s

Credit, which shows that Bank has not lent enough credit to agriculture sector. SBI has to

entertain agriculture sector loans so that it can have more number of borrowers for the bank.

In case of weaker section advances, SBI is granting 8.9% of Net Banks Credit, which is less

as compared to Syndicate Bank. SBI has advanced 37% to priority sector, which is less as

compared with other Bank.

52

4.5 RISK CONTROLLED STRATEGY FOLLOWED BY MANAGER

 Policy and Strategy

 The manager shall be responsible for approving and periodically reviewing the credit risk

strategy and significant credit risk policies.

 Credit Risk Policy  

Every bank should have a credit risk policy document approved by the Board. The

document should include risk identification, risk measurement, risk grading/ aggregation

techniques, reporting and risk control/ mitigation techniques, documentation, legal issues and

management of problem loans.

Credit risk policies should also define target markets, risk acceptance criteria, credit

approval authority, credit origination/ maintenance procedures and guidelines for portfolio

management.

 The credit risk policies approved by the Board should be communicated to

branches/controlling offices. All dealing officials should clearly understand the bank’s approach

for credit sanction and should be held accountable for complying with established policies and

procedures.

Senior management of a bank shall be responsible for implementing the credit risk policy

approved by the Board.

53

Credit Risk Strategy

Each bank should develop, with the approval of its Board, its own credit risk strategy or plan

that establishes the objectives guiding the bank’s credit-granting activities and adopt necessary

policies/ procedures for conducting such activities. This strategy should spell out clearly the

organisation’s credit appetite and the acceptable level of risk-reward trade-off for its activities.

The strategy would, therefore, include a statement of the bank’s willingness to grant loans based on the type of economic activity, geographical location, currency, market, maturity and anticipated profitability. This would necessarily translate into the identification of target markets and business sectors, preferred levels of diversification and concentration, the cost of capital in granting credit and the cost of bad debts.

 

The credit risk strategy should provide continuity in approach and also  take into account the cyclical aspects of the economy and the resulting shifts in the composition/ quality of the overall credit portfolio. This strategy should be viable in the long run and through various credit cycles.

Senior management of a bank shall be responsible for implementing the credit risk strategy approved by the Board.

54

55

CHAPTER 5

FINDINGS AND CONCLUSION

Project findings reveal that SBI is sanctioning less Credit to agriculture, as compared with its key competitor’s viz., Canara Bank and Syndicate Bank.

Recovery of Credit: Credit recovery of SBI during the past few years is increasing gradually, which indicates SBI ‘s recovery policy is very good, hence this reduces NPA.

Total Advances: As compared total advances of SBI is increased year by year.

State bank Of India is expanding its Credit in the following focus areas:

1. SBI Recurring Deposits2. SBI Housing Loan3. SBI Car Loan4. SBI Educational Loan5. SBI Personal Loan6. SBI Term Deposits

In case of indirect agriculture advances, SBI is granting 3.1% of Net Banks Credit, which is less as compared to Canara Bank, Syndicate Bank and Corporation Bank. SBI has to entertain indirect sectors of agriculture so that it can have more number of borrowers for the Bank.

SBI’s direct agriculture advances as compared to other banks is 10.5% of the Net Bank’s Credit, which shows that Bank has not lent enough credit to direct agriculture sector.

Credit risk management process of SBI used is very effective as compared with other

banks.

56

CONCLUSION

The project undertaken has helped a lot in gaining knowledge of the credit policy and credit risk

management in State Bank of India. Credit Policy and Credit Risk Policy of the Bank has

become very vital in the smooth operation of the banking activities. Credit Policy of the Bank

provides the framework to determine (a) whether or not to extend credit to a customer and (b)

how much credit to be extended. The Project work has certainly enriched the knowledge about

the effective management of credit policy and credit risk management in banking sector.

In pursuance of the instructions and guidelines issued by the Reserve Bank of India, the State

bank Of India is granting and expanding credit to all sectors. The concerted efforts put in by the

Management and Staff of State Bank Of India has helped the Bank in achieving remarkable

progress in almost all the important parameters. The Bank is marching ahead in the direction of

achieving the Number-1 position in the Banking Industry.

57

CHAPTER 6

RECOMMENDATIONS

SBI is complying with the credit policy guidelines issued by RBI and it should maintain

it in the same pace.

SBI’s lending capacity is better than the other top performing private and public sector

banks like Canara bank, IDBI, Syndicate bank, etc. but it should also keep into

consideration of the risk factors involved in lending loans. By considering the risk factor

it would be able to control or reduce its bad loans.

Banks has to grant the loans for the establishment of business at a moderate rate of

interest, because of this, the people can repay the loan amount to bank regularly and

promptly.

Bank should not issue entire amount of loan to agriculture sector at a time, it should

release the loan in installments. If the climatic conditions are good then they can release

remaining amount.

The manager should keep on revising its Credit Policy, which will help Bank’s effort to

correct the course of the policies. The Chairman and Managing Director/Executive

Director should make modifications to the procedural guidelines required for

implementation of the Credit Policy as they may become necessary from time to time

because of organizational needs.

58

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