Final Sip Report

A REPORT ON

“TO UNDERSTAND AND ANALYZE THE SYSTEM OF

CREDIT APPRAISAL AND RISK ASSESSMENT AT

STATE BANK OF INDIA”

By

Neelam S. Mandowara

10BSPHH010444

IBS Hyderabad

IBS Hyderabad 2010-2011

A REPORT ON

“TO UNDERSTAND AND ANALYZE THE SYSTEM OF

CREDIT APPRAISAL AND RISK ASSESSMENT AT

STATE BANK OF INDIA”

By

Neelam S. Mandowara

10BSPHH010444

A report submitted in the partial fulfillment of

The requirement of

MBA Program of

IBS Hyderabad

Beneficiary:

STATE BANK OF INDIA

MID-Corporate Group

Regional Office, Ahmedabad

Date of submission 13 May 2011


AUTHORIZATION

This project was undertaken at State Bank of India, MID-Corporate Group, Regional Office

(MCGRO), and Ahmedabad from February 14th to May 21th, 2011 as a Special Assignment for

summer internship project in management for the partial fulfillment of the MBA Program at

ICFAI Business School, Hyderabad

Date: 13 May 2011

Beneficiary:

1. Mr. J. Karthikeyan , DGM(Sales Hub),SBI MID-Corporate Group, Regional Office,

Ahmedabad

2. Mr. Anand Singh, chief manager (CPC), SBI MID-Corporate Group, Regional Office,

Ahmedabad

3. SBI MID-Corporate Group, Regional Office, Ahmedabad


STATEMENT OF PRIVACY

This report is prepared as a part of the academic curriculum of MBA course offered by ICFAI

Business School, Hyderabad and is solely intended for the purpose of serving as a reference to

the officials of SBI- MCG Regional office, Ahmedabad. The same should not be used by anyone

for any other technical/legal/commercial purpose.

No part of the report should be either made accessible to or used by any official out side the

SBI-MCG Regional Office, Ahmedabad, without prior authorization by the person in-charge of

the report.


ACKNOWLEDGEMENT

I take this opportunity to humbly express my sincere thanks to all those concerned with my

project titled “To Understand and Analyze the System of Credit Appraisal and Risk Assessment

at State Bank of India”.

I express my deep sense of gratitude to Mr. Kaushik Bagchi, General Manager, MCGRO and

Mr. J. Karthikeyan, DGM (SH), SBI MID-Corporate Group, Regional Office, Ahmedabad for

providing me the opportunity to work at State Bank of India- MID-Corporate Group for my

Summer Internship Program.

I am obliged to Mr. Anand Singh, Chief Manager (CPC), and my company guide, without his help

I may well have not completed the project satisfactorily. His invaluable guidance has proved to

be a key to my success in overcoming difficulties faced during the course of project work.

I am also indebted to Miss. Nidhi Lakahni, Credit Analyst (CPC), who has always encouraged me

to carry out innovative tasks, to critically analyze the cases and gave her valuable inputs as and

when required.

I would also like to show my appreciation to whole staff of State Bank of India, MID-Corporate

Group, Ahmedabad for this their help and support.

I express my deep feelings of gratitude to Prof. D.S. Chary, ICFAI Business School, Hyderabad

and my faculty guide for motivating me at every step of the project and guiding me the right

direction.

With Regards

Neelam S. Mandowara

10BSPHH010444


EXECUTIVE SUMMARY

I Neelam S. Mandowara pursuing my MBA at ICFAI Business School, Hyderabad and as a part

of academic curriculum, I have done my 14-week summer internship at State Bank of India

MID-Corporate Group, Ahmedabad Region.

The project instructed was to “Understand and Analyze the System of Credit Appraisal and Risk

Assessment at State Bank of India”; the task was accomplished by practical exposure of the

process followed by the Bank.

Objective of the Project

1. To understand the process of Credit Appraisal followed at State Bank of India.

2. The project report can be used by State Bank of India MID-Corporate Group as guide for

novice.

3. Evaluation of the Credit Appraisal Process and thereby giving Recommendations to the bank

for improving it.

Background

India being a country with wide array of resources has great business opportunities owing to

that business flourished in India somewhere in 17th

century with the growth in industries fund

requirements of enterprises were increasing and hence lead to the invention of a proper

banking system in year 1786 since than banks are backbone to the growth and expansion of

industries.

State Bank of India came to existence in year 1955 and since than it is the largest bank of the

country with present asset base of $352 billion and $285 billion in deposits, it is a regional

banking behemoth and is one of the largest financial institutions in the world. It has a

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

The MID-Corporate Group of SBI was formed as a part of business process reengineering ,

bank provides both fund based and non fund based credit to its customers by effectively

scrutinizing the borrower and hence, deciding upon the limits to be sanctioned


Facilities given by bank to its customers includes working capital loans, term loans, letter of

credit, bank guarantee, export packing credit , foreign bill discounting etc. hence covering

both inland and export finance requirements of the enterprise.

Hence the whole project report is concentrating mainly on domestic finance owing to the

short span of internship.

Methodology

1. Understanding and Evaluation of the Credit Appraisal Process is done by working on live

projects and hence based on the analysis and daily observations the whole project report is

drafted.

2. The credit requirements of the company are assessed using the Balance Sheet & Income

Statement, Ratio analysis (Leverage, Liquidity & Profitability ratios). Apart from this, various

articles from journals, magazines, newspapers, etc have been referred to understand the

prospects of the Industry in which the company is operating.

3. A number of research articles by various scholars have been studied to understand and get

more knowledge about the topic.

Limitations of the Study

1. The project is dependent upon primary data provided by the bank. Since most of it is

confidential in nature, trainees are not allowed to use it for the report. Hence,

hypothecated values are mentioned in the project.

2. The use of secondary research is less since the project is based more on the primary

research and the observations made on day to day activities of the Bank (Mid Corporate

Group).

3. Wide ranges of products are provided to customers at MCGRO but owing to the tenor of

internship export finance is not discussed and analyzed in detail.


Table of contents

Cover Page………………………………………………………………………………………….. I

Title Page…………………………………………………………………………………………….. II

Authorization………………………………………………………………………………………. III

Statement of Privacy…………………………………………………………………………… IV

Acknowledgements…………………………………………………………………………..... V

Executive Summary…………………………………………………………………………….. VI

1. Introduction…………………………………………………………………………….

1.1 Objectives……………………………………………………………………………

1.2 Limitations…………………………………………………………………………..

1.3 Methodology……………………………………………………………………….

01

01

02

02

2. Banking Industry in India………………………………………………………… 03

3. Company Profile……………………………………………………………………..

About State Bank of India…………………………………………………….

SBI MID-Corporate Group…………………………………………………….

06

06

07

4. Theoretical background of credit appraisal………………………………

Credit…………………………………………………………………………………..

Why Credit from Banks………………………………………………………..

Cardinal Principles of Lending………………………………………………

Credit Appraisal …………………………………………………………………..

Loan Policy of State Bank of India…………………………………………

Steps of Credit Appraisal Followed State Bank of India…………

10

10

10

10

11

12

13

5. Types of Facilities…………………………………………………………………….

Working Capital Loan……………………………………………………………

14

15


Term Loan Financing…………………………………………………………….

Letter of Credit…………………………………………………………………….

Bank Guarantee…………………………………………………………………..

Stand By Line of Credit…………………………………………………………

18

21

26

28

6. Credit Monitoring Arrangement……………………………………………… 29

7. Credit Risk Assessment……………………………………………………………

What is Risk………………………………………………………………………….

Types of Risk and Risk Management……………………………………

Credit Risk Assessment Model at State Bank of India…………..

35

35

35

38

8. Pricing…………………………………………………………………………………….. 49

9. Proposal Writing……………………………………………………………………..

AS Format…………………………………………………………………………….

51

51

10. Sanctioning Authorities …………………………………………………………. 66

11. Findings & Conclusion…………….………………………………………………. 68

Findings…………………………………………………………………………………

Conclusion…………………………………………………………………………….

68

69

12. Recommendation…………………………………………………………………… 70

13. References……………………………………………………………………………… 71


INTRODUCTION

The project is all about the process of credit appraisal that is right from the time when

enterprises come for the request of loan to final disbursement of loan. The process of Credit

Appraisal passes through various stages which includes analysis of financial statements,

preparation of Credit Monitoring Arrangement (CMA followed by ratio analysis and then risk

rating is done known as Credit Risk Assessment (CRA) at SBI, after scrutinizing the credibility of

the borrower and success of the project proposed a loan sanctioning report known as Proposal

is drafted and passed on to the appropriate authorities for sanction and approval.

At MID-Corporate group of State Bank of India, projects having fund based requirement of

above 10 crores or the turnover of the enterprise is above 50crores, any of the two parameters

should be satisfied in order to qualify the loan sanctioning process under the governing powers

of MID-Corporate group.

The main focus of the project is to study about the system adopted by State Bank of India,

Being the largest bank of India the method and structure adopted by the bank is unique and

credible, as many private and public sector banks have adopted this model for appraisal

especially the risk assessment model of bank is very efficient and effective such a system has

protected bank from major defaulting and financial crisis.

Objectives of the Project

1. To understand the process of Credit Appraisal followed at State Bank of India.

2. Assessing the Short Term and Long Term finance requirements (both fund based and non-

fund based) of enterprises.

3. The project report can be used by State Bank of India MID-Corporate Group as guide for

novice.

4. To understand the rationale behind various guidelines and policies of State Bank of India.

5. To understand the organization culture and get familiar with the corporate world.

6. Evaluation of the Credit Appraisal Process and thereby giving Recommendations to the bank

for improving it.


Limitations of the Study

1. The project is dependent upon primary data provided by the bank. Since most of it is

confidential in nature, trainees are not allowed to use it for the report. Hence,

hypothecated values are mentioned in the project.

2. The use of secondary research is less since the project is based more on the primary

research and the observations made on day to day activities of the Bank (Mid Corporate

Group).

3. While preparing CMA various assumptions are made for the estimations and projections

which depend upon the person doing the calculations and hence can lead to slight

variations in results.

4. In Credit Risk Assessment there are various subjective criteria’s so it depends upon the

person doing the analysis how he rates these subjective parameters so it can lead to some

discrepancy in the ratings.

5. The process of appraisal slightly defers from the type of loans hence it will be difficult to

standardize the whole process.

6. Industry analysis is done by individuals hence the way an individual perceives a particular

sector the other one may not perceive in the same way hence it is also a kind of limitation.

7. Wide ranges of products are provided to customers at MCGRO but owing to the tenor of

internship export finance is not discussed and analyzed in detail.

Methodology

1. Understanding and Evaluation of the Credit Appraisal Process is done by working on live

projects and hence based on the analysis and daily observations the whole project report is

drafted.

2. The credit requirements of the company are assessed using the Balance Sheet & Income

Statement, Ratio analysis (Leverage, Liquidity & Profitability ratios). Apart from this, various

articles from journals, magazines, newspapers, etc have been referred to understand the

prospects of the Industry in which the company is operating.

3. A number of research articles by various scholars have been studied to understand and get

more knowledge about the topic.


Banking Industry in India

Bank is a financial organization that has functions like to borrow money from the people

and pays interest to them on their deposit, to lend money to the enterprises for productive

purposes and charge interest from them.

According to Indian Banking Regulation Act of 1949 the term function of a bank is defined

as “Accepting for the purpose of lending all investment of deposits, of money from the

public, repayable on demand or otherwise and withdrawal by cheque, draft or otherwise"

and the term Banking Organization is defined as "Any company which transacts banking

business in India."

Banking in India took its birth somewhere in the first decade of 18th century with the

establishment of The General Bank of India in 1786, which was followed by Bank of

Hindustan. But due to some reasons both of them didn’t flourished well and hence are no

more in existence.

The oldest bank which still exists in India is ‘The State Bank of India’ which was initially

established as "The Bank of Bengal" in Calcutta in June 1806. A couple of decades later, i.e.


in 1805 foreign banks like Credit Lyonnais started their Calcutta operations. At that point of

time, Calcutta was the most active trading port, chiefly due to the trade with the British

Empire, and due to which banking activity took roots there and prospered well.

The first fully India owned bank was Allahabad Bank, which was established in 1865. By the

1900s, the market expanded with the establishment of banks such as Punjab National Bank

in Lahore and Bank of India in Mumbai, both of these banks were founded by private

owners.

The Reserve Bank of India formally took the responsibility of regulating the Indian banking

sector from 1935 and after India's independence in 1947; The Reserve Bank was

nationalized and given broader powers.

The Reserve Bank of India is the supreme monetary and banking authority in the country

and has the responsibility to control the banking system in the country.

On July 19th 1969, 14 Major Banks of the Country were nationalized and on 15th April 1980

six more commercial private sector banks were also taken over by the government.

The Indian Banking industry is governed by the Banking Regulation Act of India 1949. The

industry can be classified into two major categories, non-scheduled banks and scheduled

banks.

Schedule Banks are those, which are referred to Second Schedule of RBI Act, 1934. These

are the banks which have paid-up capital and reserves of an aggregate value not less than 5


lacks and Non-Schedule Banks are those, which are not mentioned in Second Schedule of

RBI Act, 1934.

The figure below shows the structure of Scheduled Banks in India.

The pace of development for the Indian banking industry has been tremendous over the

past decade. As the world reels from the global financial meltdown, India’s banking sector

has been one of the very few to actually maintain resilience while continuing to provide

growth opportunities, a feat unlikely to be matched by other developed markets around the

world.

(6)


Company Profile of State Bank of India

About State Bank of India

The origin of State Bank of India set its roots in year 1806 when Bank of Calcutta (also

known as Bank of Bengal) was established. In 1921, the Bank of Bengal and two other

presidency banks (Bank of madras and Bank of Bombay) were amalgamated to form the

Imperial Bank of India.

In 1955, in controlling interest the Imperial Bank of India was acquired by the RBI and State

Bank of India came into existence by an act of parliament, as a successor to the Imperial

Bank of India.

Today, State Bank of India (SBI) has spread its arms around the world and has a network of

branches spanning all time zones. SBI’s International Banking Group delivers the full range

of cross border finance solutions through it four wings:

Domestic Division

Foreign Offices Division

Foreign Department

International Services division

SBI provides a range of banking products through its vast network of branches in India and

overseas, including products aimed at non-resident Indians (NRIs). The State Bank Group,

with over 16,000 branches, has the largest banking branch network in India. It also has

around 130 branches overseas. With an asset base of $352 billion and $285 billion in

deposits, it is a regional banking behemoth and is one of the largest financial institutions in

the world. It has a market share of about 20% among Indian commercial banks in deposits

and loans.

http://en.wikipedia.org/wiki/Non-resident_Indian


The Bank is also in the process of providing complete payment solution to its clientele with

its over 21000 ATMs, and other electronic channels such as Internet banking, debit cards,

mobile banking, etc.

The State Bank of India Group includes a network of 5 baking subsidiaries and several non-

banking subsidiaries offering merchant banking services, fund management, factoring

services, primary dealership in government securities, credit cards and insurance.

The Bank is forging ahead with cutting edge technology and innovative new banking

models, to expand its Rural Banking base, looking at the vast untapped potential in the

hinterland and proposes to cover 100,000 villages in the next two years.

SBI is also focusing at the top end of the market, on whole sale banking capabilities to

provide India’s growing mid / large Corporate with a complete array of products and

services. Bank is consolidating its global treasury operations and entering into structured

products and derivative instruments.

Today, the Bank is the largest provider of infrastructure debt and the largest arranger of

external commercial borrowings in the country. It is the only Indian bank to feature in the

Fortune 500 list.

SBI MID-Corporate Group

Mid Corporate Group is a Strategic Business Unit (SBU), created as part of Business Process

Re-engineering (BPR) within the Bank to focus and aggressively market in the Mid Corporate

sector.

Mid Corporate Group was incorporated in the year 2004 and has 8 Regional offices all over

India (known as MCGRO).

Following are the eligibility criteria for a customer to avail services for loan under the

governing power of SBI-MCG:

Turnover of the enterprise should be between `50 crores and `350crores.

The amount of fund based and non fund based exposure should be at least `10crore


The Bank’s Mid Corporate Group offers a wide array of client focused products and services

to take care of overall banking requirements of the Mid-Corporate clients.

The Mid Corporate Group is headed by Dy. Managing Director (DGM) and Group Executive

(MC). The Chief General Manager (MCG) is in charge of Mid Corporate Regional Offices

(MCROs) which are all headed by General Managers under whom the Branches of the

Group function.

Organizational Structure at SBI MID-Corporate Group

GM and DGM are at the top of pyramid and they are the main decision making

authorities. DGM also administers the whole functioning of the credit processing cell.

AGMs have administrative as well as credit appraisal tasks such as examination of

proposals submitted by team leaders, CRA validation, handling restructuring issues etc.

CMs are team leaders and there task is to facilitate the process of credit appraisal by

guiding and motivating the credit analysts to accomplish the task effectively.

Bottom of pyramid consists of the credit analyst, who carries out the whole process of

credit appraisal.


The following are some of the major facilities provided by bank:

1) Working Capital loan (Cash Credit)

2) Term Loan (Project Finance)

3) Export Packing Credit/Pre shipment credit in Foreign Currency/Foreign Bill discount

Limits

4) Bank Guarantee (Non-Fund Based)

5) LC (Non-Fund Based)

6) Stand by Limit of Credit (SLC)

At SBI MID-Corporate the Pre-Sanction Process involves following:

Appraisal & Recommendations

Assessment

Sanction

At SBI MID-Corporate the Post-Sanction Process involves following:

Follow up

Supervision

Monitoring & Control


Theoretical Background of Credit Appraisal

CREDIT

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

his wealth to a borrower 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.

Why Credit From Banks

The most important variables of an economy are the consumption demands of the vast

population and the supply of machinery to meet this demand and also the modern

economy is driven by technology. Hence, in present scenario the total output by industrial

and non-industrial sectors is very huge and the finance requirement of which cannot be met

by an industrialist all alone so comes the role of commercial banks as credit provider to the

industry.

Augment of resources to set-up a manufacturing facility i.e. term credit repayable over a

specified period of time and the working capital loan which is required to finance the

working capital cycle

Cardinal Principles of Lending

1. Safety

The borrower must repay the loan amount with interest as per the loan agreement;

the ability to repay the loan depends upon the borrower’s capacity and willingness

repay.

The lending banker ensures this by satisfying himself about the adequacy and quality

of the asset charged, and also whether the business is viable enough to earn

sufficient margins to pay the interest and generate profits to repay the debt.


2. Liquidity

Commercial banks lend funds to the borrowers through long term and short term

deposits made by the customers of the bank which are repayable on demand or

over short to long periods.

So, an unusual proportion of long-term loans in a bank’s books may lead to an asset-

liability mismatch and a liquidity crisis. Generally to avoid such situations banks are

restricting long term lending to the extent of one third of their advances portfolio.

3. Profitability

Banks lend funds to earn interest out of which they pay interest on deposits, incur

staff cost, other operational expenses and distribute dividends to the shareholders.

Hence, spread over borrowing rate and lending rate should be adequate.

So, the rate of interest on lending varies according to the degree of risk involved in

lending to various classes of borrowers. This is mainly based on internal rating

factors derived from business and industry risk factors, financial risk and

management risk etc.

These three principles are pillars for success and smooth functioning for any bank and hence a

balance between all these has to be maintained.

Credit Appraisal

It is the process through which banks decides on various issues before lending money to the

corporate, it can be defined as the process in which the decision maker makes an attempt

to find answers to some basic questions like:

1. Whether the need by the entrepreneur is justified

2. Whether the requirement of funds estimated will be serviced

3. Whether the product of the bank supports the requirement

Lending bankers usually compute the credit requirements after undertaking a structural

analysis of the business and nature of business by applying various tools like audited and


projected financials, ratio analysis, margin assessment etc. having decided on that the

proposal, as a reasonable and acceptable business risk, is a bankable proposition.

The next step involves assessing the nature and extent of the proposed exposure. The bank

provides a range of debt instruments including all types of term and working capital

facilities, which can be structured either as fund based or non-fund based or a combination

of both.

Loan Policy of State Bank of India

SBI’s Loan Policy is directed towards fulfilling the Bank’s vision “Customer first and first in

customer satisfaction”. Loan Policy is aimed at accomplishing Bank’s mission to create

products and services that help their customers to achieve their goals. Loan Policy applies to

all domestic lending. SBI’s Loan Policy is reviewed once in a year and is aligned with the

chairman’s Policy Guidelines.

The Policy establishes a commonality of approach regarding credit basics, appraisal skills,

documentation standards and awareness of institutional concerns and strategies, while at

the same time leaving enough room for flexibility and innovation.


Steps of Credit Appraisal at State Bank of India

The above chart shows the whole process of credit delivery carried out at SBI; however, this

flow varies from banks to banks. Different banks have their own formats and may differ

marginally in credit delivery.

SBI which is country’s largest lender, this is the normal flow which is followed. The process

may vary marginally for the type of facilities involved, but more or less this is the standard

set for credit delivery.

In the above chart first and last two steps are carried out at branch level with the help of

relationship manager while other than this all the steps are carried out by MCGRO.

Disbursement of loan

Suitable documentation

Conveying sanction of credit limits and acceptance of term and conditions of sanction.

Proposal is submitted to concerned authorities for sanction

Drafting of final project proposal

Credit Risk Assessment (CRA)

Ratio Analysis

Preparation of Credit Monitoring Arrangement (CMA)

Collecting information about the company & the promoters

Thorough study of the documents submitted by the client

Submission of project report and required financial details

Receipt of application for loan from the client


TYPES OF FACILITIES

There are basically two heads under which a loan sanctioned to any corporate entity can be

classified as shown below with the subdivisions:

1. Fund Based

Working Capital loan

Term Loan

Stand By Line of Credit

2. Non-Fund Based

Letter of Credit

Bank Guarantee


Fund based requirements supports the industry/corporate to meet their funding

requirements for working capital finance or towards acquiring fixed assets etc. Hence,

Funds deployed in a business enterprise can be broadly classified into two components viz.

fixed capital and working capital.

Fixed capital is invested in fixed assets (capital assets), through which enterprises engages

for manufacturing of goods/ products for sale /acquire assets for providing services and

generate profits. To meet such requirement banks offer the product called Term loans,

which are available for a period not less than 3 years whereas the loans provided for a

period of one to three years, are classified as Demand Loan.

On the other hand, working capital is deployed in purchasing the items, which are

transformed into saleable goods by the production process so to meet this day to day

requirement banks offer working capital loan which is considered to be a short-term loan

and has to be renewed every year.

Hence, we can say that the assets representing working capital rapidly convert from one

form to another in short period of time (max. one year)while this is not the case with the

fixed capital, the cash conversion time in case of fixed assets is quite large.


Besides meeting the credit requirement of the borrowing enterprise by way of fund based

credit facilities, banks also cater to the non-fund based requirements of their clients.

The fund based facilities provided by banks require immediate outlay of funds which must

be provided beforehand whereas the non-fund based facilities are essentially in the nature

of promise made by banks in favour of a third party to provide funds on behalf of their

clients if certain situations emerge or certain conditions are fulfilled. These non-fund based

facilities may be in the nature of bank guarantee or letter of credit issued by banks.

Working Capital Loan

The term working capital refers to the current assets holding of an enterprise. For

manufacturing enterprise therefore, the average levels of holding of raw materials, goods in

process, finished goods, receivables, cash and other current assets together constitute the

working capital.

Operating Cycle Concept of Working Capital

The operating cycle concept of working capital envisages measurement of the average time

taken by an enterprise in manufacturing the goods and selling them for cash so that the

funds can be deployed for starting other batch of production.


The figure below shows the operating cycle or working capital cycle

Cash is required to purchase the raw materials, a manufacturing enterprise ensures that

there should always be a minimum level of stock of raw material, which takes care of

regular demand as well as any abrupt discontinuity in demand or supply; these raw

materials are then pressed into production.

The processing time depends on the nature and specification of the final product. In the

course of processing, the enterprise may generate stock of semi-finished goods in the

course of production now, when semi finished goods finally rolled out as finished goods

these are stored till sale of goods as well as the process of delivery takes sometime, the

enterprise may have to ensure that a minimum level of finished goods always remains

available to meet the unforeseen demand.

A portion of sale proceeds may remain locked for sometime in form of receivables and

on expiry of credit period they are realized. Thus, every rupee invested in current assets

at the beginning of the cycle comes back to the promoter with the profit element added

after a lapse of specific time period and this length is known as working capital cycle.

Operating Cycle

RM

SFG

FGRec.

Cash


Hence, as the funds are locked in the cycle the enterprise requires funding from banks

for smooth functioning of their day to day activities.

Assessment of working capital loan

The above figure is showing the block diagram of balance sheet where the left hand side

represents the liabilities/sources of funds and right hand side represents Assets/Application

of Funds. Long-term liabilities include equity capital, retained profits, term loans and

unsecured loans while current liabilities include creditors, working capital bank finance and

other current liabilities.

All the short-term sources are used to fund the current assets and the difference between

current assets and current liabilities known as net working capital is funded by long-term

sources which can be through internal cash accruals etc. as depicted clearly from the figure

above.

It is believed that bank credit should be the last resort which should be tapped only after all

internal and external sources of funding working capital requirements of the enterprise are

exhausted, Hence, banks lend only a portion of working capital gap (WCG), which is the

Fixed Assets

Current Liabilities

Long-Term Liabilities

Current Assets


value of the acceptable level of current assets after netting off the other sources of funding

working capital requirements.

Hence, method of computation Assessed Bank Finance (ABF) is adopted by the banks, there

are various methods for the computation of the same as proposed by Tandom and Nayak

committee out of which the method adopted by State Bank of India is given as

ABF = WCG – (actual/projected) NWC

Where,

ABF= Assessed Bank Finance

WCG= Working Capital Gap = Current Assets - Other Current Liabilities

NWC= Net Working Capital = Current Assets - Current Liabilities

This is calculated in the CMA itself which will be discussed later.

The financing of Working capital also depends upon some set benchmark for the ratios that

is current ratio should at least be 1.2 for trading companies and 1.33 for rest and gearing

ratio (TOL/TNW) should not exceed 5 for trading and 3 for others. In absence of the same

deviation has to be approved by the appropriate authority

Term Loan Financing

A term loan is provided for acquisition of Long Term assets such fixed assets, Long Term

Working Capital Margin as well as to acquire capital goods; which are required to be repaid

out of cash generations from operations over a period of time. Repayment of term loans is,

therefore, required as per schedule planned beforehand.

The scope and approach in providing term credit by lending bankers are, thus different from

working capital credit or other conventional form of advances. Term loan is a form of a

participation loan as the lending institution has a stake in the unit covering a fairly long

period of time and longer the period of repayment, the riskier is the proposition. Hence, any

appraisal of term loan has an inbuilt method of assessment of the risk contained therein.


The basic purpose of appraisal of proposal for providing term credit requirements is to

ensure that the borrower acquires the proposed fixed assets, puts them to use in producing

merchandise which would have a market, and generate enough cash from operations to

repay the term loan and service the interest commitments thereon over the stipulated

period of repayment. The appraisal process, therefore, visualize a meticulous examination

of all the relevant aspects of the economics of the project.

Points to been seen while term loan appraisal

Prima facie Acceptability

The analyzer should inspect the MOA & AOA of the borrower organization, should

check the RBI and SBI policy guidelines, government regulations, exposure norms,

the credit history of the borrower is checked with the help of CIBIL, ECGC etc and

finally the debt to equity ratio of the borrower organization, Once these all are

under the satisfactory level the credit analyst will move further with the appraisal

process.

Technical Feasibility

To check the viability of the project proposed which includes examination of

suitability, adequacy, design, accessibility, production process, factors of production,

and cost of production etc. of the project.

This is analysis is done in order to see whether the loan taken from the bank will be

deployed for a profitable purpose or not, for this there are various methods like Net

Present Value (NPV), Project Evaluation and Review Technique (PERT) etc.

Economic Viability

Once the technical feasibility of the project is examined and if found to be

satisfactory, the part of economic feasibility of the project where the market

analysis is done to see whether the raw materials and all other requirements are

easily available or not and whether the final product of this project will be successful

or not in the market for which demand and supply gap is studied.


Financial Feasibility

Data from the borrower should be analyzed to ensure that the project meets the

minimum financial criteria. Thus the data can be broadly grouped as:

Cost of the project including working capital margin

A comprehensive and critical review of the project cost is necessary to ascertain,

the reasonability and flexibility of estimates of cost, arrangement for raising

funds for financing of the project, acceptability of the project and the

modifications required.

Cost of Production and Estimates of Profitability:

A complete and vital assessment of the production cost is necessary to

determine, the quality of product, the true production cost, demand gap-

reasonableness of price in competition, Break-Even analysis to ascertain profit

margin. The estimate of profitability enables the banker to draw up the

repayment programme, start-up time, etc.

Break Even Point:

In a manufacturing unit, if at a particular level of production, the total

manufacturing cost equals the sales revenue, this point of no profit/no loss is

known as the break-even point

The Break-even point is worked out as under:

BEP = Fixed Cost

---------------------------

Contribution

Where, contribution is give as unit selling price minus variable cost per unit.

Break even point is expressed as a percentage of full capacity. A good project

should have break-even point of at least 75%

Commercial Viability

Once all other aspects of project success has been analyzed, for a lending bank most

important part is to check the implementation period of the project, moratorium

required , check the projected profitability, breakeven analysis, Debt Service

coverage Ratio (DSCR) etc. all this is done to examine in how many years the

borrower would be able to pay back the debt.


Managerial Competence

This is done to know and understand the proficiency of the management in making

the project a success for this the experience, integrity, track record of the directors

is studied.

All the points covered so far are very core points and is not the core competency of a credit

analyst and hence, for such kind of sensitive analysis for term loans especially for Greenfield

projects bank has to employ experts from external agencies or technically reputed

consultants who have a sound knowledge about the industry or products as discussed in

this section and the report submitted by such consultants is known as TEV (Techno

Economic Viability) report.

For term loan appraisal some cut-off of ratios should be achieved i.e. Gross DSCR should be

at least 1.75, gearing ratio(TOL/TNW) should not be more than 3 and repayment schedule

should not be more than 8 years this will also include the moratorium. In absence of the

same deviation has to be approved by the appropriate authority

Note: The calculation and study of ratios will be discussed later under the section of CMA

Letter Of Credit

Letter of credit is issued by banks to facilitate trade between two parties, whether domestic or

international level. It is an undertaking issued by a bank, on behalf of the buyer to the seller, to

pay for the goods and services as per agreed terms, provided that the seller presents

documents which comply with the terms and conditions stipulated in the letter of credit.


Parties in an LC Transaction

A transaction in a letter of credit may involve several parties at different stages. The various

parties with different rights and responsibilities are the following:

Applicant

The buyer finalises the terms and conditions of a purchase transaction and on receipt of the

confirmed offer from the Seller, submits a request to his bank for issuing a letter of credit in

favour of the seller.

Beneficiary

The beneficiary of the letter of credit is the person in whose favour the credit has been

issued. Generally, the credit is issued favouring the seller of goods and services.

Issuing Bank

On the receipt of request from its customer, the applicant’s (purchaser’s) bank examines

the proposal and opens a letter of credit in favour of beneficiary with the stipulated terms

and condition hence this bank is known as issuing bank.

Courtesy: www.googleimages.com


Advising Bank

In case the seller resides in a distant place or in a foreign country where the issuing bank do

not have a branch, it may contact some other bank in the beneficiary’s country. The

identified bank in the beneficiary’s country may agree to advice the credit to the beneficiary

and thus play the role of advising bank.

Negotiating Bank

The issuing bank may nominate another bank in the beneficiary’s country to which the

beneficiary presents its documents and from which it obtains payment of the sum against

the letter of credit.

Types of Letter of Credit

Revocable

A revocable credit issued by a bank could be amended or cancelled by the issuing bank at

any point of time however; such type of credit has been withdrawn under the latest

revisions.

Irrevocable

LOC which can neither be amended nor cancelled without an express agreement of all the

parties concerned, the conformation of an irrevocable LC also helps the process of

verification of the documents in a conclusive manner. This is also a measure to effectively

counter the commercial or country risks emanating from the status of the issuing bank.


Sight Credit

In such a credit the beneficiary gets the benefit of immediate payment upon presentation of

the proper documents laid down as per the terms of LC at paying bank. Though the banks

are allowed reasonable time to examine the documents. Such time does not exceed seven

banking days following the day of receipt of the documents.

Acceptance

In such a credit the beneficiary decides to grant a period of credit to the importer after

sight, the period of credit granted is known as Usance.

Red Clause

The issuing bank authorizes the advising bank to advance a part of the LC amount to the

seller to meet pre-shipment expenses. The advising bank releases the advance payment

against submission of receipt and an undertaking to present the documents by the

beneficiary before the LC expires. The amount paid in advance is recovered with interest

from the final payments to be made against submission of supply documents

Green Clause

It is an extension of red clause LC, in this the applicant also provides for storage facilities at

the port of shipment in addition to the pre-shipment advance to the beneficiary.

Revolving

A buyer may need a specific type of merchandise on a regular basis and the supply may also

be required to replenish regularly in such cases a revolving LC is issued in the favour of

seller guaranteeing payment against individual consignments.

Standby

Such credits require a simple statement of claim or proof of delivery of goods or certificate

of non-performance or an improper performance of the other party to the underlying

contract.


From all the types of LCs discussed above SBI issues sight and acceptance (Usance) credit,

revolving LC is not preferred because it increases the liability of the bank and monitoring of the

same is quite difficult but if insisted by the client, bank may consider such request on case to

case basis.

Assessment of LC Limit at State Bank of India

When customer approaches to SBI for LC, based on the nature of transactions and business,

the requirement of LC limit is examined.

LC Limit is given both for the domestic as well as Import purchase. Sometimes, based on the

requirement of the customer, CAPEX LC (LC issued in favour of the supplier of capital

goods/fixed assets) facility is also provided.

The assessment of required of LC limit is based on various parameters like estimated annual

purchase and out of which how much purchase will be made based on LC, credit availed

from the suppliers, lead time etc.

Following table shows how requirement of LC limit is assessed. The figures are taken

hypothetically for the understanding of assessment of LC.

Computation for Inland LC limits: (` in Crores)

Annual Purchase of Raw Material Estimated for 2011-12 276.39

Annual RM Purchase under LC (10%) 27.64

Monthly Purchases 2.30

Average Usance Period 3.00 months

Lead time including Transit Period 0.30 month

Max. LC Limit (2.30x3.30) 7.60

Recommended LC Limit 7.00


Bank Guarantee

A guarantee is defined as “a contract to perform the promise or discharge the liability of a third

person in case of his default”. Thus there are three parties involved in a contract of guarantee

which are as follows:

Applicant

The client on whose behalf the guarantee is being issued.

Beneficiary

To whom the guarantee is issued.

Guarantor

It is the issuing bank who gives the guarantee on behalf of applicant.

In case of bank guarantee, the liability of the issuing bank begins only after the default is

committed by the principal debtor (applicant) and such default is brought to the notice of the

issuing bank by the beneficiary with in the stipulated time, thereby demanding the

compensation for the consequential loss suffered by the latter, the demand made in this

manner by the beneficiary is called invocation in banking parlance.

Types of Bank Guarantee

Financial Guarantee

It may be seen as a certificate issued by the bank regarding the financial ability/worth of its

client (applicant) to meet certain financial obligations, making payment and satisfying the

dues as per contract terms etc. Generally, at State Bank of India does not issue BG more


than 18 months and if required to be issued it is being considered after due approval from

the controllers.

Performance Guarantee

The issuing bank provides a guarantee to the beneficiary to make good the monetary loss in

the event of non-performance or short-performance of a contract by the client (applicant),

thus the issue of performance guarantee involves an assessment of the technical

competency, managerial ability or vocational experience to execute a contract successfully,

also the issue of such guarantees should be backed by adequate securities

Both the types of guarantee is issued by SBI, it is the Credit Conversion Factor (CCF) which is

different while calculating the limit, CCF for Financial BG is 100% and for Performance BG is 50%

This is required for the purpose of capital charge in terms of BASEL norms.

Assessment of Bank Guarantee at State Bank of India

When customer approaches to SBI for BG, based on the nature of transactions and

business, the requirement of BG limit is examined.

The assessment of required of BG limit is based on various parameters like outstanding for

last financial year, due during current year, additional requirement during the current year

etc.

Following table shows how requirement of BG limit is assessed. The figures are taken

hypothetically for the understanding of assessment of BG.

Computation of BG Limit (` in Crore)

Outstanding BGs for Last Financial Year 0.23

Add: BGs Required During Current Year

Due During Current Year

1.77

0.00

Less: Estimated Maturity/Cancellation of BGs during the current year 0.00

Required BG Limit 2.00

Recommended BG Limit 2.00



A stand-by Line of Credit is issued to the clients in order to meet their emergent and

unforeseen needs while carrying out their operations.

The facility may be made available as Fund Based or Non-Fund Based limits ensuring that

the aggregate exposure does not exceed the overall SLC limit.

The SLC issued for emergent working capital requirements is termed as SLC (WC). The

facility is available for a maximum period of 2 months at any one instance; however no

restriction has been placed for number of times the facility can be used by the borrower.

The quantum of finance under SLC is calculated as 15% of (FB+NFB) WC Limit and should

not exceed `5Cr.

The SLC issued for term loan requirements is termed as SLC (TL), this is given to facilitate the

borrower for expeditious implementation of expansion/modernization plan and firming up

capital expenditure to avoid time/cost overrun. The validity of sanction of SLC (TL) will be 12

months from the date of sanction. The quantum of finance under SLC (TL) is calculated as 2

times the residual cash accruals and should not exceed `5 Cr for corporate borrower and `2

Cr for non-Corporate.

Assessment of SLC at State Bank of India

Though both term and working capital SLC is permitted at SBI but generally working capital

SLC is demanded by the clients.

Following table shows how requirement of SLC (WC) limit is assessed. The figures are taken

hypothetically for the understanding of assessment of SLC

Computation of SLC Limit (` in Crore)

FB WC limit (Proposed) 21.00

NFB WC limit (Proposed) 7.40

Maximum SLC limit eligible (15% of FB WC and NFB WC) 4.26

Recommended Limit 3.00


CREDIT MONITORING ARRANGEMENT

Credit Monitoring Arrangement also known as CMA, its format is as prescribed by RBI. RBI decided to monitor each high value WC credit facility and advised the lending banks to report the details of such sanctioned credit facilities in prescribed format and hence, introduced Credit Monitoring Arrangement (CMA) after discontinuing Credit Authorisation Scheme (CAS) in 1988.

The lending banks, while sending the details to RBI in this manner, observed that these forms served well the purpose of analysis as well as the financial appraisal of the WC credit. In CMA Financials of three year audited figures, current year estimates and next year projections for working capital and in case of term loans projections are made till the repayment of the long-term loan is done are examined in a CMA. The estimated and projected figures are calculated according to past trends and future expectations.

CMA Format and Analysis of CMA

Form I: Particulars of existing/proposed Limits from the banking system

This form basically shows the limits from all banks and financial institutes, the limits include

existing limits, shows the extent to which the limits has been utilized and the requested limits

for the current year.

Form II: Operating Statement

The P&L statement prepared by a company may serve well the purpose of all shareholders,

the government and the tax authorities, but a rearrangement of the various items of

income and expenses is necessary for the purpose of undertaking a meaningful analysis and

taking a credit decision.

While analyzing the operating statements, various factors such as growth in sales over

previous year as well as estimated growth as per industry trend is examined. Also the

various operating and other costs like interest and depreciation etc. is compared with the

past trends and based on the future expectation, cost estimates are made for the purpose

of arriving at the profit of the enterprise. Any abnormal costs or losses are separately

examined and analyzed accordingly.


Form III: Analysis of Balance Sheet

It is necessary to restructure various items of financial statements submitted by an

enterprise in a format meaningful for the purpose of credit analysis. The initial step in an

exercise of restructuring the balance sheet is to classify the various assets into current, non-

current, fixed and intangible assets. Similarly, the liabilities also need to be classified into

various categories viz. current, deferred, net worth etc.

Classification of items in this manner helps rearrange them in the order of priority from the

point of view of a lending banker.

Balance sheet shows the position of assets and liabilities of an entity as on the date of

balance sheet. There are various types of assets like tangible, intangible, fixed, current etc

and similarly various liabilities like short term loans, long term loans, current liabilities and

provisions etc.

Each of such assets and liabilities are examined and analyzed for source, purpose and

application of the same. Moreover, the amount and duration of existence of such assets

and liabilities are also taken into consideration to arrive at the regular funding position of

the entity.

Based on past trends, requirement of the entity and future funding pattern, positions of the

assets and liabilities at the future dates are estimated and set accordingly for deciding the

finance requirement of the organization.

Form IV: Comparative Statement of Current Assets and Current Liabilities

This form is used to understand the holding levels of the enterprise as it is the main source to study the actual working capital requirement of the enterprise; it also shows the cover period of receivables.

Based on the holding period or say requirement of amount of fund to be invested in current assets, and availability of the credit to the company for paying the current liabilities, working capital requirement of the entity is assessed and further, after adjusting the long term surplus available for the same and internal accruals contributing to the same, the CC limit is arrived at.

The extent of limit is also dependent upon the overall funding pattern of the entity and the fact is also to be assured that promoters also contribute towards the working capital requirement and contribution from bank finance is at acceptable level.


Generally all the corporate will wish to show high holding levels and fewer creditors hence it is the responsibility of the analyzer to understand the actual requirements and assess the same.

Form V: Calculation for Assessed Bank Finance

In this form the maximum working capital limit which is known assessed bank finance is

calculated.

Form VI: Fund Flow Statement

The change in position of an item in the balance sheet is known as flow, the statement of

changes is known as fund flow statement or as the statement of sources and application of

funds.

The inflow and outflow of funds is represented by a change in the assets and liability items

of the balance sheet of an enterprise. While analyzing the inflow and outflow of the fund of

an enterprise, separate analysis is made for long term sources and uses as well as short

term sources and uses.

Increase in long term liabilities and decrease in long term assets denotes long term source

of the fund and decrease in long term liabilities and increase in long term assets denotes

long term application/use of fund. The difference of the source and uses of long term fund

is known as long term surplus or deficit as the case may be.

When long term surplus is generated, it is used towards the short term application or say

working capital finance. Whenever there is deficit in fund flow i.e. long term uses exceed

long term sources, it is called diversion of fund from short term sources to long term usage.

In general, diversion of fund is not desirable as it indicates that fund created/availed for the

working capital are not used for the purpose for which they have been availed. The

diversion may be accepted based on examining the genuineness in special cases with

proper and satisfactory justification for the same.


Summary of Ratios

Various ratios are calculated as a part of analysis; among them the most important ones are as

discussed below:

Current Ratio

This is the most important ratio indicative of the liquidity position of an enterprise and is

widely used by credit analyst in assessing the degree of liquidity enjoyed by an

enterprise.

The ratio is expressed as:

Current Ratio = Current Assets Current Liabilities

A current ratio of 2:1 thus implies that the value of current assets of the enterprise is

double the amount of current liabilities, higher the current ratio better is the liquidity of

the enterprise as it shows that enterprise has enough funds to meet its current

liabilities.

As a part of analysis this ratio should clear some cut-off value so that loan requirement

of the enterprise can be made permissible that is for working capital loan this ratio

should be 1.2 and 1.33 for trading and non-trading firms respectively, studying this ratio

for the purpose of term loan does not have much significance.

Gearing Ratio

This ratio is expressed as given below:

Gearing Ratio = TOL/TNW

Where,

TOL = Total Outside Liabilities

TNW = Tangible Net Worth

This ratio shows how much debt an enterprise has with respect to the tangible net

worth it possess, smaller the value better it is its gearing.

This ratio provides information on the position of owned funds compared to the total

outside liabilities of the enterprise and is also termed as capitalization ratio. This ratio is


generally used in analyze the position of external funding position vis-à-vis the owned

funds of an enterprise.


of the enterprise can be made permissible that is for working capital loan and term loan

this ratio should be not more than 5 and 3 for trading and non-trading firms respectively

Profitability Ratio

This ratio is expressed as given below:

Profitability Ratio = PBT/ Net Sales

Where,

PBT = Profit before Tax

Net Sales = Gross Sales – Excise Duty

This ratio shows how much profit the enterprise is earning out of the annual sales;

larger the value better is the operations of the enterprise.

It measures the overall efficiency of production, administration, selling, financing, and

pricing, value greater than 1 is appreciable.

Interest Coverage Ratio

This ratio is given as

Interest Coverage Ratio = PBDIT/ Interest

Where,

PBDIT = Profit before depreciation and interest

This ratio indicates the leverage enjoyed by the enterprise in paying the interest

obligations. This ratio is calculated to check how credible is the enterprise to make its

interest payments, higher the value it is better for the lending banker, this ratio is

studied in case of loans in which only interest is received i.e. working capital loans.


DSCR (Debt Service Coverage Ratio)

This ratio is given as,

DSCR = (PAT + Depreciation + interest on TL)/ (Annual Principal Installments +

Interest on TL)

This ratio indicates the capability of an enterprise for servicing both the interest and

principal installments of a debt, this ratio is studied in case of term loans only as in term

loan repayment of installment and interest both has to be received on time.


of the enterprise can be made permissible that is for term loan this ratio should not be

less than 1.75 for trading firms.

Debt to Equity Ratio

This ratio is given as,

Debt to Equity Ratio = Total Long Term Liabilities/Shareholder’s Equity

This ratio is studied to measure the financial leverage of the enterprise, it indicates what

proportion of equity and debt the enterprise is deploying to finance its assets.

A high debt/equity ratio generally means that the enterprise has been aggressive in

financing its growth with debt. This can result in volatile earnings as a result of the

additional interest expense.

Lending bankers always prefer some margin while financing the borrowers that are

generally 65% is financed by bank and 35% should come from the promoters it may be

through equity.


Credit Risk assessment

What is RISK

Risk is defined as any situation involving exposure to danger. In terms of finance, risk can be

defined as: “he that the expected or prospective advantage, gain, profit or return may not

materialize;it means that the actual outcome of investment may be less than the expected

outcome.

Greater the variability or dispersion in the possible outcomes, or the broader the range of

possible outcomes, the greater the risk. The measure of risk is Standard Deviation.

Types of Risk and Risk Management

As per the Reserve Bank of India guidelines issued in Oct. 1999, there are three major types of

risks encountered by the banks and these are Credit Risk, Market Risk & Operational Risk.

1. Credit Risk

Credit risk is defined as the possibility that a borrower or counterparty will fail to meet

its obligations in accordance with agreed terms, the degree of credit risk is the

probability that a loan lent to a borrower may not be repaid.

The extent of repayment and the time taken in the process are the important factors in

the computation of probability of default.

2. Market Risk


Market risk gives rise to the possibility of loss to a bank caused by changes in the market

variables.

The Bank for International Settlements defines market risk as “the risk that value of on

and off balance sheet positions will be adversely affected by movements in equity and

interest rate in markets, currency exchange rates and commodity prices.”

Thus, Market Risk is the risk to the bank’s earnings and capital due to changes in the

market level of the interest rates or prices of securities, foreign exchange and equities,

as well as the volatilities of those changes. It is sub-classified as:

Interest Rate Risk

Interest Rate Risk is the potential negative impact on the Net Interest Income and it

refers to the vulnerability of an institution’s financial condition to the movement in

interest rates. Changes in interest rate affect earnings, value of assets, liability off-

balance sheet items and cash flow. Hence, the objective of interest rate risk

management is to maintain earnings, improve the capability, ability to absorb

potential loss and to ensure the adequacy of the compensation received for the risk

taken.

Liquidity Risk

Bank Deposits generally have a much shorter contractual maturity than loans and

liquidity management needs to provide a cushion to cover anticipated as well as

sudden deposit withdrawals. Liquidity is the ability to efficiently accommodate

deposit as also reduction in liabilities and to fund the loan growth and possible

funding of the off-balance sheet claims. The cash flows are placed in different time

buckets based on future likely behaviour of assets, liabilities and off-balance sheet

items. Liquidity risk consists of Funding Risk, Time Risk & Call Risk.

Funding Risk: It is the need to replace net out flows due to unanticipated

withdrawal/nonrenewal of deposit.

Time risk: It is the need to compensate for non-receipt of expected inflows of

funds i.e. performing assets turning into nonperforming assets.


Call risk: It happens on account of crystallization of contingent liabilities and

inability to undertake profitable business opportunities when desired.

The Asset Liability Management (ALM) is a part of the overall liquidity risk

management system in the banks. It implies examination of all the assets and

liabilities simultaneously on a continuous basis with a view to ensuring a proper

balance between funds mobilization and their deployment with respect to their

maturity profiles, cost, yield, risk exposure, etc. It includes product pricing for

deposits as well as advances, and the desired balanced maturity profile of assets and

liabilities.

Foreign Exchange Risk

Forex risk is the risk that a bank may suffer as a result of adverse exchange rate

movements during a period in which it has an open position, either spot or forward, or a

combination of the two, in an individual foreign currency. The banks are also exposed to

interest rate risk, which arises from the maturity mismatching of foreign currency

positions. Even in cases where spot and forward positions in individual currencies are

balanced, the maturity pattern of forward transactions may produce mismatches. As a

result, banks may suffer losses as a result of changes in premia/discounts of the

currencies concerned. In country like India which is pegged to single currency viz. USD,

cross currency transaction also sometimes involves Forex risk.

3. Operational Risk

According to Basel Committee operational risk is defined as “the risk of loss resulting

from inadequate or failed internal processes, people and system or from external

events.”

The key to management of operational risk lies in the bank’s ability to assess its process

for vulnerability and establish controls as well as safeguards while providing for

unanticipated worst-case scenarios.


Credit Risk Assessment Model at State Bank of India

Credit risk management encompasses identification, assessment, measurement, monitoring

and control of the credit exposure. The bank has well defined Credit Risk Management

Policy and this has been in practice since 1996.

Over the years, bank’s policy and procedures in this regard have been enunciated, practiced

and refined based on evolving concepts and bank’s actual experience. The risk assessment

policy and procedure of SBI has been aligned to ‘Standardized Approach’ under Basel II from

1.4.08 and the bank is gearing itself to adopt ‘Foundation Internal Rating Based Approach’

The bank undertakes the following functions in the process of identifying and assessing the

credit risk underlying a proposal:

Developing and refining the credit risk assessment models used for taking ‘Commercial

Banking’ and ‘Retail Banking’ exposures.

Conducting industry research, which is integral to assessing the risk associated with any

loan proposal of corporate.


CRA Process for Commercial Advances

Before a credit facility is sanctioned to a client/obligor, the risk level is measured, as per the

credit risk assessment framework developed by Credit Risk Management Department

(CRMD).

The credit risk rating is worked out by Credit Processing Cell on the audited balance sheets

(projected financials in case of a new unit) and data collected by the credit analyst about

the management, industry etc. of the enterprise.

The internal rating thus obtained is validated and approved by a separate committee,

specially set up for this purpose. The process of validation and approval is made prior to

sanction/renewal/enhancement of the credit facilities.

The CRA model is divided in two sectors viz. trading (applicable for enterprises engaged in

services and trading activities) and non-trading sectors (applicable for enterprise engaged in

manufacturing activities) these two sectors are examined differently because trading and

non-trading industries have different way of functioning and different requirements

Therefore different parameters have been set for trading and non-trading business and

accordingly scores are defined.

For a credit proposal, a credit rating is based on audited financials as validated by CRA

validation committee. The bank now has a unified Credit Risk Assessment System, which is

used for assessing the credit risk of borrowers as well as facilities viz., working capital, term

loan and non-fund based exposure etc., to commercial and institutional borrowers, MSME’s


(Micro, Small and Medium Enterprise) ), SSI (Small Scale Industries), SBF (Small Business

Finance) and agriculture segment for exposure of 25lakhs and above.

Their are two models for the each of the two sectors, the models are classified as shown

below:

Sr. No. Exposure Level

(FB+NFB)

Non-Trading

Sector

Trading Sector

1 Over 5 Crore Regular Model Regular Model

2 Rs 0.25 to 5 Crore Simplified Model Simplified Model

The rating process reflects the risk involved in the facility/borrower and would be an

evaluation of the borrower’s intrinsic strength.

The type of ratings is different depending upon the type of model this is as shown in table

below:

Sr. No. Model Type of Rating

1 Regular (i) Borrower Rating

(ii) Facility Rating

2 Simplified (i) Borrower Rating

In the CRA model of SBI depending upon the extent of risk involved scores are given for

each type of parameter on which risk has to be studied and depending upon the total score

the final ratings are given and hence depending upon the risk score the pricing is decided.

Borrower Rating

This rating is done to see the risk which may be faced because of the credibility of the

borrower, the scale for borrower’s rating is SB1 to SB16 depending upon the scores obtained by

the enterprise under various heads as discussed hereinafter. In this rating process, various risks

are studied with regard to the borrower mentioned below:


Financial Risk

Various financial parameters are studied in this section this includes:

Gearing Ratio (TOL/TNW)

Current Ratio

PBDIT/Total Assets

Retained Profits/Total Assets

PBDIT/Interest

PAT/Operating Income

Net Cash Accruals

Growth in Net Sales

Factors Influencing Financial Flexibility

Group Risk

Forex Risk

Future Prospects

Gross average DSCR, etc.

For all these financial indicators based on the latest audited financials (projected in case of

new unit) scores are assigned and each factor has weightage of its own in the risk

assessment and depending upon that final score is calculated. For each indicator moving

average of last three years and industry comparison (in case of manufacturing) is also

carried out.

Qualitative Factors

If there are any qualitative remarks like Contingent Liabilities, Auditors Qualifying Remarks,

and Accounting Policies etc. affecting the business, negative scoring is also defined based on

the extent and effect of such qualitative factors on the overall functioning and credibility of

the enterprise.

Business and Industry Risk

Some risk is always associated with the type of business the borrower enterprise is in, the

parameters examined in this section are:


Competition and Market Risk

Industry Outlook

Industry Cyclicality

Regulatory Risk

Business Environment

Technology and Vulnerability to Microeconomic Environment

Access to Resources

Product Profile

R&D

Distribution Network

Restructuring

Level of Integration, etc.

These all parameters are very subjective hence study of all the factors to be considered

is done by the credit analyst and then rating is done depending upon the analysis.

Management Risk

Risk is well associated with the way management is running the day to day functions of the

borrower enterprise and hence it becomes a very important part of borrower ratings. This

column covers points like:

Integrity

Corporate Governance

Conduct of Account

Managerial Competence

Commitment

Payment Record

Experience in the Industry

Length of Relationship with Bank

Credibility

Adherence to the Covenants of Sanction


Ability to meet changes, etc.

External Rating

Solicited Rating by a recognized External Credit Rating Agency (ECRA) translates to

additional Score. External Credit Rating Agencies assign Bank Loan Rating on long term and

short term rating scales of various credit rating facilities. So with each the ECRA rating some

risk weight is given and the scores are calculated. Following ECRAs recognized by RBI are

considered for this purpose:

Sr. No. Type ECRA

1

Domestic

(a) Credit Analysis & Research Limited

(b) CRISIL Limited

(c) FITCH India

(d) ICRA Limited

2

International

(a) FITCH

(b) Moodys

(c) Standard and Poor’s

Country Risk

This is the risk that a borrower will not be able to service the obligation to pay because of

cross-border restrictions on the convertibility or availability of a given currency. Applicable

to Borrowers for whom 25% or more of their cash flow or assets are located outside India.

Financial Statement Quality

The credit analyst is to comment on the quality, adequacy and reliability of the financial

statements/information irrespective of the risk rating. The quality is to be indicated as

Excellent/good/satisfactory/poor.


Rating Transition Matrix

In this section comparison of risk ratings done over a period of three years, Comments on

the Movement of Rating /Risk Scores are furnished. Any major fluctuation in scores

resulting in up-gradation or deterioration in rating by more than one stage, is commented

upon, Up-gradation in rating only on account of higher score in parameters other than

Financial Risk, is to be examined and commented upon.

Maximum Score that is assigned to all these types of risks is as shown in table below

Risk Type Regular Model Simplified Model

Existing

Company

New

Company

Existing

Company

New

Company

Financial Risk 65 25

(65 X 0.39)

70 35

(70/2)

Qualitative Factor (-ve) (-10) (-10) (-10) (-10)

Business & Industry Risk 20 30

(20 X 1.5)

20 40

(20 X 2)

Management Risk 15 45

(15 X 3)

10 25

(10 X 2.5)

External Rating +5 +5 +5 +5

Total 100 100 100 100


The scores obtained from all the parameters above has to clear the hurdle score to classify the

enterprise acceptable for sanctioning of loan, the hurdle rates under Borrower’s Rating is as

shown in table below:

Hurdle Score

Risk Type Regular Model Simplified Model

Existing

Company

New

Company

Existing

Company

New

Company

Financial Risk 25 10 30 15

Business & Industry Risk 12 16 10 20

Management Risk 8 22 5 13

Aggregate hurdle Score 15 48 45 48

Overall Hurdle Score SB10 SB10 SB10 SB10

Facility Rating

A borrowing company may be availing either one or more of Fund Based Facilities such as

Working Capital (WC)/Term Loan (TL) or Non-Fund Based Facilities like Letter of Credit

(LC)/Bank Guarantee (BG), all the facilities are to be rated separately viz. if a borrowing

company has both WC and TL and Bank Guarantee and LC, in total the company would have

one Borrower Rating and four Facility Rating (i.e. 1+1+1+1 = 4)

Loss Given Default (LGD)

Facility Rating would reflects the degree of severity of loss in the event of default on the

obligation. Facility Rating Grade thus translates on a LGD scale, indicating loss percentage, LGD

is calculated on a sample basis in CRMD (Credit Risk Management Department) from the data

available with them.

Risk Drivers for LGD

Current Ratio / Project Debt to Equity

Current ratio is studied in case of working capital loan and project debt to equity is

studied as a risk driver in case of term loan.


Nature of Charge

Scoring is done only for 1st charge, the quantum of Collateral vis-à-vis the total

Exposure i.e., Exposure at Default (EAD) is the basis of scoring.

EAD = for Fund Based Exposure: outstanding+ 75% of unutilized limits and for Non-

Fund Based Exposure it is the total limit to be sanctioned

Industry

Recovery Rates /Default Rates vary from Industry to Industry, industry specific

factors determine the current position of an industry in an Economic Cycle.

Some of the factors which impacts recovery are the state of growth of that particular

industry, the financial strength of the unit as well as the quality of the Asset.

Units belonging to an industry under positive growth phase, and with better

financial strength and asset quality stand a better chance of being sold as a going

concern than the one under a recessionary phase having depressed financials /asset

quality.

In a highly favourable phase, the Default Point (DP) is far away while in a highly

unfavorable position, the industry’s susceptibility to be pushed into DP goes up

substantially.

The Scoring under the parameter is divided into the following two sub-heads:

(a) Industry Characteristics & Distance to Default

In this clause the scoring is done according to CRMD norms.

(b) Industry Recovery Score

The recovery score is calculated as given below:

Score = {(100-LGD) X3}/100 in case if the industry of the enterprise is not listed

than the industry score is taken as 0.72 on an average.

Geography

In this clause scoring is done depending upon the region, in which the enterprise is

functioning, risk varies form place to place depending upon the availability of resources

etc.


Unit Characteristics

The Scoring under the parameter is divided in the following sub-heads:

(a) Leverage/Enforcement of Collateral

Leverage is a measure of the extent of claimants for an Asset in the event of

default of a Borrowing Company i.e., it is inversely proportional to the

enforcement of claim.

Even for senior stake holders, higher leverage impacts the enforcement of

collateral and recovery there from, as in many cases consent may have to be

obtained from smaller claimants before disposal of Assets to affect recovery.

The enforcement of Collateral for recovery therefore becomes a challenge. The

assessment under the parameter is to be made in this section.

(b) Safety, Value & Existence of assets

Once a default occurs with no sign of reversing the process in sight (including

restructuring of debt), the Bank needs to explore ways for disposal of assets for

satisfaction of its dues. For such reasons, examination of the quality of Collateral

& its useful life becomes important at the time of each successive review of the

credit facility.

This aspect is necessary to determine the quality of upkeep of the assets and

their degree of deterioration (once default occurs), the likelihood of its

disappearance, decline in its market value compared to Book Value. A borrowing

concern under financial strain cuts back on maintenance of Collateral. The Risk

assessment under the parameter needs to consider all such factors.

Macroeconomic Conditions

Economic downturn impacts LGD as all retarding economic variables impact the

Demand-Supply Paradigm. It affects production/trade, recession sets in which in

turn accelerate the loan default rate. Asset value deteriorates with few buyers, and

distress sale at a depressed price becomes the only option to reduce the loss to

some extent.

Normally, assets need to be valued both in the up & down scenario of the economy.

Accounting for this scenario is complex. Basel–II Document has advocated a


conservative approach to be adopted – Pillar I Capital calculations must reflect

economic downturn condition, where necessary, to capture relevant risks. The other

parameters under Macro-Economic Conditions are an offshoot of such a situation.

The risk assessment under the parameter is to be done in this section.

The scoring under the parameter is divided in the following sub-heads:

(a) GDP Growth Rate : Impact of Business Cycle (b) Insolvency Legislation in the Jurisdiction (c) Impact of Systemic/Legal Factors on Recovery (d) Time Period for Recovery

Total Security (Primary + Collateral)

The collaterals are an important ingredient of facility rating design; their quality and

depth affects the severity of LGD for any facility. As an element of risk is involved,

prudence is required in assessing the value of the collateral offered for obtaining credit

facility. Scoring is done depending upon the type and amount of security to be given by

the client on account of the loan taken.

Risk Drivers for EAD

Credit Quality of Borrowers

The Score obtained by a unit under Borrower Rating reflects not only its financial

strength but it is also an indicator as to how far it is away from Default stage/Point.

In some cases, the deterioration in Rating may be a gradual affair while there would

be isolated instances of a steep decline also in the event of any unexpected event

resulting in Unexpected Losses.

Measuring the position of a unit from the Default Point then assumes importance

from the Default and the consequent Loss Severity angle.

Tenor of Facility

Risk is involved with the time period for which the loan is sanctioned because it cannot

be assured that the performance of an enterprise will be the same or will be better over

a longer span of time and hence risk weights are assigned depending upon the tenor of

facility


Pricing

Pricing of loans in the bank cover interest income as well as fee income. Bank has quoted a

single Base Rate (BR) which is the reference rate below which the bank will not undertake

any lending activity except some permitted categories of advances like Staff Advances,

Crop. Loans upto 3 lakhs, metal gold scheme etc.

Pricing of Bank’s funds and services while being basically market driven, is also determined

by two important considerations:

Minimum desired profitability

Risk inherent in the transactions

The Base Rate is reviewed by the Asset Liability Management Committee (ALCO) with

periodicity of at least once in a quarter; the present base rate for the bank is fixed at 8.50%

p.a.

Credit Risk Premia (spreads) as per the existing Credit Risk Assessment (CRA) model of the

bank is added to the base rate as per Credit Rating of the borrower.

Since CRA rating takes into account the inherent risks in the business based on financial,

industry, segment and management risks, the pricing for rated borrowers is uniform

irrespective of segments (viz: C&I,SIB and AGRI)


For long term exposures, the factors that weigh are the rate charged by the financial

institutions/ other banks, the period of exposure, the pattern of volatility in interest rates

and the expected movement of rates in the long term perspective.

Bank can price loans at fixed and floating rate basis linked to the base rate. However, the

effective to be charged is equal to or above the Base Rate.

The Bank has adopted an appropriate authority structure to facilitate competitive pricing of

loan products. The authority concerned while exercising the discretion takes into

consideration the risk rating of the loan assets, the trends in movement of interest rates,

market competition and overall business consideration.

for working capital and loans upto 3 years and limits between `25 Lakhs to `100 Crores the

spread is as shown in table below:

Rating Base Rate Spread Effective Rates

SB 1 to SB 2 9.25 4.75 14.00

SB 3 to SB 5 9.25 6.00 15.25

SB 6 to SB 7 9.25 6.50 15.75

SB 8 to SB 9 9.25 6.75 16.00

SB10 9.25 7.25 16.50

SB11 to SB15 9.25 7.50 16.75

Appropriate tenor premium is built in the pricing for Term loans of various maturities

beyond 3 years as shown in table below:

Sr. No. Term Term Premia (%)

1 >3 yrs less than 5 yrs 0.50

2 From 5 yrs to less than 7 yrs 0.75

3 From 7 yrs to less than 10 yrs 1.00

4 10 yrs and above 1.25


Proposal writing

A project proposal is the final draft of the whole process of credit appraisal and is referred

to team leader; it contains all the information regarding the enterprise, analysis done by the

credit analyst at each stage of appraisal. The proposal is prepared as credentials to

sanctioning authority for approval.

There are two formats for drafting a project proposal that is as shown:

S-Format: this format is prepared in case of sanction or renewal

AS-Format: this format is prepared for continuation of limits, sanction of Ad-hoc

facilities, and all sort non-business proposals.

S-Format

First page of proposal is Date Chart for Disposal of Credit Facilities

1. Name of Branch

This clause has name of the branch from which the project has came to MCRO for

appraisal.

2. Module

Each region has various divisions and hence, that is mentioned in this section for

example: Sales Hub, Ahmedabad.

3. Circle

Regional office of MID-Corporate Group of SBI is defined as various circle depending

upon the region it covers, hence the circle within which the branch which has brought

the project falls in, has to be mentioned here for example: MID-Corporate, Ahmedabad

region.

4. Name of Unit

This clause has name of the enterprise which has applied for the loan from SBI

E.g. XYZ Private Limited (XPL)


5. Nature of facilities applied for

This clause is in form of a table showing the existing and proposed limits of fund based

and non-fund based facilities, from SBI and other banks under consortium or multiple

banking Arrangement (MBA), this table also shows the percentage exposure of SBI as

compared to total outlay under consortium or MBA.

6. Date of receipt of the proposal at CPC

The date on which the project came to MCRO for appraisal e.g. 12.03.2011

7. Proposal withdrawn by sanctioning authority

If in case the proposal has been withdrawn by the sanctioning authority on demand of

team leader or credit analyst based on various issues that date has to be mentioned in

this clause.

8. Date of making reference to bank’s consultant

Bank has its own consultancy cell, if in any case the appraisal of loan is referred to the

consultancy cell that date is mentioned in this section.

9. Date of receipt of report from bank’s consultant

If any report is received by the Bank’s consultancy cell that date is mentioned here.

10. Queries raised on

The date on which some queries has been raised to the client or his consultant is

mentioned here.

11. Date of receipt of complete information

The date on which all the information required from the client is met, that date is

mentioned in this section.

12.

a. Date of submission to sanctioning authority

This clause has dates that when the proposal was submitted to team leader and to

next higher authority respectively.

b. Authentication of the official submitting the proposal to the next higher authority

This clause has the signature of credit analyst and the team leader.


Next page of the proposal is Executive Summary which contains table of contents which has

detail about the name of section and page number of the same, the sections of proposal is

as discussed in a chronological order.

Section 1 : Memorandum for the MID-Corporate Credit Committee

This section contains information regarding the borrower and the industry as shown below:

A. Borrower’s Profile

This section contains details about the borrower i.e. name of the company, address of

registered office, type of industry and activity of the enterprise, this section also has

information about since how long the enterprise id banking with SBI.

All this information is gathered by the credit analyst in order to understand and examine

how has been the relationship of the entrepreneur with SBI and whether he is credible

or not.

In this section there is a clause of IRAC status i.e. Income Reorganization and Asset

Classification; The IRAC norms serve two primary purposes i.e. to depict the true

position of a bank's loan portfolio and to help arrest its deterioration. This clause is

taken into consideration only when an existing client comes with new requirements.

According to IRAC norms loan assets are classified in the following categories:

Standard

If the IRAC status is standard that means that the enterprise has paid all its debt on

time i.e. both interest and installment in case of term loan and interest and loan

repayment in case of working capital or any irregularity which falls within a period of

90days. Or we can say that these are the assets, which do not disclose any problem

and do not carry more than the normal risk attached to the business.

Sub-Standard

Assets are classified sub-standard if they remain non-performing for less than or

equal to 12 months. They have well defined credit weaknesses and are characterized


by the distinct possibility that the bank will sustain some loss if the deficiencies are

not rectified.

Doubtful

Assets are classified doubtful if they remain non-performing for more than 12

months. They have all the weaknesses inherent in sub-standard assets with the

added characteristic that collection or liquidation of the dues is highly improbable.

Once an asset is classified doubtful than bank has to make some provisions, the

percentage of provision to be made is as given below:

For the first year of default provision made by bank is 20% of the total exposure

For the second year of default provision made by bank is 30% of the total

exposure

For the third year of default provision made by bank is 50% of the total exposure

Loss

These are assets where loss has been identified by the bank or internal / external

auditors or RBI inspection, but the amount has not been written off, wholly or in

part. Such assets are considered uncollectible and of so little value that their

continuance as bankable assets is not warranted, even though there may be some

salvage or recovery value. Once an asset is classified loss than 100% provision has to

be made by the bank and the account is categorized as a bad debt.

B. Brief Background( company/group/promoters/management including shareholding

pattern)

This section has brief history about the enterprise related to date of incorporation;

products manufactured or traded, details about the background of the directors i.e.

their qualification, experience in industry etc. , shareholding pattern is also mentioned

in this part to see how much money is brought in by the promoters. This section is very

useful in studying about the industry and promoters and hence their credit worthiness.


C. Brief write-up on industry/sector and company’s standing in the industry

This section has the write-up on industry as a whole, this done to see whether the

exposure to be made in this sector by the bank is fruitful or not. In case of

manufacturing companies the whole manufacturing process is also discussed in this

section.

D. CRMD Exposure norms

CRMD stands for Credit Risk Management Department of SBI, it undertakes reviews of

industry/sector exposure for select industries at periodic intervals, and CRMD issues

advisories on the general outlook in near terms for industry from time to time.

The norms are classified as qualitative and quantitative approach as given below:

Qualitative approach

This approach measures that whether the industry outlook is positive, neutral or

negative, this helps in deciding whether to finance this particular industry or not.

Quantitative approach

This approach measures the fund based exposure in this sector as a percentage of

bank’s total fund based exposure. This gives a clear picture about the exposure in

this sector and helps in decision making.

E. Indebtedness/Exposure and capital charge

Indebtedness

This column shows the existing and proposed fund based and non-fund based outlay

of SBI to the enterprise.

Exposure

Indebtedness plus the investment and leasing done by SBI in the enterprise and is

nothing but the exposure of the bank in the enterprise.

External Rating

A table showing the details about the rating done by the External Credit Rating

Agency i.e. name of the agency, rating and the outlook of the given rating.


Capital Charge

The capital charge is the capital that will be blocked because of the exposure made

in the enterprise, it is given by

For Fund Based Facilities

Capital Charge = Proposed Exposure X Risk Weight X 11%

For Non-Fund Based Facilities

Capital Charge = Proposed Exposure X Risk Weight X CCF X 11%

Here risk weight of facilities depends upon the external rating of the company, the

figure below shows the various risk rates associated with different external ratings:

CCF signifies the factor used to convert non fund based limit to funded limit, on

which the bank provides applicable capital charge, it varies depending upon the type

of facility i.e. for documentary LC it is 20%, for Financial BG it is 100%, performance

BG it is 50% etc.

Long Term

Rating

Short Term Rating Risk Weight

CARE CRISIL FITCH ICRA

AAA PR1+ P1+ F1+ A1+ 20%

AA PR1 P1 F1 A1 30%

A PR2 P2 F2 A2 50%

BBB PR3 P3 F3 A3 100%

BB & Below PR4 &

PR5

P4 &

P5

B,C,D A4 &

A5

150%


ROCE of bank is also calculated in this clause it is the amount that bank require each

year in return for providing financing to a business. It is essentially a theoretical

number which is supposed to reflect the return bank expects for the amount of risk

in the business, it is given by:

ROCE (%) =

Section 2: Present Proposal

A. Sanction and Approval for

In this column the information about the limits that is to be sanctioned is mentioned

and if some recommendations are to be approved by the committee is mentioned for

example some changes in pricing, some concession in processing charges etc.

B. Credit Limits(Existing and Proposed)

This is the same table that is on the first page of the proposal showing all the existing

and proposed limits of fund based and non-fund based facilities from SBI and total limits

from MBA (Multiple Banking Arrangement) or Consortium, also showing the % share of

SBI.

C. Sharing Pattern

In this column all the banks under MBA or consortium are mentioned with existing and

proposed limits and percentage share of each of the banks. A separate table is made for

both working capital limits (FB and NFB) and term loan (FB and NFB).

This whole section is concentrating on the limits required and how the financing is done for

the same through MBA or Consortium and how much is the exposure of SBI. This section

also has a brief description about why the loan or enhancement in existing limits is required

by the enterprise.


Section 3: Performance and financial indicators

This section is of great importance as it contains the analysis from CMA hence, all financial

justification and description is given in this section.

A. Financial indicators

This section is taken from the CMA showing the two year audited, present year

estimates and next year’s projections of the financial indicators. These financial

indicators include Net Sales, Operating Profit, PBT, PBT/Net Sales, PAT, Cash Accruals

,PBDIT,PUC(Paid Up Capital),TNW(Tangible Net Worth), Adj. TNW,TOL/TNW,TOL/adj.

TNW, Total CA, Current Ratio and NWC(Net Working Capital), any slump or spurt is

these indicators is justified in this section.

B. Movement in TNW (Tangible Net Worth)

The following is the formula for calculating Net Worth of a company:

TNW = Net Worth – Intangible Assets – Revaluation reserve

Opening TNW

Add:

Profit / (-) Loss after tax

Increase in Share Capital

Decrease / (-) Increase in intangible assets

Increase/ (-) Decrease in Reserves

Adjust prior year expenses

Increase in deferred tax liability

Less:

Dividend paid / Withdrawals

Equals:

Closing TNW

The basic reason to study this is to get a clear image about the increase or decrease in

net worth i.e. to understand among cash accrual, equity or application money which

element is contributing to the change in overall TNW.


C. Synopsis of Balance Sheet

Two year audited figures of balance sheet are mentioned in this section with analysis on

the elements of balance sheet.

Section 4: Risk Assessment

This section contains the gist of the whole Credit Risk Assessment done by the credit

analyst; this is of great importance for the Bank as depending upon this pricing is decided.

A. Credit Rating

This section contains the table having synopsis of borrower’s rating and facility rating

obtained by the enterprise while CRA(Credit Risk Assessment) and also the rating

obtained by ECRA(External Credit Rating Agency).In case of enhancement or renewal

both existing and proposed ratings are shown so as to make the ground for comparison.

B. Risks and Mitigation Factors

This section shows threat and various risks which may be faced by the company and

how capable are the company and its promoters to mitigate the same.

C. Warning Signals/Major irregularities in Inspection report/Credit Audit/other reports

In credit audit report, I/A report, statutory reports or qualification in Auditors Report if

in any case some irregularity or any adverse feature which may affect the appraisal and

assessment of credit or which may hinder the decision making are mentioned and

justified in this section.

D. Security

This section has brief detail about the primary and collateral given by the enterprise as

security against the loan taken is shown. This section also has the guarantee column

which shows the personal guarantee of the directors.

E. Changes if any, Justification


In case of renewal or enhancement if there are some changes made in the collaterals or

personal guarantee is mentioned in this section with the justification of the same.

Section 5: Pricing

This section concentrates on the pricing i.e. interest rate to be charged on the loan to be

given taking in consideration all the required factors.

A. Conduct of the Account

If any irregularity is observed in WC or TL that is mentioned in this section with specific

description of the same, also the utilization of fund based and non-fund based limits is

mentioned.

B. Income Analysis

In this section actual, estimated and projected ROCE is studied in order to analyze the

income expected to be earned by the bank due to this outlay.

C. Other Bank’s /FI(Financial Institutions) Pricing

This section shows the details about the pricing of other banks which are associated

with the enterprise; this is checked in order to study the competitive pricing.

D. Proposed Pricing

Pricing that is interest rate to be charged to the enterprise on the outlay depends upon

the CRA rating, the present base rate charged by SBI is 9.25% and depending upon risk

rating spread above base rate is charged.

Proposed pricing of an enterprise can be on card rate (i.e. the actual rate calculated

according to the risk rating of the enterprise) or some other proposed rate(i.e. some

concessional rate) depending upon various factors like competition and threat of loss of

business, overall earnings from the enterprise, additional business potential, cross

selling etc. Hence, this section contains the details about pricing for each type of facility

availed by the client.


E. Justification for concessions already extended/proposed

If loan is sanctioned on proposed rate (concessional rate) other than card rate the same

has to be justified with valid and convincing reasons, showing both benefit and loss to

the bank.

Section 6: Loan Policy and compliance

A. Whether names of promoters, directors, company, group concerns figure in

defaulter/willful defaulter list

RBI Defaulters’ list, Willful defaulters’ list, ECGC caution list and CIBIL is checked to see

whether any personal related to the enterprise has its name on it and if yes it has to be

justified. In case if the name appears in the list of willful defaulters than loan is not

sanctioned to such a party.

B. Deviation in Loan Policy

Some norms has been set by bank regarding the cut-off of ratios, contribution from

promoters, prudential norms, fund based exposure to the industry etc. any deviation

form the norms is mentioned and justified in this section.

C. Deviation in Take Over norms and comments

Any deviation from the take over norms is to be justified and approved by appropriate

authority and detail about that is mentioned in this section.

D. Directors of the borrower company are relatives of any of the Bank’s Board/Senior

Officer of the Bank/Member of any other Bank’s Board

This has to be mentioned explicitly as if such a thing happens or comes in notice will not

be acceptable for sanctioning of loan.

E. Compliance with section 20 of the Banking Regulation Act: whether any of the directors

of the bank is director of the borrower company or is having any interest in the same

This has to be mentioned explicitly as if such a thing happens or comes in notice will not

be acceptable for sanctioning of loan.


Section 7: Future Plans and Business Potential

A. Future Plans and Business Potential including cross selling/retail marketing based on

Co/group’s future plans

This is studied to see the future growth plans of the company and how this could be

beneficial to the bank and what other relationship or facility the client is utilizing from

SBI from its vast product portfolio.

B. Environmental and Sustainability Implications

Some manufacturing firms are required to take environmental clearance, that is

checked in this section i.e. whether the clearance is taken or not and if taken validity

and expiry of the same.

C. Earlier terms of Sanction: Compliance status

Whatever stipulations and observation are made in last resolution is mentioned in this

section with compliance status.

D. Statutory dues/other contingent liabilities

Any contingent liability has to be mentioned in this section and has to be seen whether

they can affect the bank.

Section 8: Justification for the Proposal

Justification of the whole proposal is summarized in a single page in this section.

Section C: Assessment of fund based and non-fund based limits

This whole section shows the details of how the limits of fund based and non-fund based

facilities is assessed and calculated, the calculation of each of them has been discussed

earlier in the project report where all the facilities are discussed discretely. Below is the

order in which the calculations are represented in this section.

A. Assessment of Working Capital Limits

Inventory and Receivable levels(months)


Assessed Bank Finance

B. Assessment of LC Limit

Requirement and calculation of recommended LC Limit is assessed in this section

C. Assessment of BG Limit

Requirement and calculation of recommended BG Limit is assessed in this section

D. Calculation of SLC Limit

Requirement and calculation of recommended SLC Limit is assessed in this section,

terms and conditions governing SLC and compliance of the same is also mentioned in

this section.

E. Credit Exposure Limit (CEL)

CEL is calculated only in cases where Forex risk is involved. Assessment of CEL is done as

shown below:

1. Past Performance Method

In this method average of past three year actual figures of export and import is

taken, than it is compared with the latest figure and higher the value out of these

two is considered.

2. Documentary Evidence Method

Current estimations are compared with the values considered in step 1 and the

value which is higher is considered.

3. Final CEL calculation

(a) CEL = 2% of the value considered in step 2 above

(b) CEL= 2% of total FB exposure in case of FCNRB

F. Fund Flow Analysis

In this section long term sources, uses and surplus/deficit for audited, estimated and

projected financials is examined to see whether the overall fund flow pattern of the

company is satisfactory or not.


Section D: Terms and Conditions

A. Security: as mentioned in section 4

B. Change in security if any, Justification: as mentioned in section 4

C. ECGC (Export Credit Guarantee Corporation) Cover

In case of EPC(Export Packing Credit) and FBD(Foreign Bill Discounting) ECGC Policy and

ECGC Guarantee is to be taken by the client and bank respectively, and brief of same is

mentioned in this section.

D. Margins

Margin for each facility is mentioned in this section, in case of working capital margin for

various elements of working capital is calculated i.e. for raw material and finished goods

is fixed to 25%, while in case of stock in process, receivables margin depends upon the

period in which they will be realized as cash. While in case of LC and BG the margin

depends upon various factors like Usance in case LC, amount of BG etc.

E. Rate of Interest: interest rate charged for each facility is mentioned in this section in a

tabular format.

F. Insurance

Stocks/properties/machinery charged/hypothecated to the Bank is to be insured for the

full value or 10% over the sanctioned limit, whichever is higher in the joint names of the

bank and the borrower with an insurance Co. approved by the Bank at the borrower’s

expenses and the policy to be lodged with the Bank.

G. Processing Charges/Upfront Fee

In case of working capital loan the fee charged by bank is known as processing charges

which is `400 per lakh and in case of term loan the fee charged is known as upfront fee

and that depends upon the period and amount of term loan. Though the charges are

fixed but concession can be given subjected to the approval from higher authorities.


H. Inspection

As per the extant information a regular post sanction inspection is to be carried out by

Bank Official/Asset verification team or any other agency appointed by the bank.

I. Repayment Schedule

In case of term loan the whole repayment schedule is mentioned in this section

J. Validity of Sanction

The period after the approval of limits within which the customer should respond back

by way of documentation or by availing a part of limits and if not done revalidation is

done.

K. Validity of Pricing

The period for which the pricing is valid, is mentioned here and if the limit is not utilized

at least once in that duration than new pricing is to be done by the bank.

L. Mortgage Charges

Mortgage charges of SBI are `20,000 per Equitable Mortgage (EM) and these charges

are fixed irrespective of the asset worth.

M. Commitment Charges

If the average utilization of limits sanctioned is equal to or less than 60% than bank

charges some penalty to its customer and that is commitment charges.

N. Commission on LC/BG Charges

Commission charges on LC and BG depends upon various factors like Usance period,

sanctioned amount etc. for example in case of domestic BG below 5 crores the

commission charge is 2.75% of the total outlay.

O. Financial Covenant

According to bank norms TOL/TNW should not exceed a value of three; current ratio

should be equal to or more than 1.33 etc. any adverse deviation by more than 20% from

the stipulated levels would attract penal interest of 1% and 2% in case of default


payment of interest/installment. Hence, this section mentions such deviations and penal

charges.

P. Other Special Conditions

Any other special conditions specific to the enterprise or industry is mentioned in this

section.

Section E: Group/Associate profile

Brief details about the group and associate firms are studied in this section.


Sanctioning Authorities

The two significant principles around which the scheme of delegation of financial powers

revolve are:

Powers are exercisable only in relation to duties and responsibilities specially entrusted

to a functionary

All sanctions are subject to report to the next higher authority

The scheme of delegation of financial powers for advances and allied matters in the bank

has a graded authority structure as depicted from the pyramid.

Higher discretionary powers have been made available in case of top rated borrowers

(usually SB1 to SB5) and functionaries across the hierarchy are vested with such dual

powers depending on the rating of the borrower.

The powers for sanctioning credit facilities by various authorities are vested with them of

total indebtedness of the borrower. As seen in the following figure that higher the authority

higher is the power.

ECCB

CCCC

WBCC-I

WBCC-II

MCCC

SMECC


The Executive Committee of Central Board(ECCB) has full powers for sanctioning credit

facilities. The sacnctioning powers are delegated down the line to ‘Committees of officials’

at various administrative offices and to individual line functionaries.following table shows

the members of the various committees in hirearchy:

Name of the Committee Members of the Committee

ECCB: Executive Committee of Central

Board

Headed by Chairman

BOD are committee members

CCCC: Corporate Centre Credit Committee Two DMDs and One MD

WBCC-I: Wholesale Banking Credit

Committee –I

Two CGMs and One DMD

WBCC-II: Wholesale Banking Credit

Committee –II

Two GMs and One CGM

MCCC: MID-Corporate Credit Committee Two DGMs and One GM

SMECC: Small and Medium Enterprise

Credit Committee

Two AGMs and One DGM


Findings & Conclusion

Findings

I have gained practical knowledge for 3 months at SBI as a part of my summer internship

and learnt the process of credit appraisal carried out at State Bank of India for sanctioning

the credit facilities and in due course I came across following practical problems/issues

regarding the appraisal, which are taken care accordingly by the credit analysts.

Every loan request made by the clients were found to be unique by the nature of facility

demanded, type of industry, volume of operations, funding pattern and experience of the

businessmen hence, each and every loan request has some or the other issues which are

distinctive.

In my project tenure I worked for three companies’ viz. one textile and other two were

hospitality industry and here is the critical findings out of the work done at the organization.

When there is a request from the enterprise that additional bank finance is required, the

overall funding pattern is examined. Moreover, sometimes the client demands an increase

in bank borrowings by diverting the accruals of the business to the other businesses instead

of investing in the same business as observed in the appraisal of enterprise carrying

operations in textile industry such a demand is not acceptable. In such cases, genuineness

of the requirement is assessed and accordingly bank finance is arrived at.

Change in Industry scenario affects the profitability of the company. As observed in the

enterprise dealing in textile industry, prices of raw material were rising and hence

profitability was tumbling than the expected projections all because the burden of cost cant

be immediately passed on to the customers. Moreover, in case of increasing prices of raw

material, the client was interested in holding much stock and thereby demands for increase

in working capital limit. In such case genuineness of the requirement is examined upon and

finance is made available accordingly.


As explained earlier, benchmark current ratio for non trading unit is 1.33 and for trading

unit is 1.20. But in certain industries like hospitality industries, current ratio was observed to

be around at 1.00. In such type of industries, funding pattern and requirement of limits

differ from other normal business operations as happened in the case of one hospitality

company appraised. Such cases are analyzed accordingly and bank finance is decided based

on such analysis.

In one of the enterprise dealing in hospitality industry, short term funds were diverted

towards long term application and thereby deficit was arising in the enterprise and in such

case, reason for the diversion is examined and the same is accepted if genuineness is

justified.

Conclusion

From the above project titled “To Understand and Analyze the System of Credit Appraisal

and Risk Assessment at State Bank of India”, I conclude that the project has been completed

successfully at State Bank of India MID-Corporate Group, Ahmedabad as a requisite of the

MBA course at ICFAI Business School, Hyderabad.

This project has helped me to understand the corporate world, and has given me a good

exposure of Credit Appraisal. Learning form the project includes understanding the types of

credit facilities and assessment of the same, financial statement analysis, preparation and

analysis of Credit Monitoring Arrangement (CMA), carrying out ratio analysis and

implication of each ratio depending upon the type of industry, carrying out Credit Risk

Assessment and hence deciding the pricing i.e. interest rate to be charges to the enterprise

and finally drafting the project proposal.

Lastly the project has helped me to understand that every loan application is unique by the

nature of facility demanded, type of industry, volume of operations, funding pattern and

experience of the businessmen hence, each and every loan request has some or the other

issues and have distinctive ways to find the solution.


RECOMMENDATION

In all the system of credit appraisal adopted by State Bank of India is robust and very well

maintained but during the tenure of internship I found some minute pitfalls which if

improved upon can build a more efficient system.

A proper filing of the documents of all the previous appraisals should be maintained.

Though binders are prepared but are not arranged in a proper manner hence tracing them

becomes a tedious and time consuming task for the credit analyst. Hence, arrangement of

all the binder should be done in alphabetical order or branch wise.

Internet access should be made available to the credit analysts so as to keep them in touch

with changes in industry, government reforms etc., also lot of things mentioned in the

proposal are very subjective and varies from time to time hence an accesses to internet will

help the credit analyst in carrying the process of credit appraisal effectively.

Latest books and magazines should be made available at CPC as a reference material for

credit appraisal.

Feedback form submitted by Relationship Manager to CPC team should be drafted very

carefully according to the bank’s instructions with all the information about the

performance of the borrower account from the date of sanction to the due date of next

renewal. This will help the team to take more informed decision for the sanction of credit

facilities, keeping in view the conduct of the account in the past.

Some basic documents are required from all the clients irrespective of the amount and type

of loan requirement. Hence, a checklist of such documents should be made available at the

branch. So that when client’s request for loan is forwarded to CPC for appraisal, it should

have all the requisite documents to save time of the CPC cell.

The team leaders should make a point that in any case whether existing or new connection

pre-sanction visits should be done as it will give a clear picture of functioning of the

enterprise and hence a better analysis can be carried out.


REFERENCES

Books

MUKHERJEE D.D., 2010, Credit Appraisal, Risk Analysis and Decision Making Mumbai: Snow

White Publication Pvt. Ltd.

Pandey I.M, 2007, Financial Management

Khan M.Y. and Jain P.K., Fourth Edition, Financial Management, Tata McGraw Hill.

Circulars and other Print Material

Loan Policy of the State Bank of India

Instruction Guides given by State Bank of India to the employees

Internal resources especially available for the employees

Circulars and guidelines published by State Bank of India on regular intervals

Annual Reports of State bank Of India (2008-2010)

Websites

www.investopedia.com

www.statebankofindia.com

www.rbi.org.in

www.scrib.com

www.wikipedia.com

www.bankersacademy.com

www.riskglossary.com

www.googleimages.com

www.banknet.com

Final Sip Report

Documents

Transcript of Final Sip Report