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A

PROJECT REPORT

ON

“TO STUDY THE PROCESS OF CREDIT APPRAISAL,

RISK RATING & CREDIT MONITORING SYSTEM IN PUNJAB

NATIONAL BANK”

By:-

Sayan Sarkar

Enrolment No: 14BSPHH010638

UNDERTAKEN AT –

PUNJAB NATIONAL BANK (Circle Office), KOLKATA

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A REPORT ON

“TO STUDY THE PROCESS OF CREDIT APPRAISAL,

RISK RATING & CREDIT MONITORING SYSTEM IN PUNJAB NATIONAL

BANK”

By:-

Sayan Sarkar

Enrolment No: 14BSPHH010638

A report submitted in partial fulfillment of the requirement of MBA program, IBS Hyderabad

Submitted to:

Mrs. Sharmistha Dasgupta, Senior Manager, PNB, CO, Kolkata Mrs. Swatee Das, Senior Manager, PNB, CO, Kolkata

Prof. Dipanjan Kumar Dey

Faculty Guide

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AUTHORIZATION

11th May 2015

(To whomsoever it May Concern)

This is to certify that, Sayan Sarkar, Enrol No: 14BSPHH010638 student of IBS-Hyderabad, has

undertaken his Summer Internship Program (SIP) from our bank at Circle Office at A.G. Towers (3rd

Floor) 125/1,Park Street,Kolkata-700017 from 23/02/2014 -11/05/2014 for the project titled “To study

the process of Credit Appraisal, Risk Rating and Credit Monitoring System in Punjab National

Bank” under our supervision.

The bank has no objection if Sayan Sarkar:

1. Participates for IBS Alumni Federation Award (IBSAF) for Excellence in SIP-2015,being

conducted by IBS and share findings of the project for academic purposes and

2. Uses the bank name for the abstract of the above project in public domain, if selected for the

award.

We wish him well for all his future endeavors.

Sharmistha Dasgupta Swatee Das

Senior Manager, Credit Senior Manager, Credit Risk Management

Punjab National Bank Punjab National Bank

Circle Office Circle Office

Kolkata Kolkata

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ACKNOWLEDGEMENT

I would take this opportunity to express my sincere gratitude to all the people who for their

valuable assistance and continuous support during my Summer Internship Program.

Firstly, I would like to thank B.S. Mann, Circle Head, Punjab National Bank, and Mr.

Sagnik Chatterjee, Deputy General Manager (FGM office) Kolkata for their confidence in

me and giving me opportunity to work in the organization.

I am highly grateful and obliged to my bank guides, Mrs. Sharmistha Dasgupta, Senior

Manager - Credit and Mrs. Swatee Das, Senior Manager – Credit Risk Management,

Punjab National Bank, Kolkata for their guidance and support at each and every stage

during development of the project. Their guidance, inputs and suggestions have played a

crucial role at every stage in the development of the project and I had gained a lot of

knowledge from them.

I would also like to thank Mr. Suvro Dasgupta, Manager, PNB (Barabazar Branch), for his

insights and guidance in learning “Preventive monitoring system” which is a part of post

sanction follow up. His inputs also helped in the development of the project.

A heartfelt gratitude to Prof. Dipanjan Kumar Dey, Faculty IBS Hyderabad, my faculty

guide, with his continuous guidance throughout the program helped me to complete this

project in a timely and systematic manner.

.

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DECLARATION

This is to certify that the thesis titled “TO STUDY THE PROCESS OF CREDIT

APPRAISAL, RISK RATING & CREDIT MONITORING SYSTEM IN PUNJAB

NATIONAL BANK” is a bonafide work done by Sayan Sarkar, Enrolment Number:

14BSPHH010638 in partial fulfillment of the requirements of MBA Program and

submitted to IBS Hyderabad.

I also declare that this project is a result of my own efforts and that it has not been copied

from anyone and I have taken only citations from the literary resources which are

mentioned in the Bibliography section.

Place: Kolkata Date: 11th May, 2015

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TABLE OF CONTENT Sr. No. Particulars Page

Number

i. Authorization 3

ii. Acknowledgement 4

iii. Declaration 5

iv. Executive Summary 8-9

1. Credit Appraisal 10

1.1 Facilities sanctioned by banks 10

1.1.1 Fund Based 10-11

1.1.2 Non fund based 11

1.2 Process followed for Credit Appraisal 12

1.3 Checklist for Pre Sanction Appraisal 13

2. Credit Risk Rating 14

2.1 Credit Rating Model 14-15

2.1.1 Evaluation in Risk Rating 16-18

2.2 Credit Risk Rating Grades and Pricing 18

3. Credit Monitoring 19

3.1 Preventive Monitoring System 19-20

3.1.1 Objective of PMS 20

3.1.2 Modules of PMS and Score 20-21

3.2 Audit 21

3.3 Inspection 22

3.4 Bank Checklist for Post-Sanction Follow Up 22

3.4.1 Cash Credit 22

3.4.2 Packing Credit 22-23

3.4.3 Cheques/ Bills Purchased 23

3.4.4 Term Loan 23

3.4.5 Overdraft 23

3.4.6 Demand Loan 23

3.4.7 Duty Drawback 24

3.4.8 Letter of Credit 24

3.4.9 Letter of Guarantee 24

3.4.10 Consortium Lending 24

Glossary 25-26

Citations and Bibliographies 27

Feedback 28

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LIST OF ACRONYMS

AOA Article of Association

BG Bank Guarantee

BO Branch Office

CC Cash Credit

CMA Credit Monitoring Arrangement

CO Circle Office

CRMD Credit Risk Management Division

CRMD Credit Risk Management Division

CRs Confidential Report

DD Demand Draft

DGM Deputy General Manager

DP Drawing Power/ Delivery against Payment

ECGC Export Credit Guarantee Corporation

FB Fund Based

FGM Field General Manager

GRs Goods Receipt

HO Head Office

IPs Immovable Property

KYC Know Your Customer

L&A Loans & Advances

LCBs Large Corporate Banks

LCs Letter Of Credit

LIC Life Insurance Corporation

MFIs Micro Finance Institutions

MOA Memorandum of Association

MPBF Maximum Permissible Bank Finance

MTRs Money Transport receipt

NA Not Applicable

NBFC Non Banking Financial Companies

NFB Non Fund Based

NPA Non Performing Asset

O/Ds Overdrafts

PC Packing Credit

PMS Preventive Monitoring System

RBI Reserve Bank of India

ROC Registrar of Companies

RRs Railway Receipts

TL Term Loan

TNW Total Net Worth

TOL Total Liabilities

TRs Transport Receipts

UTI United Trust of India

WC Working Capital

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Executive Summary

“To Study the Process of Credit Appraisal, Risk Rating and Credit Monitoring System in Punjab National

Bank” is the topic of study in the entire internship program. Commercial banks play an important role in

the financial system and the economy. As a key component of the financial system, banks allocate funds

from savers to borrowers in an efficient manner. Thus help in the creation of new money and growth in

the economy.

Finance has been the life blood of any organization whether it is a Manufacturing, Trading or Service

Sector. Organizations require fund either for their day to day operations known as “Working Capital” or

for the creation of assets through “Term Loan”. Commercial Banks provide credit to different activities in

an economy like agriculture, industry, transport, retail, small business, NBFC, leasing etc. To provide

credit facilities to cover all sectors, it has proposed different credit appraisal models. Credit Appraisal

involves the collection of different data and information. The data are analysed with the help of different

tools and techniques for credit decision.

Any amount of finance (Loans & advances) of a Bank is an asset in its books. It is a major source of

bank’s revenue (Income). Since a bank needs to grow and survive, it needs income. So, utmost care is

taken while financing so that the risk becomes minimum and their assets remain performing (revenue

generating).

Basically, both proposed or existing borrower furnishes with the CMA data which includes past 3 years

audited financial statements, estimates for current year, projections for the next year, project report, if any

and other relevant information/data along with loan application. Credit appraisal is an analysis of viability

and calculation of Maximum Permissible Bank Finance (MPBF) based on submitted data and other

relevant information.

There is a prescribed Format of Punjab National Bank called “Board Format” where relevant information

is placed for fresh as well as for renewal of credit limits. Board Format is designed in such a manner so

that different important aspects of the borrowing unit are analysed like promoter’s past experience &

capability, past performance, conduct of account, financial capability/health , project viability, security

offered, marketing of product, competition, future prospect based on economic scenario, statutory

compliance and compliance of existing terms and conditions etc to enable the authorities to judge credit

worthiness of a proposal keeping in mind the risk factor and to take judicious and speedy decision.

In Indian banking system, several banks pool together their banking resources and provides fund to a

single borrower, generally for large advance with a common appraisal, common documentation and a

system of joint supervision and follow up. Such an advance is called Consortium lending. The main

objective of Consortium lending is to diversify the risk and to maintain maximum capital exposure norms

as stipulated by RBI. The consortium selects a leader which is called lead bank. Lead bank takes

maximum exposure and carries out certain task like appraising the various aspects of credit proposal,

convenes the consortium meeting etc. Even as a consortium member bank, Punjab National Bank has to

follow the credit appraisal procedures as per its own bank guidelines.

Risk factor is involved in every credit decision. To minimise the risk, bank takes the help of a tool called

“Risk Rating”. Rating is done in all types of accounts with limit 2 lacs and above. Punjab National Bank

has introduced 13 such rating models covering all categories of loan such as Large Corporates, Mid

Corporates, New Entrepreneur, Small loans, NBFCs etc. It is based on evaluation method. Evaluation is

made in the following four field’s viz., Financial Evaluation, Business Evaluation, Management

Evaluation and Conduct of Account Evaluation. These models are automated and designed by experts. It

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requires specific inputs to get system generated score. The maximum score is 100. The score indicates the

level of lending risk. Accordingly, pricing of the bank i.e., lending rate of interest is fixed linked with is

linked with Risk Rating. Higher rated (lower risk) accounts are charged with lower rate of interest than

lower rated (higher risk) account. Pricing (rate of interest) is fixed for any advance by adding risk

premium with the base rate. Base rate is the minimum lending rate.

Once the loan is sanction and disbursed the bank has to follow up and monitor the conduct of account

which is called Post Sanction Follow Up. The bank needs to prevent the misuse of funds and monitor the

progress of the project/account as per terms of sanction. For monitoring the misuse of funds and slippage

of the account to be an NPA (bad account) the bank uses “Preventive Monitoring System (PMS)”. Like

other tools, PMS is used as an indicator which gives early warning of any kind of danger that the account

is turning out to be bad. It is an automated model which evaluates conducts of accounts, compliance of

terms and conditions of sanction, status of project completion and risk rating for comparison and

generates PMS Score which helps to understand the level of risk in the account/proposal. Here, lower the

score, lower is the risk. However there are other monitoring systems like “Audit” and “Inspection”. There

are two parts of Audit viz., Quarterly concurrent audit and statutory audit. During inspection and audit

each loan account is thoroughly checked and observation is made on the deficiencies keeping in mind the

compliance of terms and conditions of sanction and other relevant aspects. The very object of

inspection/audit is to set right the deficiencies observed to safeguard bank’s interest and to prevent the

account to be an NPA. Provisions need to be made from profit of the bank for NPA accounts and thereby

adversely affect the income of the bank. NPA accounts are sometimes restructured after its viability study

as per RBI guidelines. The objective of such restructure is to upgrade the account. However, monitoring

will continue like any other account.

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1. CREDIT APPRAISAL

Credit appraisal means an investigation/assessment done by the bank prior providing any loans &

advances/project finance & also checks the commercial, financial & technical viability of the proposed

project, its funding pattern & further checks the primary & collateral security cover available for recovery

of such funds. It is a process carried by bank to ascertain the risks associated with the extension of the

credit facility.

1.1 Facilities Sanctioned by Banks

LOAN

Fund Based Non-Fund Based

Letter of Credit Letter of Guarantee

Cash Credit/ Cheques/Bill Term Loan Overdraft Demand Loan Duty Drawback

Packing Credit Purchase

1.1.1 Fund Based:

In fund based loan, fund is released and withdrawal is made as per requirement of the business. Loan

sanctioned by bank is either short term loan (repayable within a period of 12 months) to create current

assets or long term loan (repayable over a period of 12 months) to create fixed assets. Therefore, the

primary security of the loan is the relevant short term assets (current asset) or the relevant long term asset

(fixed asset) created out of the short term or long term bank finance.

Cash Credit: Cash Credit is ‘working capital’ finance. Limit is set up based on working capital

gap and business cycle. Withdrawal is allowed upto the limit sanctioned and within the drawing

power of the client whichever is lower.

Packing Credit: A borrowing facility provided by a financial institution to help an exporter to

finance the costs of buying or making a set of products, and then packing and transporting them

before shipment occurs. A packing credit loan will often be extended if a letter of credit has been

issued by a purchaser of the products that is based in another country or a confirmed order for

exporting the goods exists.

Cheques/ Bill Purchase: When the cheque or bill is drawn favoring the borrower, the same is

purchased or discounted (Usance bill) and fund is released instantly. Bank collects the payment of

the cheque/bill in due course.

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Term Loan: The loan which is provided for the purchase of Assets and is repaid in regular

payments over a set period of time (generally over 12 months).

Overdraft: It is a temporary facility over and above the limit to meet the demand in exigency.

However, overdraft limit can be sanctioned against security of Bank deposit, LIC policies and

government securities.

Demand Loan: It is a short term loan which is payable on demand. The loan is sanctioned against

banks fixed deposit, shares and government securities mainly for the purpose of consumption.

Duty Drawback: A refund that can be obtained when an import fee has already been paid for a

good, but the good is then subsequently exported. Since refund of import duty takes times, bank

sanction loan against the refundable duty as duty drawback. After receipt of the amount from the

government the loan is adjusted.

1.1.2 Non Fund Based:

In Non Fund Based loan, banks fund is not involved but equivalent amount of bank risk may be involved

in future when letter of credit is invoked or letter of guarantee is devolved. Letter of credit and letter of

guarantee are issued by bank on behalf of the borrower/client for purchase of goods and fulfilment of

promise respectively. Since the liability of the bank in these cases may or may not arise, the liability is

treated as contingent liability.

Letter of Credit: It is a document from a bank guaranteeing that a seller will receive payment in

full as long as certain delivery conditions have been met. In the event that the buyer is unable to

make payment on the purchase, the bank will cover the outstanding amount.

Letter of Guarantee: A guarantee issued by a bank on behalf of a customer for the purpose of

purchase of goods or fulfilment of promise/contractual obligation/financial obligations. Banks

liability arises in the event of default by the borrower.

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1.2 Process followed for Credit Appraisal

Receipt of application from applicant

Receipt of documents

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

Credit Risk rating of the borrower

Pre-sanction visit by bank officials & obtaining required clarifications/papers.

Checking from RBI defaulters list, wilful defaulters list, CIBIL data, ECGC caution list, etc for borrowers’

and guarantors..

Title Deed verification reports of the properties to be obtained from empanelled advocates

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

Analysis of financial data and preparation of proposal with calculation of MPBF and recommendation

Verification of pre-sanction checklist of bank

Sanction of proposal by appropriate sanctioning authority

Execution of Loan Documentations

Disbursement of loan

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1.3 Checklist for Pre Sanction Appraisal While dealing with pre-sanction Credit Appraisal, it is sometimes felt that the branches at the time of

submitting the loan proposals to the Controlling Offices, many a times, do not include all the critical

meaningful information for speedy and hassle free disposal of the cases, resulting in a unavoidable

correspondence and delay.

To obviate this, Pre-Sanction checklist is followed by bank, which would help in minimising queries from

Sanctioning Authorities, will facilitate prompt disposal of loan proposals. The recommending official

should ensure that the points enumerated in the Checklist are duly addressed/ covered at the time of

submission of Credit Proposal.

Accordingly, Punjab National Bank has made a guideline as prerequisite verification and scrutiny of

different aspects of pre-sanction appraisal for new sanction as well as renewal sanction of existing unit

which are summarized as under. on-Compliance of points of checklist is to incorporated in the proposal.

Sl. No. Checklist

1. Assessment Part

That all required documents have been submitted and duly verified by the borrower.

Justification of acceptance of projected sales keeping in view of production plan, actual

sales, market trend and peak and non-peak level market share.

Modification in plant and machinery, if any.

Proper classification of Current Assets & Current Liabilities.

Valuation of stock and its realizability as per laid down guidelines.

Scrutiny of fund flow statement for exact requirement.

Installed/licensed capacity with projections.

Proper classification of current assets.

Borrower’s activities, market reputation and collection of CR along with CR of

guarantor.

Vetting of Credit Rating report.

All documents are signed by the borrower.

Report of Allied concerns and facilities with other banks.

2. Verification of Antecedents of Borrower/Guarantor/Supplier

Whether spot verification of the factory/business premises/IP securities/ collateral

securities has been done before sanction of limits.

Statutory clearance like pollution clearance and other approvals from regulatory

authority.

3. Additional Safeguards for Existing Accounts.

Any change of management from last sanction, analysis of past track records/conduct.

Irregularities observed by Auditor/Inspector/Stock should be removed.

If there are wide variations between the provisional and the audited accounts, whether

the same are properly analysed / examined.

4. Documentation/ Creation of Charge

All cuttings in documents have been authenticated by the executants(s). Verification of

document by legal counsel, where necessary.

Proper stamping of document and creation/modification of charge with ROC.

Search and valuation of IPs with proper insurance.

5. Disbursement

Obtaining approval from authorities for non compliance of any terms of sanction

before disbursement.

Direct payment to the suppliers and no cash disbursement without sanction.

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2. Credit Risk Rating Reserve Bank of India has laid down guidelines on Risk Management Systems in Banks for

implementation by the banks. In terms of these guidelines, banks should have a comprehensive risk

scoring / rating system that serve as a single point indicator of diverse risk factors of a counter party and

for taking credit decisions in a consistent manner. The risk rating system is designed to reveal the overall

risk of lending, for setting pricing and non-pricing terms of loans and also to present meaningful

information for review and management of loan portfolio.

Credit Risk Rating is the primary activity that is carried out after the approval of Techno Economic

Viability report. The rating evaluates a loan on four aspects namely Financial Aspects, Management

Aspects, Industry Aspects and Conduct of Accounts Aspects. These are the four main pillars on which it

determines the rating. The rating is of utmost importance since it categorises the loan into high, moderate

or low risk. Falling short of achieving the minimum required rating would inevitably stop further

proceedings of loan appraisal.

The various steps taken by the bank to comply with the above RBI guidelines, inter-alia, include

development of various Credit Risk Rating Models for different categories of borrowers to measure the

risks inherent in individual loans in its credit portfolio. All borrowers having (FB+NFB) limits of above

Rs.2 Lacs excluding borrowers covered under PNB Score/Scoring models (i.e., excluding all retail loans,

Trading & SME loans up to Rs.50 Lacs and all Direct Agriculture loans) should invariably be rated on

these models.

2.1 Credit Rating Models: . PNB has devised and implemented Eight Default Rating models, two

Transaction Rating Model, one Half Yearly Rating model & one NPA Marking Model as discussed

below:

Sr. No Credit Risk Rating Model Applicability

Total Limit Sales

1. Large Corporate Above Rs. 15 Crore

OR

Above Rs.100 Crore

except Trading Concerns.

2. Mid Corporate Above Rs.5 Crore and

upto Rs.15 Crore

OR

Above Rs.25Crore and

upto Rs.100Crore

All trading concerns falling in the Large Corporate category shall also be rated under

this model.

3. New Projects Rating Above 5Cr OR Cost of Project above

15Cr

4. Small Loans Above Rs.50laks and

upto 5 Cr

Upto Rs.25 Cr

5. Small Loans II Above Rs. 2laks and upto

Rs.50laks

6. NBFC All Non Banking Financial Companies irrespective

of limits.

7. Entrepreneur New Business

Model

Borrower setting up new

business and requiring

finance above Rs 20 lacs

upto Rs. 5 Cr (AND

Cost of Project upto

Rs.15 Cr.

However, all new trading business irrespective of

limits shall be rated under this model.

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New Non Banking Financial Companies

(NBFCs)/New Micro Finance Institutions (MFIs).

New borrower entities, setting up new business

requiring only working capital/NFB limits of above

Rs.5 crore but not involving setting up of any project

as such.

Projects already completed with own finance, audited

results for first year of operations are not yet

available and proposal is only for sanction of

WC/NFB facilities.

8. Credit Risk Rating Model for

Banks/FI

All Banks and Financial Institutions.

Sr. No Transaction Rating Model Applicability

1. Facility (Expected Loss)

Rating Framework

Assigning rating to facility sanctioned to the borrower

based on default rating and securities available

2. Future Lease Rental Model Advances to property owners against future lease

rentals.

Sr. No Half Yearly Rating Model Applicability

1. Half Yearly Rating Model i) All listed companies rated on large /mid corporate

rating models. ii) Other borrowal accounts rated on

large / mid corporate rating models availing limits

(FB+NFB) above Rs.50.00 crores from our bank

Sr. No NPA Model Applicability

1. NPA Model For marking NPA accounts in on-line PNBTrac

Credit Risk Rating System

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2.1.1 Evaluation in Risk Rating

Credit risk rating models evaluate the default risk of a borrower on four broad aspects viz. Financial

Aspect, Management Aspect, Industry Aspect and Conduct of Account Aspect. These areas are bifurcated

into sub-areas and each sub-area is further split into a number of parameters as per details as under:

A. Financial Evaluation: The evaluation shows the financial stability and soundness of the

business enterprise. With the help of different ratios the same is evaluated as shown as under:

Category Parameter

Growth Rate Gross Sales growth rate (%)

Profitability OPBDIT/Sales (%)

Short term bank borrowings/Net sales (%)

Cash Flows Operating Cash Flows/Total Debt (%)

Net Operating Cash Flow/Total Debt (%)

Solvency Ratio Debt Equity Ratio

TOL/TNW

Liquidity Ratios Current Ratio

Interest Coverage

Debt Coverage

Ratios

DSCR

Profitability Ratio Return on Capital Employed (%)

B. Management Evaluation: To understand how far the management is efficient in doing the

business is evaluated with different parameters like sales, PBT, debt repayment etc. as per

details as under:

Parameters

Actual Gross Sales

Targeted Sales

Actual PBT

Targeted PBT

Management Set-up and Corporate Governance

Commitment and sincerity

Track record in execution of projects

Track record in debt repayment

Track record in Industrial relations

Financial strength/ flexibility /Group support

Capital market perception

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C. Business/Industry Evaluation: Every unit is business/industry specific. Thus to understand

its competitive position in present market scenario in different aspects, the evaluation is done

as per details as under:

D. Conduct of Account Evaluation: It shows the actual business operation and its efficiency.

Therefore evaluation of conduct of account is of utmost importance in risk rating. Account

evaluation is judged on the following points:

Preventive monitoring system rating

Status of account

Operations in account

Submission of financial data/ statements

Parameters

Operating leverage

Inventory turnover

Net sales/Op. Assets

Raw material consumed/Net Sales

Credit period allowed

Competitive Position :

Expected sales growth

Market dominance /Market share

Trend in market share

Input Related Risk :

Availability of raw material and other critical inputs

Proximity to raw material

Status of backward integration

Production Related Risk :

Capacity utilization

State of technology used

Flexibility in product manufacturing

Product Related Risk :

Product range

Product quality

Price Competitiveness :

Economies of scale

Pricing flexibility

Marketing :

Selling and distribution network

Proximity to market

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Total Score and Weights assigned to each parameters of the above evaluation are as under:

Financial Evaluation 40%

Business & Industry

Evaluation 25%

Management Evaluation 25%

Conduct Evaluation 10.00%

2.2 Credit Risk Rating Grades and Pricing

Based on the above parameters, system generates score for each credit rating and assigns rating on the

basis of score obtained as under. However rating of each account must be vetted by appropriate authority

of the bank as per bank guidelines.

Score Obtained Rating Description

Above 80.00 PNB-A1 Minimum Risk

Above 70.00 upto 80.00 PNB-A2 Marginal Risk

Above 64.00 upto 70.00 PNB-A3 Modest Risk

Above 58.00 upto 64.00 PNB-A4 Lowest Risk

Above 52.00 upto 58.00 PNB-B1 Average Risk

Above 46.00 upto 52.00 PNB-B2 Marginally Acceptable Risk

Above 40.00 upto 46.00 PNB-B3 Cautiously Acceptable Risk

Above 35.00 upto 40.00 PNB-C1 High Risk

Above 25.00 upto 35.00 PNB-C2 Very High Risk

25.00 and below PNB-C3 Exceptionally High Risk

Minimum lending rate (except loan against bank’s own deposit) is the base rate of the bank which is

changed from time to time. Pricing of the bank i.e., rate of interest charged by bank is linked with Risk

Rating. Higher the credit rating score, lower is the credit risk. Risk premium is added with the base rate

according to the rating/credit risk to fix lending rate. Risk premium is different for different types of

accounts and may be changed from time to time.

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3. Credit Monitoring

A significant aspect of effective management in lending is proper monitoring of credit. The success of

credit monitoring largely depends on two factors viz., a) Co-operation of the borrower clients in

furnishing the required data and statements like monthly stock statements, half yearly and yearly balance

sheet and profit and loss accounts, monthly statement of sales and purchases with outstanding creditors

and debtors, etc. to the bank on time and b) the capacity and knowledge of the credit monitoring

authorities to take timely decisions and corrective steps to keep the borrowal account in good health. Had

there been proper and effective monitoring, it could prevent many accounts from becoming NPA.

Thus Punjab National Bank has devised few credit monitoring techniques which will reduce the

conversion of good accounts turning into bad accounts. Such measures are as under.

Credit Monitoring

Preventive Monitoring System Audit Inspection Post-Sanction Checklist

Stock Audit Concurrent Audit Statutory Audit CARD Audit

3.1 Preventive Monitoring System(PMS)

Post-sanction Credit Monitoring of borrowal accounts is an important ingredient of a sound Credit

Management System and calls for monitoring of the health/conduct of accounts on a continuous basis.

Credit Risk Policy, Credit Appraisal and Credit Monitoring are the three pillars of Credit Management.

The quality of bank’s credit portfolio can be significantly improved with the help of proper systems,

processes and tools of credit monitoring. The early detection of deterioration in the quality of a borrowal

account and timely action may minimize the possible losses to the bank. Once the account becomes an

NPA, it is difficult for the bank to recover its entire dues.

For the purpose, Bank has in place Preventive monitoring system (PMS) for post sanction monitoring of

borrowers having sanctioned limits (FB plus NFB) above Rs. 1 crore applicable for all corporate

Borrowal Accounts, except for the following:

NPA Accounts.

Advances against Life Insurance Policies.

Advances against Bank’s own deposit.

Advances against Shares.

Advances against Deposits, Govt. Securities, Units of UTI.

Advances against bullion and jewellery.

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PMS is a credit monitoring tool which covers a number of signals/ indicators, that are material for

evaluating the conduct or health of a borrowal account and seeks to measure the performance of the

account on the said signals on a continuous basis. It assigns numerical score to each signal and captures

the conduct of an account in a single total numerical value called PMS Index Score on indicators covering

timeframe of past one year. Its focus is on prevention of loan loss by focusing on borrowal accounts

showing ‘early warning’ signs of deterioration. However success of the system depends on generation of

report at regular interval and taking remedial action in time.

PMS model is based on Behavioural scoring which helps to automatically segment and rate accounts,

customers and portfolios thus allowing efficient management of a particular borrower’s credit account as

well as the entire credit portfolio. The system seeks to improve efficiency, efficacy and compliance level

in the borrowal accounts.

3.1.1 Objectives of PMS

PMS is an imperative credit monitoring tool. It seeks to track & evaluate the health of borrowal accounts

on a continuous basis. The objectives of the system are listed below:

A. To detect unsatisfactory/adverse signals/indicators at an early stage in a comprehensive manner

for which compliance of the following points to be looked into.

Compliance with terms & conditions of sanction

Status of Project Implementation

Conduct of account

Adherence of other bank guidelines and statutory requirements

B. To emphasize thorough probe into reasons behind observed signals and analysis thereof. Some of

the causes can be:-

Incorrect business decisions

Adverse market conditions

Unplanned expansion etc.

Malafide intentions.

C. To propose speedy corrective/remedial actions/steps to prevent the account from becoming NPA

as well as to minimize the loan losses. Some of the actions which can be taken are:-

Stipulating higher margin on Primary Security.

Asking for more collateral.

Influencing business decision of the borrower.

Infusion of fresh funds.

Inserting more banks into the consortium.

Efforts for recovery of dues.

Exit from the account.

3.1.2 Modules of PMS and Score

The Preventive Monitoring System (PMS) is a post sanction credit-monitoring tool consisting of a

number of signals/parameters for evaluating the health of a borrowal account on a continuous basis. It

consists of three parameters.

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Compliance of terms and conditions of sanction- This module evaluate the compliance part i.e.,

adherence of all the terms and conditions of the sanction. The score in this module is assigned on

the basis of selected options out of the available options in PMS.

Project Implementation- This module of PMS seeks to monitor the progress of implementation

of projects financed by the bank and also to capture warning signals, which can tell upon the

health of the account.

Conduct of Account- This is the automated module which calculates score on the basis of data

pertaining to operations in the borrowal account, which is directly derived from transaction system

and ladder. Each and every credit facility of the borrower is analysed to detect any kind of

delinquency or negative signals in the account.

On successful submission of inputs in all the three modules as above, PMS report is generated with score.

Lower score indicates lower risk and vice versa as per details as under. However correctness of score

depends on correct feeding of data. There are Benchmarks and weights which are assigned to the facilities

availed like Term Loan, Cash Credit, Overdraft, Packing Credit, Bills Purchased, Letter of Credit, Letter

of Guarantee and so on. Based on those parameters, benchmark and weights, the system will work out

score, cumulative scores which shall be translated into PMS rank of the corporate in following categories:

PMS Score PMS Rank PMS Indicator

0-25% 1 Healthy

>25-50% 2 Satisfactory

>50-65% 3 Early Warning

>65-80% 4 Warning

>80% 5 NPA

3.2 Audit

It is one of the most important methods of monitoring credit portfolio by Punjab National bank. Audit is

conducted to ensure the validity & reliability of information and the information is free from material

error.PNB conducts the following types of audit:

(a) Quarterly Concurrent Audit: In large and exceptionally large branches, auditors verify the

workings of the branch on day-to-day basis and submit quarterly report. The irregularities pointed

out in the report needs to be rectified by branch and to report to the higher authorities.

(b) Statutory Audit: It is conducted once in a year. The irregularities pointed out in the report needs

to be removed by branch .Removal to be apprised to the higher authorities.

(c) Stock Audit: The auditor reports their observations after physical checking of stock of borrower.

Any adverse observation needs to be rectified immediately after taking up the matter with the

borrower and compliance to be reported to higher authorities.

(d) CARD Audit: CARD audit is conducted by Credit Audit Review division of Head office where

credit limits of a borrower is Rs. 5.oo cr and above. The irregularities pointed out in the Card

report pertaining to the account to be got removed as early as possible and compliance to be

reported to higher authorities.

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3.3 Inspection

The main object of inspection is checking of documents, records and facilities to verify adequacy of

system control, ensure compliance with established bank guidelines and operational procedures. The

system of annual Inspection in Punjab National Bank is very important as each branch is graded based on

reported outstanding irregularity and its gravity.

On the basis of Inspection/audit report,, the sanctioning authorities monitor the account(s).In case of need,

proper instruction/guidance is provided to branch level to safeguard the interest of the bank. The

outstanding irregularities pointed out in the Audit/Inspection report pertaining to an account needs to

incorporate in the loan proposal of the borrower to bring it to the knowledge of sanctioning authorities to

enable them to monitor the account.

3.4 Bank Checklist for Post-Sanction Follow Up

Lending decisions are based on sound appraisal and assessment of credit worthiness. Past record of

satisfactory performance and integrity are no guarantee for future thought they serve as a useful guide to

project the trend in performance. A loan granted on the basis of sound appraisal may go bad due to the

failure of the borrower to meet its promise of performance. Thus post sanction follow up monitors the end

use of funds and whether the businessmen are continuing to do their business according to their

projections and in terms of sanction. The main objective of post sanction follow up is to prevent the

slippage of an account to NPA. Thus it is very important to monitor the account continuously.

Keeping the point in view, Punjab National Bank has made post sanction follow up checklist separately

for each category of loan which is summarised as under:

3.4.1 Cash Credit(Hypothecation/Pledge)

Submission of stock/ book debt statement should be regular and to be verified/ checked

physically from borrower’s record on periodical basis by bank official in terms of sanction

and valuation as per banks guidelines.

Book debt should be out of genuine trade transaction. Power of Attorney to be obtained

incase of advance against book debt.

No DP will be allowed against old and obsolete stock and stocks received under LC and

unpaid for stock. DP should not be over the limit without proper sanction.

Turnover in account should be satisfactory. Frequent overdrawn is not allowed. Overall

ceiling of limit should be maintained.

Stocks to be insured fully in the joint name of bank and borrower and all terms and

conditions are to be adhered.

Necessary documents should be got executed in time including Balance Confirmation

letter.

Pledged stock to be properly stored and to be attended by Godown Keeper/ Chowkidar.

3.4.2 Packing Credit(PC)

Each PC will be allowed against sanctioned LC of approved bank.

Submission of stock statement should be regular and to be verified/ checked physically

from borrower’s record on periodical basis by bank official in terms of sanction. Valuation

to be done as per banks guidelines. Stock under PC to be kept segregated.

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Separate account to be maintained for each PC and to be got adjusted within a period of

180 days, if not got extended.

Stocks to be insured as per bank guidelines and party to deal with the bank exclusively.

No PC will be allowed against expired LC and no shipment will be allowed by an

unapproved clearing agent.

3.4.3 Cheques/Bill Purchased

Cheques must be in favour of the borrower and apparently in order.

Cheques are purchased for good clients only.

Genuine bill to be purchased accompanying RR/TRs. TR must be of approved transport

company.

Bills drawn on allied or associated concerns should not be purchased.

Cite bill is preferable and purchase of bill of longer period (Usance bill) should be

avoided.

Incase of frequent returning of bill, prompt action to be taken to realise the money and

further purchase in such accounts to be avoided.

CR of the drawee should be collected from the banker.

For Usance bill (bill with future due date) drawee wise record with limit to be maintained

and no excess purchase over the limit is to be allowed without proper sanction.

3.4.4 Term Loan

Preferably payments are made directly to the suppliers for procurement of asset which are

to be insured as per bank guidelines in the joint name of the bank and the borrower.

Time of project completion and commencement of production as per schedule to be

adhered.

Instalment payments should be regular and in case of default proper steps to be taken and

the matter to be brought to the notice of the sanctioning authority.

3.3.5 Overdraft

Securities to be endorsed in the favour of the bank incase of post office/UTI certificates

and owner to be got verified.

Third party advance is also allowed with proper sanction and documentation.

Incase of advance without security i.e., clean overdraft, bank should try to adjust the

account as early as possible.

Procedural compliance should be made in all cases.

3.3.6 Demand Loan

Demand loans are sanction against fixed deposit, LIC, shares and government securities

which are to be pledged with the bank.

Incase of shares and government securities, the same to be transferred in the name of the

bank.

Third party demand loan is also granted as per banks stipulation.

Proper documentation must be made as per bank guidelines before release of the loan.

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3.3.7 Duty Drawback

Documentary evidence to be furnished for import of goods and duty paid for the same by

the clients.

Amount to be released under proper documentation and adhering to the guidelines of RBI.

3.3.8 Letter of Credit

LC to be issued against sanction limits keeping stipulated margin. Issue of LC over the

sanction limit to be got approved.

Party to ensure that LC is retired promptly.

Stock under LC to be insured as per terms of sanction.

Incase of Revolving LC the maximum number and amount per LC to be as per terms of

sanction.

Incase of devolvement (non compliance of terms of LC by borrower) of LC, prompt action

to be taken.

Incase of foreign LC, valid import license to be obtained and FLC is opened strictly in

terms of sanction.

3.3.9 Letter of Guarantee

LG is issued with proper sanction and within the limit keeping stipulated margin.

Expired LGs to be reversed in the books of the bank. Incase of invocation (failure of

borrower to comply terms of LG) of LGs, matter to be dealt appropriately and to be

brought to the notice of the sanctioning authority.

Bank should avoid issue of LGs on behalf of the party where invocation is frequent.

3.3.10 Consortium Lending

In Indian banking system, several banks pool together their banking resources and provides fund to a

single borrower, generally for large advance with a common appraisal, common documentation and a

system of joint supervision and follow up. Such an advance is called Consortium lending. The main

objective of Consortium lending is to diversify the risk and to maintain maximum capital exposure norms

as stipulated by RBI. The consortium selects a leader which is called lead bank. Lead bank takes

maximum exposure and carries out certain task like appraising the various aspects of credit proposal,

convenes the consortium meeting etc.

Punjab National Bank has stipulated to following checklist for Consortium Lending.

Consortium agreements to be got executed by the consortium leader and attested copy

thereof is held.

Consortium meetings are held periodically and letter are exchanged by the participating

bank intimating balances in the account periodically.

Undertaking (as per terms of sanction) to be taken from the borrower agreeing to deposit

sale proceeds, book debts realised, etc. on pro rata basis has been obtained.

Stocks to be periodically checked by participating banks and reports to be exchanged.

All terms and conditions governing the consortium advance as per sanction to be complied

with.

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Glossary

Bank Guarantee: It is a kind of guarantee from a lending institution which ensures that the

liabilities of a debtor will be met and incase the debtor fails to settle a debt, the bank will cover it.

Base Rate: It is the minimum interest rate at which a bank can lend except for loans to its own

employees, its retired employees and against bank’s own deposits.

Cash Flows to Debt Ratio (Operating Cash Flow/Total Debt): This coverage ratio compares a

company’s operating cash flow to its total debt. Is provides an indication of a company’s ability to

cover total debt with its yearly cash flows from operation. The higher the percentage ratio, the

better the company’s ability to carry its total debt.

Credit Enhancement: A method whereby a company attempts to improve its debt or credit

worthiness. Through credit enhancement, the lender is provided with reassurance that the

borrower will honor the obligation through additional collateral, insurance, or a third party

guarantee. Credit enhancement reduces credit/default risk of a debt, thereby increasing the overall

credit rating and lowering interest rates.

Debt Service Coverage Ratio (Net Operating Income/ Total Debt Serviced): It is the amount

of cash flow available to meet annual interest and principal payments on debt, including sinking

fund payments. A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1,

say .95, would mean that there is only enough net operating income to cover 95% of annual debt

payments.

Debt to Equity Ratio (Debt/Equity): It is the debt to equity ratio which show the ratio

of both the component in the capital structure. Door to Door Tenor: It indicates the total period within which the total debt borrowed is to be

paid which includes the period of moratorium, i.e., the period for which payment has been

postponed.

Escrow Account: An escrow account is a temporary pass through account held by a third party

between the processes of transaction between two parties. This is a temporary account as it

operates until the completion of the transaction process, which is implemented after all the

conditions between a buyer and a seller are settled.

Hypothecation: It is a mode of creating an equitable charge on a property to secure the payment of a

debt in which the property itself continues to be in the possession of the debtor. It is a legal transaction

whereby a merge charge is given on the goods for the amount of the debt but the hypothecated goods

remain in the actual possession of the borrower. And neither possession nor ownership passes to the

lender. The instrument which creates a charge is known as Letter of Hypothecation.

Interest Service Coverage Ratio (EBIT/ Interest expense): The interest coverage ratio is used

to determine how easily a company can pay interest expenses on outstanding debt. The lower the ratio, the more the company is burdened by debt expense. When a company's interest coverage ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable.

Inventory Turnover: A ratio showing how many times a company's inventory is sold and

replaced over a period. The days in the period can then be divided by the inventory turnover formula to calculate the days it takes to sell the inventory on hand or "inventory turnover days."

Lead Bank: A bank that oversees the arrangement of loan syndication and is paid an additional

fee for this service, which involves recruiting the members and negotiating the financing terms.

Lien: The legal right of a creditor to sell the collateral property of a debtor who fails to meet the

obligations of a loan contract.

Liquidity Ratios: A class of financial metrics that is used to determine a company's ability to pay

off its short-terms debts obligations. Generally, the higher the value of the ratio, the larger the

margin of safety that the company possesses to cover short-term debts.

Loan Syndication: The process of involving several different lenders in providing various

portions of a loan. Loan syndication most often occurs in situations where a borrower requires a

large sum of capital that may either be too much for a single lender to provide, or may be outside

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the scope of a lender's risk exposure levels. Thus, multiple lenders will work together to provide

the borrower with the capital needed, at an appropriate rate agreed upon by all the lenders. Moratorium: It is an agreement between a creditor and a debtor to allow additional time for the

settlement of a debt.

Mortgage: A legal agreement that conveys the conditional right of ownership on an asset or

property by its owner (the mortgagor) to a lender (the mortgagee) as security for a loan. The

lenders security interest is recorded in the register of title documents to make it public

information, and is voided when the loan is repaid in full.

Multiple Banking: Multiple banking is a banking arrangement where a borrowal avails finance

independently from more than one bank. Thus, there is no contractual relationship between

various bankers of such borrower. Also in such arrangement each banker is free to do hid own

credit assessment and old security independent of other bankers.

Operating Leverage (% change in EBIT/ % change in Sales): The Degree of Operating

Leverage (DOL) is the leverage ratio that sums up the effect of an amount of operating leverage

on the company’s earnings before interests and taxes (EBIT). Operating Leverage takes into

account the proportion of fixed costs to variable costs in the operations of a business. If the degree

of operating leverage is high, it means that the earnings before interest and taxes would be

unpredictable for the company, even if all the other factors remain the same.

Pari Passu: A Latin phrase meaning "equal footing" that describes situations where two or more

assets, securities, creditors or obligations are equally managed without any display of preference.

An example of pari-passu occurs during bankruptcy proceedings when a verdict is reached, all

creditors can be regarded equally, and will be repaid at the same time and at the same fractional

amount as all other creditors. Treating all parties the same means they are pari-passu.

Pledge: It is delivery of goods by a borrower to a lender as security for the payment of a debt or

the performance of a promise. The ownership remains with the borrower but the possession of the

goods is with the lender until the debt is paid.

Profitability Ratios: A class of financial metrics that are used to assess a business's ability to

generate earnings as compared to its expenses and other relevant costs incurred during a specific

period of time. For most of these ratios, having a higher value relative to a competitor's ratio or the

same ratio from a previous period is indicative that the company is doing well. Solvency Ratios: The solvency ratio indicates whether a company’s cash flow is sufficient to

meet its short-term and long-term liabilities. The lower a company's solvency ratio, the greater the

probability that it will default on its debt obligations.

Working Capital (Current Asset-Current Liabilities): The capital which is required to run its

day to day operation in a business is known as working capital. It is the excess of Current Asset

over its Current Liabilities.

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Citations & Bibliographies

Study Material

IRMD, Risk Rating Manual. Cir. No: 12/2014, New Delhi, March 14, 2014

IRMD, PMS Manual. New Delhi.

Pre- Sanction and Post- Sanction Credit Appraisal Manual.

Credit Appraisal files and correspondence.

Websites

www.investopedia.com. May 6, 2015

www.businessdictionary.com. May 6, 2015

Books

Toor, NS. Analysis of Balance Sheet. New Delhi: Skylark, 2006.

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