RESEARCH METHODOLOGYCORPORATE BANKINGSTATEMENT OF PROBLEM: To study the emergence and evolution of the corporate banking as an important division of the commercial banking and also to study the credit appraisal models supporting the increased activities of corporate lending by banks. In todays global Banking arena, Corporate Bankers are facing a string of unprecedented and sweeping challenges in the areas like Treasury Management, Trade Finance, Risk Management, Compliance Management, Electronic Trading and Derivatives Markets. Compounding this are the mounting complexities from ongoing regulatory changes, decreasing margins and fierce competition NEED FOR STUDY: Over the period of time, with the tremendous increase in the growth pattern of industrial development, the need for the corporate loans have increased more than ever. So, the increasing trend urges the banks and financial institutions to focus on corporate banking as a separate division. So, the researchers have preferred to study the concept of corporate banking and all the operational aspects attached to it in the entire process.

OBJECTIVE OF THE STUDY: To study the banking industry, as a whole with the help of various analysis including SWOT analysis, PEST analysis and Porters Five Force analysis. To acquire basic knowledge about the corporate lending in India and its relevance with respect to banks. To analyze the credit risk models of both public bank and private bank and bring out its comparative picture on the basis of various parameters.1

To study credit risk management strategies of bank.

RESEARCH DESIGN: A research design is the arrangement of the condition for collection and analysis of data. Actually it is the blueprint of the research project. The research type is descriptive research. The main objective of this design is search primary and secondary data. The research primarily focuses on the secondary sources and first hand information through focus group interviews. DATA COLLECTION: As the research type is descriptive, the method of data collection was informal. SOURCES: The relevant information were collected from both primary and secondary sources like follow up with bank managers web search, newspaper articles TOOLS: Focus group interviews with the managers of banks.

BENEFICIARIES: For the banks: It will give them the in depth review of the various aspects involved in the corporate banking with emphasis on the credit risk management. For the corporates: The report shows the comparative study of the credit appraisal and sanctioning procedure involved in the credit lending by banks as well as financial institutions. Secondly, they will also get the relevance of the corporate lending by the banks and its various relevant aspects. For the management students:2

The report studies the entire banking industry from various aspects using different analytical tools. Secondly, it introduces into the world of credit lending and its trend in India. Moreover, it also shows the operational procedures involved in the corporate lending with emphasis on risk modeling and credit risk management.

LIMITATIONS OF THE STUDY: The scope of the report is mainly depends on the information extracted from secondary sources and the information given by the managers of banks. So, lack of the availability of the first hand information may act as a limitation to the project report.

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CHAPTER: 1

AN OVERVIEW ON BANKING INDUSTRYIn recent years, the banking industry around the world has been undergoing a rapid transformation. In India also, the wave of deregulation of early 1990s has created heightened competition and greater risk for banks and other financial intermediaries. The cross-border flows and entry of new players and products have forced banks to adjust the product-mix and undertake rapid changes in their processes and operations to remain competitive. The deepening of technology has facilitated better tracking and fulfillment of commitments, multiple delivery channels for customers and faster resolution of miscoordinations. Unlike in the past, the banks today are market driven and market responsive. The top concern in the mind of every bank's CEO is increasing or at least maintaining the market share in every line of business against the backdrop of heightened competition. With the entry of new players and multiple channels, customers (both corporate and retail) have become more discerning and less "loyal" to banks. This makes it imperative that banks provide best possible products and services to ensure customer satisfaction. To address the challenge of retention of customers, there have been active efforts in the banking circles to switch over to customer-centric business model. The success of such a model depends upon the approach adopted by banks with respect to customer data management and customer relationship management. Over the years, Indian banks have expanded to cover a large geographic & functional area to meet the developmental needs. They have been managing a world of information about customers - their profiles, location, etc. They have a close relationship with their customers and a good knowledge of their needs, requirements and cash positions. Though this offers them a unique advantage, they face a fundamental problem. During the period of planned economic development, the bank products were bought in India and not sold. What our banks, especially those in the public sector lack are the marketing attitude. Marketing is a customer-oriented operation. What is needed is the effort on their part to improve their service image and exploit their large customer information base effectively to communicate product availability. Achieving customer focus requires leveraging existing customer information to gain a deeper insight into the relationship a4

customer has with the institution, and improving customer service-related processes so that the services are quick, error free and convenient for the customers. Furthermore, banks need to have very strong in-house research and market intelligence units in order to face the future challenges of competition, especially customer retention. Marketing is a question of demand (customers) and supply (financial products & services, customer services through various delivery channels). Both demand and supply have to be understood in the context of geographic locations and competitor analysis to undertake focused marketing (advertising) efforts. Focusing on region-specific campaigns rather than national media campaigns would be a better strategy for a diverse country like India. Customer-centricity also implies increasing investment in technology. Throughout much of the last decade, banks world-over have re-engineered their organizations to improve efficiency and move customers to lower cost, automated channels, such as ATMs and online banking. As is proved by the experience, banks are now realizing that one of their best assets for building profitable customer relationships especially in a developing country like India is the branch-branches are in fact a key channel for customer retention and profit growth in rural and semi-urban set up. However, to maximize the value of this resource, our banks need to transform their branches from transaction processing centers into customer-centric service centers. This transformation would help them achieve bottom line business benefits by retaining the most profitable customers. Branches could also be used to inform and educate customers about other, more efficient channels, to advise on and sell new financial instruments like consumer loans, insurance products, mutual fund products, etc. There is a growing realization among Indian banks that it no longer pays to have a "transaction-based" operating model. There are active efforts to develop a relationshiporiented model of operations focusing on customer-centric services. The biggest challenge our banks face today is to establish customer intimacy without which all other efforts towards operational excellence are meaningless. The banks need to ensure through their services that the customers come back to them. This is because a major chunk of income for most of the banks comes from existing customers, rather than from new customers. Customer relationship management (CRM) solutions, if implemented and integrated correctly, can help significantly in improving customer satisfaction levels. Data warehousing can help in providing better transaction experiences for customers over different transaction channels. This is because data warehousing helps bring all the transactions coming from different channels under the same roof. Data mining helps banks analyse and measure5

customer transaction patterns and behaviour. This can help a lot in improving service levels. It must be noted, however, that customer-centric banking also involves many risks. The banking industry world over is being thrust into a wild new world of privacy controversy. The banks need to set up serious governance systems for privacy risk management. It must be remembered that customer privacy issues threaten to compromise the use of information technology which is at the very center of e-commerce and customer relationship management - two areas which are crucial for banks' future.

The critical issue for banks is that they will not be able to safeguard customer privacy completely without undermining the most exciting innovations in banking. These innovations promise huge benefits, both for customers and providers. But to capture them, financial services companies and their customers will have to make some critical tradeoffs. When the stakes are so high, nothing can be left to chance, which is why banks must immediately begin developing comprehensive approaches to the privacy issue.

The customer centric business models based on the applications of information technology are sustainable only if the banks protect client confidentiality in the process - which is the basic foundation of banking business.

1.1 EVOLUTION OF BANKING IN INDIABanking in India has its origin as early as the Vedic period. It is believed that the transition from money lending to banking must have occurred even before Manu, the great Hindu Jurist, who has devoted a section of his work to deposits and advances and laid down rules6

relating to rates of interest. During the Mogul period, the indigenous bankers played a very important role in lending money and financing foreign trade and commerce. During the days of the East India Company, it was the turn of the agency houses to carry on the banking business. The General Bank of India was the first Joint Stock Bank to be established in the year 1786. The others which followed were the Bank of Hindustan and the Bengal Bank. The Bank of Hindustan is reported to have continued till 1906 while the other two failed in the meantime. In the first half of the 19th century the East India Company established three banks; the Bank of Bengal in 1809, the Bank of Bombay in 1840 and the Bank of Madras in 1843. These three banks also known as Presidency Banks were independent units and functioned well. These three banks were amalgamated in 1920 and a new bank, the Imperial Bank of India was established on 27th January 1921. With the passing of the State Bank of India Act in 1955 the undertaking of the Imperial Bank of India was taken over by the newly constituted State Bank of India. The Reserve Bank which is the Central Bank was created in 1935 by passing Reserve Bank of India Act 1934. In the wake of the Swadeshi Movement, a number of banks with Indian management were established in the country namely, Punjab National Bank Ltd, Bank of India Ltd, Canara Bank Ltd, Indian Bank Ltd, the Bank of Baroda Ltd, the Central Bank of India Ltd. On July 19, 1969, 14 major banks of the country were nationalized and in 15 th April 1980 six more commercial private sector banks were also taken over by the government. The Indian banking can be broadly categorized into nationalized (government owned), private banks and specialized banking institutions. The Reserve Bank of India acts a centralized body monitoring any discrepancies and shortcoming in the system. Since the nationalization of banks in 1969, the public sector banks or the nationalized banks have acquired a place of prominence and has since then seen tremendous progress. The need to become highly customer focused has forced the slow-moving public sector banks to adopt a fast track approach. The unleashing of products and services through the net has galvanized players at all levels of the banking and financial institutions market grid to look anew at their existing portfolio offering.

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Conservative banking practices allowed Indian banks to be insulated partially from the Asian currency crisis. Indian banks are now quoting a higher valuation when compared to banks in other Asian countries (viz. Hong Kong, Singapore, Philippines etc.) that have major problems linked to huge Non Performing Assets (NPAs) and payment defaults. Co-operative banks are nimble footed in approach and armed with efficient branch networks focus primarily on the high revenue niche retail segments. The Indian banking has finally worked up to the competitive dynamics of the new Indian market and is addressing the relevant issues to take on the multifarious challenges of globalization. It has come a long way from being a sleepy business institution to a highly proactive and dynamic entity. Banks that employ IT solutions are perceived to be futuristic and proactive players capable of meeting the multifarious requirements of the large customers base. Private banks have been fast on the uptake and are reorienting their strategies using the internet as a medium The Internet has emerged as the new and challenging frontier of marketing with the conventional physical world tenets being just as applicable like in any other marketing medium. This transformation has been largely brought about by the large dose of liberalization and economic reforms that allowed banks to explore new business opportunities rather than generating revenues from conventional streams (i.e. borrowing and lending). The banking in India is highly fragmented with 30 banking units contributing to almost 50% of deposits and 60% of advances. Indian nationalized banks (banks owned by the government) continue to be the major lenders in the economy due to their sheer size and penetrative networks which assures them high deposit mobilization. The Indian banking can be broadly categorized into nationalized, private banks and specialized banking institutions. The Reserve Bank of India acts as a centralized body monitoring any discrepancies and shortcoming in the system. It is the foremost monitoring body in the Indian financial sector. The nationalized banks (i.e. government-owned banks) continue to dominate the Indian banking arena. Industry estimates indicate that out of 274 commercial banks operating in India, 223 banks are in the public sector and 51 are in the private sector. The private sector bank grid also includes 24 foreign banks that have started their operations here. Under the ambit of the nationalized banks come the specialized banking institutions.8

These co-

operatives, rural banks focus on areas of agriculture, rural development etc., unlike

commercial banks these co-operative banks do not lend on the basis of a prime lending rate. They also have various tax sops because of their holding pattern and lending structure and hence have lower overheads. This enables them to give a marginally higher percentage on savings deposits. Many of these cooperative banks diversified into specialized areas (catering to the vast retail audience) like car finance, housing loans, truck finance etc. in order to keep pace with their public sector and private counterparts, the co-operative banks too have invested heavily in information technology to offer high-end computerized banking services to its clients. Complementing the roles of the nationalized and private banks are the specialized financial institutions or Non Banking Financial Institutions (NBFCs). With their focused portfolio of products and services, these Non Banking Financial Institutions act as an important catalyst in contributing to the overall growth of the financial services sector. NBFCs offer loans for working capital requirements, facilitate mergers and acquisitions, IPO finance, etc. apart from financial consultancy services. Trends are now changing as banks (both public and private) have now started focusing on NBFC domains like long and medium-term finance, working cap requirements, IPO financing etc. to meet the multifarious needs of the business community.

1.2 STRUCTURE OF BANKING INDUSTRY:Banking system plays an important role in a countrys economy. It promotes growth and development of the country. Indian money market comprises organized and the unorganized institutions. The organized and unorganized institutions in the Indian banking system serve a source of short term credit to agriculture, industry, trade and commerce.

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In the Indian banking structure the Reserve Bank of India is the central bank. It regulates, direct and controls the banking and financial institutions in the country. There are three high banking institutions, namely, RBI, NABARD and EXIM Bank. There are separate financial institutions catering to the needs of different sectors of the economy. Development Banks, Investment Banks, Co-operative Banks, Land Development Banks, Commercial Banks in public and private sectors, NABARD, RRBs, EXIM Bank, etc. The indigenous bankers and moneylenders dominate unorganized sector. The Indian banking structure can be seen from the chart shown under:

Apex Banking Institution

RBI IRBI

IDBI

NABARD

EXIM Bank

SIDBI

NHB

Banking Institutions

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Commercial Development Banks Bank

Regional Rural Banks

Co- operative Banks

Land Development Banks

Public Private Sector Sector Banks Bank

Foreign PACs exchange Banks

CCBs

SCBs

PLDs

SLDB

All India State Level Level

SBI and Subsidiaries

Nationalised Banks IDBI ICICI SIDBI SFCs

SIDC

Foreign Bank

Indian Scheduled Bank

Non Schedule Bank

The chart reveals that there are several apex banking institutions working at the national level. RBI is the highest banking authority regulating, directing and controlling all the banking and financial institutions in the country. There are development banks, namely IDBI, SIDBI, ICICI at the national level and State Financial Corporations and State Industrial Development Corporations which have been set-up. There are 29 public sector banks. Co-operative banks have three tier system. At the village level there is Primary Agriculture Co-operative Society(PACs), at the district level there is Central Co-operative Bank and at the state level there is State Co-operative Bank. Co11

operative banks provide short term and medium loans to the agriculture sector. Land Development Banks provide long term agriculture credit. It comprises Primary Land Development Bank(PLDB) at ht district level and State Land Development Bank(SLDB) at the state level. RRBs provide loans and advances to the rural poor and NABARD is an apex body regulating, directing and controlling the financial and banking institutions providing finance for the agriculture and rural development. TYPES OF BANKS Modern age is the age of specialization with the changing situation worldwide, bank functions have also undergone a major change. Economic conditions and financial needs of a country are different than those of other countries throughout the world. Some financial institutions deal in accepting deposits and making loans and advances to different sectors of the economy. Some institution makes loans and advances for medium and short term, while others are meant for long term advances. Some are financing industrial sector and foreign trade while others are advancing loans to agriculture sector. In broader sense of the term banks may be classified into following categories: Central Bank Commercial Banks Development Banks Investment Banks Co-operative Banks Foreign Exchange Banks Savings Banks Export-Import Bank Specialized National Banks Indigenous Bankers International Financial Institutions

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1.3 GROWTH OF BANKING SECTOR(DECADE WISE) Pre-Liberalization: The growth of the Banking Sector in the pre liberalization period can be analyzed as under. 1971-80: This was the decade immediately following the Nationalization of 14 commercial banks. Also the banking sector grew at the fastest pace in this decade. 1. Assets:

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The assets of the sector grew at 21.58 % CAGR1. They increased from RS.82.52bn to Rs.582.33bn. This kind of growth was achieved due to massive increase in the number of branches resulting in a spurt in deposit mobilization. 2. Deposits: The deposits grew from Rs.64.79bn to Rs.439.87bn. at a CAGR 21.11 %. The growth was higher in later part of the decade. This growth rate would have been higher had the current accounts grown at a rate higher than 18 %. This indicates peoples preference for using bank as place to keep their savings. The bank was not used as a place to keep money to be used for transaction motive. This is further clarified by the poor ratio of average current deposits to total deposits at 23.45 %. 3. Advances: The advances grew at 19.26 % CAGR from Rs.46.85bn to Rs.272.67bn. Also the growth was higher in the later part of the decade. Thus the advances grew at a pace slower than the deposits due to decreasing credit deposit ratio, which reduced from 72.30 % in 1970 to 61.99 % in 1980.

4. Net worth: The Net worth increased from Rs.1.16bn to Rs.5.33bn at a CAGR of 16.48 %. The Capital of the banks remained flat throughout the decade growing at just 8.54 % and also the growth came in the later part of the decade. The capital increased form Rs.470.2mn to Rs.1.07bn. However, the Reserves grew at a healthy pace of 20 % CAGR from Rs.690mn to Rs.4.27bn. Thus the banks in this decade did not raise capital and funded their growth from internal accruals. This resulted in a wide gap between Reserves and Capital indicating the banks hunger for Capital. 1981-90:

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1. Assets: The growth of the sector was significantly subdued since the last decade. The assets grew at just 16.30 % CAGR compared to 21.58 % in the previous decade. The total assets increased from Rs.582.33bn to Rs.2636.93bn. 2. Deposits: Deposits increased from Rs.439.86bn to Rs.1820.46bn at a CAGR of 15.26 %. The current accounts remained the usual laggards in terms of growth growing at just 12.67 % CAGR. The term and saving deposits grew at a slightly faster pace of 16.17 % and 15.5 % CAGR. 3. Advances: Advances grew at a CAGR of 16.79 % from Rs.272.67bn to Rs.1287.85bn. This is due to the fact that the banks have stepped up their credit-deposit ratio from 62 % to 70.74 %. This indicates higher investment than saving in the economy. 4. Net worth: The Net worth increased from Rs.5.33bn to Rs.47.1bn. Thus the net worth grew at a whopping 24.33 % CAGR. The capital hungry banks went on capital raising spree in the latter half of the decade. Thus the capital grew at a CAGR of 34.53 %. In absolute terms, the capital soared from Rs.1.06bn at the beginning of the decade to Rs.20.73bn at the end of the decade. The Reserves however grew at more or less constant pace of 19.97 % CAGR throughout the decade. At the end of the decade the Capital had kept pace with the Reserves and the gap between them had significantly narrowed down. Post-Liberalization: The growth of this sector after 1991 can be represented as under. 1991-2000: 1. Assets: The rate of the sector further slowed down during this decade. The assets grew at a CAGR of 15.24 % from Rs.2636.93bn to Rs.11103.68bn. The growth rate however, was greater in the later part of the decade indicating future prospects of increase in growth. 2. Deposits:15

The deposits grew from Rs.1820.47bn to Rs.9003.06bn at a CAGR of 16.69 %. There was a spurt in the last 3-4 years of the decade indicating improving trend. In this decade however, the savings accounts were the laggards in terms of growth at 13.34 % CAGR. The term deposits grew at 18.38 % and current deposits grew at 15.23 %. This reversal of trend in growth rates shows that the people are increasingly using banks to deposit money to be used for transaction motive. 3. Advances: The advances increased from Rs.1287.85bn to Rs.4434.69bn at a CAGR of 12.46 %. The lower growth in advances is due to the decline in credit-deposit ratio from 70.74 % in 1990 to 49.26 %. This shows there was a marked decline in investment in this decade with savings exceeding investment. 4. Net worth: The Net worth grew at a feverish pace of 36.60 % CAGR, the highest in last three decades. This was mainly because the RBI opened the Banking sector to Private sector. As many as 9 New Private Sector Banks started their operations in this period. They brought a lot of capital in the period 1993-95. However in the later half of the decade, capital growth was virtually nil. The Reserves grew at 37.54 % CAGR from Rs.26.36bn Rs.438.34bn. However, contrary to Capital the Reserves recorded exceptional growth in the later half of the decade due to improving profits of private as well as public sector banks. However the gap between reserves and capital is once again widening.

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1.4 FUTURE LANDSCAPE OF INDIAN BANKINGLiberalization and de-regulation process started in 1991-92 has made a sea change in the banking system. From a totally regulated environment, we have gradually moved into a market driven competitive system. Our move towards global benchmarks has been, by and large, calibrated and regulator driven. The pace of changes gained momentum in the last few years. Globalization would gain greater speed in the coming years particularly on account of expected opening up of financial services under WTO. Four trends change the banking industry world over, viz. 1) Consolidation of players through mergers and acquisitions, 2) Globalisation of operations, 3) Development of new technology and 4) Universalisation of banking. With technology acting as a catalyst, we expect to see great changes in the banking scene in the coming years. The Committee has attempted to visualize the financial world 510 years from now. The picture that emerged is somewhat as discussed below. It entails emergence of an integrated and diversified financial system. The move towards universal banking has already begun. This will gather further momentum bringing non-banking financial institutions also, into an integrated financial system.

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The traditional banking functions would give way to a system geared to meet all the financial needs of the customer. We could see emergence of highly varied financial products, which are tailored to meet specific needs of the customers in the retail as well as corporate segments. The advent of new technologies could see the emergence of new financial players doing financial intermediation. For example, we could see utility service providers offering say, bill payment services or supermarkets or retailers doing basic lending operations. The conventional definition of banking might undergo changes. The competitive environment in the banking sector is likely to result in individual players working out differentiated strategies based on their strengths and market niches. For example, some players might emerge as specialists in mortgage products, credit cards etc. whereas some could choose to concentrate on particular segments of business system, while outsourcing all other functions. Some other banks may concentrate on SME segments or high net worth individuals by providing specially tailored services beyond traditional banking offerings to satisfy the needs of customers they understand better than a more generalist competitor. International trade is an area where Indias presence is expected to show appreciable increase. With the growth in IT sector and other IT Enabled Services, there is tremendous potential for business opportunities. Keeping in view the GDP growth forecast under India Vision 2020, Indian exports can be expected to grow at a sustainable rate of 15% per annum in the period ending with 2010. This again will offer enormous scope to Banks in India to increase their forex business and international presence. Globalization would provide opportunities for Indian corporate entities to expand their business in other countries. Banks in India wanting to increase their international presence could naturally be expected to follow these corporates and other trade flows in and out of India.

Retail lending will receive greater focus. Banks would compete with one another to provide full range of financial services to this segment. Banks would use multiple delivery channels to suit the requirements and tastes of customers. While some customers might value relationship banking (conventional branch banking), others might prefer convenience banking (e-banking).

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One of the concerns is quality of bank lending. Most significant challenge before banks is the maintenance of rigorous credit standards, especially in an environment of increased competition for new and existing clients. Experience has shown us that the worst loans are often made in the best of times. Compensation through trading gains is not going to support the banks forever. Large-scale efforts are needed to upgrade skills in credit risk measuring, controlling and monitoring as also revamp operating procedures. Credit evaluation may have to shift from cash flow based analysis to borrower account behaviour, so that the state of readiness of Indian banks for Basle II regime improves. Corporate lending is already undergoing changes. The emphasis in future would be towards more of fee based services rather than lending operations. Banks will compete with each other to provide value added services to their customers. Structure and ownership pattern would undergo changes. There would be greater presence of international players in the Indian financial system. Similarly, some of the Indian banks would become global players. Government is taking steps to reduce its holdings in Public sector banks to 33%. However the indications are that their PSB character may still be retained. Mergers and acquisitions would gather momentum as managements will strive to meet the expectations of stakeholders. This could see the emergence of 4-5 world class Indian Banks. As Banks seek niche areas, we could see emergence of some national banks of global scale and a number of regional players. Corporate governance in banks and financial institutions would assume greater importance in the coming years and this will be reflected in the composition of the Boards of Banks. Concept of social lending would undergo a change. Rather than being seen as directed lending such lending would be business driven. With SME sector expected to play a greater role in the economy, Banks will give greater overall focus in this area. Changes could be expected in the delivery channels used for lending to small borrowers and agriculturalists and unorganized sectors (micro credit). Use of intermediaries or franchise agents could emerge as means to reduce transaction costs. Technology as an enabler is separately discussed in the report. It would not be out of place, however, to state that most of the changes in the landscape of financial sector discussed19

above would be technology driven. In the ultimate analysis, successful institutions will be those which continue to leverage the advancements in technology in re-engineering processes and delivery modes and offering state-of-the-art products and services providing complete financial solutions for different types of customers. Human Resources Development would be another key factor defining the characteristics of a successful banking institution. Employing and retaining skilled workers and specialists, retraining the existing workforce and promoting a culture of continuous learning would be a challenge for the banking institutions.

1.5 BANKING INDUSTRY REFORMS AND VISION 2010A vision is not a project report or a plan target. It is an articulation of the desired end results in broader terms - A.P.J.Abdul Kalam

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Vision is of an integrated banking and finance system catering to all financial intermediation requirements of customers. Strong market players will strive to uncover markets and provide all services, combining innovation, quality, personal touch and flexibility in delivery. The growing expectations of the customers are the catalyst for our vision. The customer would continue to be the centre-point of our business strategy. In short, you lose touch with the customer, and you lose everything. It is expected that the Indian banking and finance system will be globally competitive. For this the market players will have to be financially strong and operationally efficient. Capital would be a key factor in building a successful institution. The banking and finance system will improve competitiveness through a process of consolidation, either through mergers and acquisitions through strategic alliances. Technology would be the key to the competitiveness of banking and finance system. Indian players will keep pace with global leaders in the use of banking technology. In such a scenario, on-line accessibility will be available to the customers from any part of the globe; Anywhere and Anytime banking will be realized truly and fully. At the same time brick and mortar banking will co-exist with on-line banking to cater to the specific needs of different customers. Indian Banking system has played a crucial role in the socio-economic development of the country. The system is expected to continue to be sensitive to the growth and development needs of all the segments of the society. The banking system that will evolve will be transparent in its dealings and adopt global best practices in accounting and disclosures driven by the motto of value enhancement for all stakeholders. Financial Sector Reforms set in motion in 1991 have greatly changed the face of Indian Banking. The banking industry has moved gradually from a regulated environment to a deregulated market economy. The market developments kindled by liberalization and globalization have resulted in changes in the intermediation role of banks. The pace of transformation has been more significant in recent times with technology acting as a catalyst. While the banking system has done fairly well in adjusting to the new market dynamics, greater challenges lie ahead. Financial sector would be opened up for greater international competition under WTO. Banks will have to gear up to meet stringent prudential capital adequacy norms under Basel II. In addition to WTO and Basel II, the Free Trade21

Agreements (FTAs) such as with Singapore, may have an impact on the shape of the banking industry. Banks will also have to cope with challenges posed by technological innovations in banking. Banks need to prepare for the changes. In this context the need for drawing up a Road Map to the future assumes relevance. The idea of setting up a Committee to prepare a Vision for the Indian Banking industry came up in IBA, in this background. Managing Committee of Indian Banks Association constituted a Committee under the Chairmanship of Shri S C Gupta, Chairman & Managing Director, Indian Overseas Bank to prepare a Vision Report for the Indian Banking Industry. The composition of the Committee is given at the end of the report. The Committee held its first meeting on 23rd June 2003 at Mumbai. Prior to the meeting the members were requested to give their thoughts on the future landscape of the banking industry. A discussion paper based on the responses received from members was circulated along with a questionnaire eliciting views of members on some of the specific issues concerning anticipated changes in the banking environment. In the meeting, which served as a brainstorming session, members gave their Vision of the future. A second meeting of the Committee was held at Chennai on 7th August 2003 to have further discussions on the common views, which emerged in the first meeting, and also to examine fresh areas to be covered in the study.

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The Vision Statement prepared by the Committee is based on common thinking that crystallized at the meetings. In the Chennai meeting it was decided to form a smaller group from among the members to draft the report of the Committee. The group met thrice to finalize the draft report. The report was adopted in the final meeting of the Committee held at Mumbai. When we talk about the future, it is necessary to have a time horizon in mind. The Committee felt, it would be rather difficult to visualize the landscape of banking industry say, 20 years hence due to the dynamic environment. While Government of India brought out India Vision 2020, the Committee is of the view that the pace of changes taking place in the banking industry and in the field of Information Technology would render any attempt to visualize the banking scenario in 2020, inconceivable. The entire financial services sector may undergo a dramatic transformation. It was, therefore, felt that we should set our goals for the near future say, for 5-10 years hence and appropriately call this exercise Banking Industry Vision 2010. The three main aspects focused in the banking vision includes product innovation, process reengineering and technology.

PRODUCT INNOVATION AND PROCESS RE-ENGINEERINGWith increased competition in the banking Industry, the net interest margin of banks has come down over the last one decade. Liberalization with Globalization will see the spreads narrowing further to 1-1.5% as in the case of banks operating in developed countries. Banks will look for fee-based income to fill the gap in interest income. Product innovations and process re-engineering will be the order of the day. The changes will be motivated by the desire to meet the customer requirements and to reduce the cost and improve the efficiency of service. All banks will therefore go for rejuvenating their costing and pricing to segregate profitable and non-profitable business. Service charges will be decided taking into account the costing and what the traffic can bear. From the23

earlier revenue = cost + profit equation i.e., customers are charged to cover the costs incurred and the profits expected, most banks have already moved into the profit =revenue - cost equation. This has been reflected in the fact that with cost of services staying nearly equal across banks, the banks with better cost control are able to achieve higher profits whereas the banks with high overheads due to under-utilisation of resources, un-remunerative branch network etc., either incurred losses or made profits not commensurate with the capital employed. The new paradigm in the coming years will be cost = revenue - profit. As banks strive to provide value added services to customers, the market will see the emergence of strong investment and merchant banking entities. Product innovation and creating brand equity for specialized products will decide the market share and volumes. New products on the liabilities side such as forex linked deposits, investment-linked deposits, etc. are likely to be introduced, as investors with varied risk profiles will look for better yields. There will be more and more of tie-ups between banks, corporate clients and their retail outlets to share a common platform to shore up revenue through increased volumes.

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Banks will increasingly act as risk managers to corporate and other entities by offering a variety of risk management products like options, swaps and other aspects of financial management in a multi currency scenario. Banks will play an active role in the development of derivative products and will offer a variety of hedge products to the corporate sector and other investors. For example, Derivatives in emerging futures market for commodities would be an area offering opportunities for banks. As the integration of markets takes place internationally, sophistication in trading and specialized exchanges for commodities will expand. As these changes take place, banking will play a major role in providing financial support to such exchanges, facilitating settlement systems and enabling wider participation.

Bancassurance is catching up and Banks / Financial Institutions have started entering insurance business. From mere offering of insurance products through network of bank branches, the business is likely to expand through self-designed insurance products after necessary legislative changes. This could lead to a spurt in fee-based income of the banks.

Similarly, Banks will look analytically into various processes and practices as these exist today and may make appropriate changes therein to cut costs and delays. Outsourcing and adoption of BPOs will become more and more relevant, especially when Banks go in for larger volumes of retail business. However, by increasing outsourcing of operations through service providers, banks are making themselves vulnerable to problems faced by these providers. Banks should therefore outsource only those functions that are not strategic to banks business. For instance, in the wake of implementation of 90 days delinquency norms for classification of assets, some banks may think of engaging external agencies for recovery of their dues and in NPA management.

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Banks will take on competition in the front end and seek co-operation in the back end, as in the case of networking of ATMs. This type of co-opetition will become the order of the day as Banks seek to enlarge their customer base and at the same time to realize cost reduction and greater efficiency.

TECHNOLOGY IN BANKINGTechnology will bring fundamental shift in the functioning of banks. It would not only help them bring improvements in their internal functioning but also enable them to provide better customer service. Technology will break all boundaries and encourage cross border banking business. Banks would have to undertake extensive Business Process Re-Engineering and tackle issues like a) how best to deliver products and services to customers b) designing an appropriate organizational model to fully capture the benefits of technology and business process changes brought about. c) how to exploit technology for deriving economies of scale and how to create cost efficiencies, and d) how to create a customer - centric operation model.

Entry of ATMs has changed the profile of front offices in bank branches. Customers no longer need to visit branches for their day to day banking transactions like cash deposits, withdrawals, cheque collection, balance enquiry etc. E-banking and Internet banking have opened new avenues in convenience banking. Internet banking has also led to reduction in transaction costs for banks to about a tenth of branch banking.

Technology solutions would make flow of information much faster, more accurate and enable quicker analysis of data received. This would make the decision making process faster and more efficient. For the Banks, this would also enable development of appraisal and monitoring tools which would make credit management much more effective. The26

result would be a definite reduction in transaction costs, the benefits of which would be shared between banks and customers. While application of technology would help banks reduce their operating costs in the long run, the initial investments would be sizeable. With greater use of technology solutions, we expect IT spending of Indian banking system to go up significantly. One area where the banking system can reduce the investment costs in technology applications is by sharing of facilities. We are already seeing banks coming together to share ATM Networks. Similarly, in the coming years, we expect to see banks and FIs coming together to share facilities in the area of payment and settlement, back office processing, data warehousing, etc. While dealing with technology, banks will have to deal with attendant operational risks. This would be a critical area the Bank management will have to deal with in future. Payment and Settlement system is the backbone of any financial market place. The present Payment and Settlement systems such as Structured Financial Messaging System (SFMS), Centralised Funds Management System (CFMS), Centralized Funds Transfer System (CFTS) and Real Time Gross Settlement System (RTGS) will undergo further fine-tuning to meet international standards. Needless to add, necessary security checks and controls will have to be in place. In this regard, Institutions such as IDRBT will have a greater role to play.

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CHAPTER: 2

STRATEGIC ANALYSIS OF BANKING INDUSTRY 2.1 PORTERS FIVE FORCE ANALYSIS:Prof. Michael Porters competitive forces Model applies to each and every company as well as industry. This model with regards to the Banking Industry is presented below:

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With the process of liberalization, competition among the existing banks has increased. Each bank is coming up with new products to attract the customers and tailor made loans are provided. The quality of services provided by banks has improved drastically. Potential Entrants

Previously the Development Financial Institutions mainly provided project finance and development activities. But they have now entered into retail banking which has resulted into stiff competition among the existing players Threats from Substitutes

Banks face threats from Non-Banking Financial Companies. NBFCs offer a higher rate of interest. Bargaining Power of Buyers

Corporates can raise their funds through primary market or by issue of GDRs, FCCBs. As a result they have a higher bargaining power. Even in the case of personal finance, the buyers have a higher bargaining power. This is mainly because of competition. Bargaining power of Suppliers

With the advent of new financial instruments providing a higher rate of returns to the investors, the investments in deposits is not growing in a phased manner. The suppliers demand a higher return for the investments. Overall Analysis

The key issue is that how can banks leverage their strengths to have a better future. Since the availability of funds is more and deployment of funds is less, banks should evolve new products and services to the customers. There should be rational thinking in sanctioning loans, which will bring down the NPAs. As there is expected revival in the Indian economy banks have a major role to play. Funding corporate at a low cost of capital is a major requisite.30

(3) (5) (4) (1) (2) Threat Organizing Power Bargaining among Rivalry Potential Entrants from Substitute is high as of the high is ExistingSupplierhas is BuyersFirms high is due high.to With new corporate increased can with Development raise competition from NBFCs financial funds easily New liberalization.due to Financial & Insurance instruments as and high competition.are products Institutions theywell companies as they asking higher return improved customer as Private and offer a on investment. the services higher rate foreign banks have is of interest focus. entered in a than big banks. way.

2.2 SWOT ANALYSIS:The banking sector is often taken as a proxy for the economy as a whole. The performance of bank should therefore, reflect Trends in the Indian Economy. Due to the reforms in the financial sector, banking industry has changed drastically with the opportunities to the work with, new accounting standards new entrants and information technology. The deregulation of the interest rate, participation of banks in project financing has changed in the environment of banks. The performance of banking industry is done through SWOT Analysis. It mainly helps to know the Strengths and Weakness of the industry and to improve will be known through converting the opportunities into strengths. It also helps for the competitive environment among the banks. STRENGTHS 1. Greater securities of Funds

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Compared to other investment options banks since its inception has been a better avenue in terms of securities. Due to satisfactory implementation of RBIs prudential norms banks have won public confidence over several years. 2. Banking network After nationalization, banks have expanded their branches in the country, which has helped banks build large networks in the rural and urban areas. Private banks allowed to operate but they mainly concentrate in metropolis. 3. Large Customer Base This is mainly attributed to the large network of the banking system. Depositors in rural areas prefer banks because of the failure of the NBFCs . 4. Low Cost of Capital Corporate prefers borrowing money from banks because of low cost of capital. Middle income people who want money for personal financing can look to banks as they offer at very low rates of interests. Consumer credit forms the major source of financing by banks

WEAKNESSES 1. Basel Committee The banks need to comply with the norms of Basel committee but before that it is challenge for banks to implement the Basel committee standard, which are of international standard. 2. Powerful Unions

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Nationalization of Banks had a positive outcome in helping the Indian Economy as a whole. But this has also proved detrimental in the form of strong unions, which have a major influence in decision making. They are against automation. 3. Priority Sector Lending To uplift the society, priority sector lending was brought in during nationalization. This is good for the economy but banks have failed to manage the asset quality and their intensions were more towards fulfilling government norms. As a result lending was done for non-productive purposes. 4. High Non-Performing Assets Non-Performing Assets (NPAs) have become a matter of concern in the banking industry. This is because of change in the Accounting Standards (Prudential Norms). Net NPAs increased to large extent of the total advances, which has to be reduced to meet the international standards.

OPPORTUNITIES 1. Universal Banking Banks have moved along the value chain to provide their customers more products and services. For example: - SBI is into SBI home finance, SBI Capital Markets, SBI Bonds etc. 2. Differential Interest Rates As RBI control over bank reduces, they will have greater flexibility to fix their own interest rates which depends on the profitability of the banks. 3. High Household Savings

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Household savings have been increasing drastically. Investment in financial assets has also increased. Banks should use this opportunity for raising funds. 4. Overseas Markets Banks should tap the overseas market, as the cost of capital is very low. 5. Internet Banking The advances in information technology have made banking easier. Business transactions can effectively carried out through internet banking.

THREATS 1. NBFCs, Capital Markets and Mutual funds

There is a huge investment of household savings. The investments in NBFCs deposits, Capital Market Instruments and Mutual Funds are increasing. Normally these instruments offer better returns to investors.

2.

Change in the Government Policy

The change in the government policy has proved to be a threat to the banking sector.

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3.

Inflation

The interest rates go down with a fall in inflation. Thus, the investors will shift his investments to other profitable sectors. 4. Recession

Due to the recession in the business cycle the economy functions poorly and this has proved to be a threat to the banking sector. The market oriented economy and globalization has resulted into competition for market share. The spread in the banking sector is very narrow. To meet the competition the banks have to grow at a faster rate and reduce the overheads. They can introduce new products and develop the existing services.

2.3. PEST ANALYSISPOLITICAL/ LEGAL ENVIROMENT Government and RBI policies affect the banking sector. Sometimes looking into the political advantage of a particular party, the Government declares some measures to their benefits like waiver of short-term agricultural loans, to attract the farmers votes. By doing so the profits of the bank get affected. Various banks in the cooperative sector are

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open and run by the politicians. They exploit these banks for their benefits. Sometimes the government appoints various chairmen of the banks. Various policies are framed by the RBI looking at the present situation of the country for better control over the banks

ECONOMICAL ENVIROMENT Banking is as old as authentic history and the modern commercial banking are traceable to ancient times. In India, banking has existed in one form or the other from time to time. The present era in banking may be taken to have commenced with establishment of bank of Bengal in 1809 under the government charter and with government participation in share capital. Allahabad bank was started in the year 1865 and Punjab national bank in 1895, and thus, others followed Every year RBI declares its 6 monthly policy and accordingly the various measures and rates are implemented which has an impact on the banking sector. Also the Union budget affects the banking sector to boost the economy by giving certain concessions or facilities. If in the Budget savings are encouraged, then more deposits will be attracted towards the banks and in turn they can lend more money to the agricultural sector and industrial sector, therefore, booming the economy. If the FDI limits are relaxed, then more FDI are brought in India through banking channels.

SOCIAL ENVIROMENT Before nationalization of the banks, their control was in the hands of the private parties and only big business houses and the effluent sections of the society were getting benefits of banking in India. In 1969 government nationalized 14 banks. To adopt the social development in the banking sector it was necessary for speedy economic progress, consistent with social justice, in democratic political system, which is free from domination of law, and in which opportunities are open to all. Accordingly, keeping in mind both the national and social objectives, bankers were given direction to help economically weaker section of the society and also provide need-based finance to all the36

sectors of the economy with flexible and liberal attitude. Now the banks provide various types of loans to farmers, working women, professionals, and traders. They also provide education loan to the students and housing loans, consumer loans, etc. Banks having big clients or big companies have to provide services like personalized banking to their clients because these customers do not believe in running about and waiting in queues for getting their work done. The bankers also have to provide these customers with special provisions and at times with benefits like food and parties. But the banks do not mind incurring these costs because of the kind of business these clients bring for the bank. Banks have changed the culture of human life in India and have made life much easier for the people.

TECHNOLOGICAL ENVIROMENT Technology plays a very important role in banks internal control mechanisms as well as services offered by them. It has in fact given new dimensions to the banks as well as services that they cater to and the banks are enthusiastically adopting new technological innovations for devising new products and services. The latest developments in terms of technology in computer and

telecommunication have encouraged the bankers to change the concept of branch banking to anywhere banking. The use of ATM and Internet banking has allowed anytime, anywhere banking facilities. Automatic voice recorders now answer simple queries, currency accounting machines makes the job easier and self-service counters are now encouraged. Credit card facility has encouraged an era of cashless society. Today MasterCard and Visa card are the two most popular cards used world over. The banks have now started issuing smartcards or debit cards to be used for making payments. These are also called as electronic purse. Some of the banks have also started home banking through telecommunication facilities and computer technology by using terminals installed at customers home and they can make the balance inquiry, get the statement of accounts, give instructions for fund transfers, etc. Through ECS we can37

receive the dividends and interest directly to our account avoiding the delay or chance of loosing the post. Today banks are also using SMS and Internet as major tool of promotions and giving great utility to its customers. For example SMS functions through simple text messages sent from your mobile. The messages are then recognized by the bank to provide you with the required information. All these technological changes have forced the bankers to adopt customer-based approach instead of product-based approach.

CHAPTER: 3

CORPORATE BANKING: AN OVERVIEW3.1 INTRODUCTION:According to American author and humorist Mark Twain: A banker is a fellow who lends his umbrella when the sun is shining and wants it back the minute it begins to rain. Many troubled businesses seeding credit in recent years might agree with Mr. Twain. Indeed securing the large amounts of credit that many businesses require can be a38

complicated and challenging task loan requests. Moreover, business loans, often called commercial and industrial loans, rank among the most important assets that commercial banks and their closest competitors hold. Corporate finance is an area of finance dealing with financial decisions business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize corporate value[1]

while managing the firm's

financial risks. Although it is in principle different from managerial finance which studies the financial decisions of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. The discipline can be divided into long-term and short-term decisions and techniques. Capital investment decisions are long-term choices about which projects receive investment, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. On the other hand, the short term decisions can be grouped under the heading "Working capital management". This subject deals with the short-term balance of current assets and current liabilities; the focus here is on managing cash, inventories, and short-term borrowing and lending (such as the terms on credit extended to customers). The terms corporate finance and corporate financier are also associated with investment banking. The typical role of an investment bank is to evaluate the company's financial needs and raise the appropriate type of capital that best fits those needs. Corporate banking is a part of commercial banking but the part that average depositor with deposits account never sees. It is a division of commercial banking which extends the financial support to the corporate for helping them achieve their organizational goals and objectives. While banks hold money and mortgages, lend money, extend or open up a line of credit for the average depositors, it is business that needs major financial services to build plant, erect buildings, make structural improvements on old ones and

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start new business ventures. This is one of the most competitive, risky and financially lucrative areas of doing business in todays world. Commercial loans were the earliest form of lending banks did in their move than 2000 year old history. Later in the 20th century finance companies, insurance firms, and thrift institutions entered the business lending field. Today loan officers skilled in evaluating the credit of businesses are usually among the most experienced and highest paid people in the financial services field, along with security underwriters. As a part of commercial banking, corporate banking is focused on analyzing and assessing the risk of the business, establishing the creditworthiness of the business and trying to predict the likelihood of success or failure of business endeavour. These are the professionals who help decide what business initiatives will be taken and when, whether or not to expand the existing businesses, help develop new markets so that new clients can be found and help develop new products for e-commerce, the internet and the international markets. Corporate Banking represents the wide range of banking and financial services provided to domestic and international operations of large local corporate and local operations of multinationals corporations. Services include access to commercial banking products, including working capital facilities such as domestic and international trade operations and funding, channel financing, and overdrafts, as well as domestic and international payments, INR term loans (including external commercial borrowings in foreign currency), letters of guarantee etc. The Investment Banking and Markets division of various bank brings together the advisory and financing, equity securities, asset management, treasury and capital markets, and private equity activities to complete the CIBM structure and provide a complete range of financial products to our clients. Increasingly, ECA financing is being considered by customers and we work closely with our project export finance teams, both onshore and offshore, to provide structured solutions. The Corporate Bank in India was ranked 2nd overall in the 2004 Greenwich Survey.40

This portfolio is largely spread within 9 sector teams divided as under : Consumer Brands Industrials Energy and Utilities Telecommunications Automotive Healthcare Transport and Logistics Metals and Mining Media

3.2 STRUCTURE OF CREDIT LENDING (CORPORATE) IN INDIA:Banks, finance companies, and competing business lenders grant many different types of commercial loans. Among the most widely used forms of business credit are the following: SHORT-TERM BUSINESS LOANS: Self-liquidating inventory loans Working capital loans Interim construction financing41

Security dealer financing Retailer and equipment financing Asset-based loans (accounts receivable financing, factoring, and inventory financing) Syndicated loans LONG-TERM BUSINESS LOANS: Term loans to support the purchase of equipment, rolling stock, and structures Revolving credit financing Project loans Loans to support acquisitions of others business firms

SHORT-TERM LOANS TO BUSINESS FIRMS:Self-Liquidating Inventory Loans Historically, commercial banks have been the leaders in extending short term credit to businesses. These loans were used to finance the purchase of inventory, raw materials or finished goods to sell. In this case the term of the loan begins when cash in needed to purchase inventory and ends when cash is available in the firms account to write the lender a check for the balance of its loan.

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Working Capital Loans Working capital loans provide businesses with short run credit, lasting from few days to about one year. Working capital loans are most often used to fund the purchase of inventories in order to put goods on shelves or to purchase raw materials; thus, they come closest to the traditional self-liquidating loan described previously. Frequently, the working capital loan is designed to cover seasonal peaks in the business customers production levels and credit needs. Normally, working capital loans are secured by accounts receivable or by pledges of inventory and carry a floating interest rate on the amounts actually borrowed against the approved credit line. A commitment fee is charged on the unused portion of the credit line and sometimes on the entire amount of funds made available. Interim Construction Financing A popular form of secured short term lending is the interim construction loan, used to support the construction of homes, apartments, office buildings, shopping centers, and other permanent structures. The finance is used while the construction is going on but once the construction phase is over, this short term loan usually is paid off with a longer term mortgage loan issued by another lender, such as insurance company of pension fund. Recently, some commercial banks have issued minipermanent loans, providing funding for construction and the early operation of a project for as long as five to seven years. Retailer and Equipment Financing Banks support installment purchases of automobiles, appliances, furniture, business equipment, and other durable goods by financing the receivables that dealers selling these goods take on when they write installment contracts to cover customer purchases.43

In turn, these contracts are reviewed by banks and other lending institutions with whom the dealers have established credit relationships. If they meet acceptable credit standards, the contracts are purchased by lenders at an interest rate that varies with the risk level of each borrower, the quality of collateral pledged, and the term of each loan. Asset-Based Financing An increasing portion of short-term lending by banks and other lenders in recent years has consisted of asset based loans, credit secured by the shorter term assets of a firm that are expected to roll over into cash in the future. Key business assets used for many of these loans are accounts receivables and inventories of raw materials or finished goods. The lender commits funs against a specific percentage of the book value of outstanding credit accounts or against inventory. In most loans collateralized by accounts receivable and inventory, the borrowing firm retains title to the assets pledged, but sometimes title is passed to the lender, which then assumes the risk that some of those assets will not pay out as expected. The most common example of this arrangement is factoring, where the bank actually takes on the responsibility of collecting the accounts receivable of one of its business customers. It typically assesses a higher discount rate and lends a smaller fraction of the book value of the customers accounts receivable because the lender incurs both additional expense and additional risk with a factored loan.

Syndicated Loan A type of large corporate loan that is increasingly used today is the syndicated loan. This is typically a loan or loan package extended to a corporation by a group of banks and other institutional lenders. These loans may be drawn by the borrowing company, with the funds used to support business operations or commercial expansion, or undrawn,44

serving as lines of credit to back a security issue or other venture. Banks engage in syndicated loans both to spread the heavy risk exposures of these large loans, often involving hundreds of lakhs or crore of rupees in credit for each loan, and to earn fee income.

LONG-TERM LOANS TO BUSINESS FIRMS:Term Business Loans Term loans are designed to fund long and medium term business investments, such as the purchase of equipment or the construction of physical facilities, covering a period longer than one year. Usually the borrowing firm applies for a lump sum loan based on the

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budgeted cost of its proposed project and then pledges to repay the loan in a series of installments. Term loans normally are secured by fixed assets e.g. Plant and Equipment owned by the borrower and may carry either a fixed or a floating interest rate. That rate is normally higher than on shorter term business loans due to the lenders greater risk exposure from such loans. Revolving Credit Financing A revolving credit line allows a business customer to borrow up to a pre specified limit, repay all or a portion of the borrowing, and re borrows as necessary until the credit line matures. One of the most flexible of all the forms of business loans, revolving credit is often granted without specific collateral to secure the loan and may be short term or caver a period as long as three, four, or five years. This form of business financing is particularly popular when the customer is highly uncertain about the timing of future cash flows or about the exact magnitude of the future borrowings needs. Loan commitments are usually of two types namely, 1. Formal Loan Commitment, and 2. Confirmed Credit Line.

Formal Loan Commitment is a contractual promise to lend to a customer up to a maximum amount of money at a set interest rate or rate markup over the prevailing base loan rate. Whereas, Confirmed Credit Line is a looser form of loan commitment where the banks indicate its approval of customers request for credit in an emergency, though the prices of such a credit line may not be set in advance and the customer may have little intention to draw upon the credit line.

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Long-Term Project Loans The most risky of all business loans are project loans, credit to finance the construction of fixed assets designed to generate a flow of revenue in future periods. Prominent examples include oil refineries, pipelines, mines, power plants and harbor facilities. Project loans are usually granted to several companies jointly sponsoring a large project. Project loans may be granted on a recourse basis, in which the lender can recover funds from the sponsoring companies if the project does not pay out as planned. At the other end, loan may be extended on a non recourse basis, in which no sponsor guarantees; the project stands or falls on its own merits. Many such loans require that the projects sponsors pledge enough of their own capital to see the project through to completion.

Term Loan / Deferred Payment Guarantees In case of term loans and deferred payment guarantees, the project report is obtained from the customer, who may have been compiled in-house or by a firm or consultants/ merchant bankers.

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Term loan is provided to support capital expenditures for setting up new ventures as also for expansion, renovation etc.

The technical feasibility and economic viability is vetted by the Bank and wherever it is felt necessary.

Banks normally expects at least 20% contribution of Promoters contribution. But the promoter contribution may vary largely in mega projects. Therefore, there cannot be a definitive benchmark.

The sanctioning authority will have the necessary discretion to permit deviations.

3.3 EMERGENCE OF CORPORATE BANKING IN INDIAThe bank lending has expanded in a number of emerging market economies, especially in Asia and Latin America, in recent years. Bank credit to the private sector, in real terms, was rising at a high rate. Several factors have contributed to the significant rise in48

bank lending in emerging economies such as strong growth, excess liquidity in banking systems reflecting easier global and domestic monetary conditions, and substantial bank restructuring. The recent surge in bank lending has been associated with important changes on the asset side of banks balance sheet. First, credit to the business sector historically the most important component of banks assets has been weak, while the share of the household sector has increased sharply in several countries. Second, banks investments in Government securities increased sharply until 2004-05. As a result, commercial banks continue to hold a very large part of their domestic assets in the form of Government securities - a process that seems to have begun in the mid-1990s. There has been a sharp pick up in bank credit in India in recent years. The rate of growth in bank credit which touched a low of 14.4 per cent in 2002-03, accelerated to more than 30.0 per cent in 2004-05, the rate which was maintained in 2005-06. The upturn in the growth rate of bank credit can be attributed to several factors. One, macroeconomic performance of the economy turned robust with GDP growth rates hovering between 7.5 per cent and 8.5 per cent during the last few years. Two, the hardening of sovereign yields from the second half of 2003-04 forced banks to readjust their assets portfolio by shifting from investments to advances. While the share of gross advances in total assets of commercial banks grew from 45.0 per cent to 54.7 per cent that of investments declined from 41.6 per cent to 32.1 per cent in the last few years. However, the credit growth has been broad-based making banks less vulnerable to credit concentration risk. The declining trend of priority sector loans in 2001-02 in the credit book of banks was due to prudential write offs and compromise settlements of a large number of small accounts which was reversed from 2002-03 on the strength of a spurt in the housing loan portfolio of banks. Even though credit to industry and other sectors have also picked up, their share in total loans has declined marginally. Retail loans, which witnessed a growth of over 40.0 per cent in 2004-05 and again in 2005-06, have been the prime driver of the credit growth in recent years. Retail loans as a percentage of gross advances increased from 22.0 per cent in March 2004 to 25.5 per cent in March49

2006. The cyclical uptrend in the economy along with the concomitant recovery in the business climate brings with it improved abilities of the debtors to service loans, thereby greatly improving banks asset quality. Despite the sharp rise in credit growth in recent years, not only the proportional levels of gross non-performing loans (NPLs) have declined, but the absolute levels of gross NPLs declined significantly. Several factors have contributed to the marked improvement in the Indian banks asset quality. One, banks have gradually improved their risk management practices and introduced more vigorous systems and scoring models for identifying credit risks. Two, a favourable macroeconomic environment in recent years has also meant that many entities and units of traditionally problematic industries are now performing better. Three, diversification of credit base with increased focus on retail loans, which generally have low delinquency rates, has also contributed to the more favourable credit risk profile. Four, several institutional measures have been put in place to recover the NPAs. These include Debt Recovery Tribunals (DRTs), Lok Adalats (peoples courts), Asset Reconstruction Companies (ARCs) and corporate debt restructuring mechanism (CDRM). In particular, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 for enforcement of security interest without intervention of the courts has provided more negotiating power to the banks for resolving bad debts.

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Sectoral Deployment of Gross Bank Credit During 2008-09 total deployment of gross bank credit increased to Rs.1.87,515 crores from Rs.1,69.536 crores in 2008-07 Non-food bank credit increased sharply during 2005-06. The credit growth was broad based. Credit to services (including personal loans and other services) increased by 52.8 per cent in 2005-06, accounting for 58.3 per cent of incremental non-food gross bank credit (NFGBC). Personal loans increased sharply in recent years mainly on account of housing loans. Real estate loans more than doubled. Other personal loans such as credit card outstanding and education loans also recorded sharp increases of 59.3 per cent and 96.5 per cent, respectively. Priority Sector Advances Credit to the priority sector decreased to 34.1 per cent in the previous year against 39.5 in 2008. In terms of revised guidelines on lending to priority sector , broad category of advances under priority sector include agriculture, micro and small enterprises, retail trade, micro-credit, education and housing. The agriculture and housing sectors were the major beneficiaries, which together accounted for more than two-third of incremental priority sector lending. Credit to small scale industries also accelerate. Several favourable policy initiatives undertaken by the Central Government and the Reserve Bank including, inter alia, the policy package for stepping up of credit to small and medium enterprises (SMEs) announced on August 10, 2005, have had a positive impact. At the individual bank-level, all the nationalised banks, and all but two of the State Bank group (State Bank of India and State Bank of Patiala) were able to meet the priority sector target of 40 per cent of NBC. However, only ten PSBs (Allahabad Bank, Andhra Bank, Bank of India, Indian Bank, Indian Overseas Bank, Punjab National Bank, Syndicate Bank, State Bank of Bikaner and Jaipur, State Bank of Indore and State Bank of Saurashtra) were able to achieve the subtargets for51

agriculture, while the sub-target for weaker sections was met by eight PSBs (Allahabad Bank, Andhra Bank, Bank of India, Indian Bank, Indian Overseas Bank, Punjab National Bank, Syndicate Bank and State Bank of Patiala). Lending to the priority sector by foreign banks constituted 34.6 per cent of net bank credit as on the last reporting Friday of March 2006, which was well above the stipulated target of 32 per cent. The share of export credit in total netbank credit at 19.4 per cent was significantly above the prescribed sub-target of 12.0 per cent. Foreign banks, however, fell a little short of the sub-target of 10.0 per cent in respect of lending to SSIs. Special Agricultural Credit Plans The Reserve Bank had advised public sector banks to prepare Special Agricultural Credit Plans (SACP) on an annual basis in 1994. The SACP mechanism for private sector banks was made applicable from 2005-06, as recommended by the Advisory Committee on Flow of Credit to Agriculture and Related Activities from the Banking System (Chairman:Prof. V.S. Vyas) and announced in the Mid-term Review of Annual Policy for 2004-05. Public sector banks were advised to make efforts to increase their disbursements to small and marginal farmers to 40.0 per cent of their direct advances under SACP by March 2007. The disbursement to agriculture under SACP by public sector banks aggregated Rs.94,278 crore during 2005-06, which was much above the target of Rs.85,024 crore and the disbursement of Rs.65,218 crore during 2004-05. The disbursement by private sector banks during 2005-06 at Rs.31,119 crore was above the target of Rs.24,222 crore. 3.21 Public sector banks were advised to earmark 5.0 per cent of their net bank credit to women. At end-March 2006, aggregate credit to women by public sector banks stood at 5.37 per cent of their net bank credit with 22 banks achieving the target. A consortium of select public sector banks was formed, with the State Bank of India as the leader of the consortium, to provide credit to the Khadi and Village Industries Commission (KVIC). These loans are provided at 1.5 per cent below the average prime lending rates of five major banks in the consortium. An amount of52

Rs.322 crore was outstanding at end-July 2006 out of Rs.738 crore disbursed by the consortium under the scheme. Micro-finance The Reserve Bank has been making consistent efforts to strengthen credit delivery, improve customer service and encourage banks to provide banking services to all segments of the population. Despite considerable expansion of the banking system in India, large segments of the countrys population do not have access to banking services. Expanding the outreach of banking services has, therefore, been a major thrust area of the policy of the Government of India and the Reserve Bank in recent years. The self-help group (SHG)-bank linkage programme has emerged as the major microfinance programme in the country and is being implemented by commercial banks, RRBs and co-operative banks. As on March 31, 2008 3.6 million SHGs had outstanding bank loans of Rs.17,000 crore, an increase of 25 per cent over March 31, 2007 in respect of number of SHGs credit linked. During 2007-08, banks financed 1.2 million SHGs for Rs.8,849 crore. As at end-March 2008, SHGs had 5 million savings accounts with banks for Rs.3,785 crore. Retail Credit Continuing the strong growth in recent years, retail advances increased by 40.9 per cent to Rs.3,75,739 crore in 2007-08, which was significantly higher than the overall credit growth of 31.0 per cent. As a result, their share in total loans and advances increased during the year. Auto loans experienced the highest growth, followed by credit card receivables, other personal loans (comprising loans mainly to professionals and for educational purposes) and housing finance. Loans for consumer durables increased by 17.3 per cent as against the decline of 39.1 per cent in the previous year.

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Major steps earlier taken by the Reserve Bank of India were somewhat more oriented towards price stability and the related monitory instruments like the bank rate, reverse repo rate, repo rate and CRR were adjusted to rein in the price instability. Naturally, the priority was inflation control for overall growth of the economy and we must congratulate the RBI for a wonderful job done. The inflation today is at a moderate level and in line with a developed economy.With these steps taken by RBI, the latest scenario is that the non-food credit growth got moderated, agricultural and service sector credit went up but the retail credit growth actually took a beating due to northbound interest rates. Such positive impact on inflation helped the economy for price stability and we feel what is important for India now is to ensure that there is sufficient focus on growth of the economy along with price stability. Lending to the Sensitive Sectors Lending by SCBs to the sensitive sectors (capital market, real estate and commodities) increased sharply during 2005-06 mainly on account of a sharp increase in exposure to the real estate market. Total exposure of SCBs to the sensitive sectors consituted 18.9 per cent of aggregate bank loans and advances (comprising 17.2 per cent to real estate, 1.5 per cent to the capital market and 0.3 per cent to the commodities sector). During 20082009 total lending to sensitive sector increased by 19.1 percent in capital market. Among bank groups, new private sector banks had the highest exposure to the sensitive sectors (measured as percentage to total loans and advances of banks) mainly due to the increase in exposure to the real estate market, followed by foreign banks, old private sector banks and public sector banks.

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MEASURES BY SIDBI SIDBI has developed a Credit Appraisal & Rating Tool (CART) as well as a Risk Assessment Model (RAM) and a comprehensive rating model for risk assessment of proposals for SMEs. The banks may consider to take advantage of these models as appropriate and reduce their transaction costs. . Public Sector Banks are advised to follow a transparent rating system with cost of credit being linked to the credit rating of the enterprise. SIDBI in association with Credit Information Bureau (India) Ltd. (CIBIL) expedited setting up a credit rating agency. SIDBI in association with Indian Banks Association (IBA) would collect and pool common data on risk in each identified cluster and develop an IT-enabled application, appraisal and monitoring system for small (including tiny) enterprises. This would help reduce transaction cost as well as improve credit flow to small (including tiny) enterprises in the clusters. The National Small Industries Corporation has introduced a Credit Rating Scheme for encouraging SSI units to get themselves credit rated by reputed credit rating agencies. Public Sector Banks will be advised to consider these ratings appropriately and as per availability, and structure their rates suitably.

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ROADMAP BY RBI The Reserve Bank of India (RBI) has worked out the roadmap for the Indian banks to graduate from the simpler approaches of the Basel II framework to more advanced ones. Basel II is the second among Basel Accords, which are primarily, recommendations on banking laws and regulations issued by the Basel committee on banking supervision. It sets up rigorous risk and capital management requirements aimed at ensuring that a bank holds capital reserves appropriate to the risk it exposes itself to through its lending and investment practices. Since March 2008, foreign banks operating in India and Indian banks having presence outside the country have migrated to simpler approaches under Basel II framework. Other commercial banks are required to migrate to these norms by March 31, 2009. These include standardised approach for credit risk which arising from default by borrowers, basic indicator approach for operational risk (arising from day to operations of the banks such robbery or power failure) and standardised duration approach for

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market risk (arising from fluctuations in interest rate and share prices) which affects the investment and market portfolio of the banks. In the framework, the RBI had earlier specified the date by which banks may file application for approvals and the the likely date by which approvals can be obtained from the central bank. While banks have the discretion to adopt the advanced approaches, they need to seek prior approval. Under market risk, banks may apply to RBI for graduating to more advanced method of internal models approach (IMA) by April 1, 2010 and then, RBI may approve it by March 31, 2011. IMA sets out a framework for applying capital charges to the market risks (both on balance sheet and off-balance sheet) incurred by banks by an internal model. The current standardised duration approach specifies a specific average duration of the banks at large, which the banks follow and make it a basis for applying capital charges to only open positions. Similarly, for operational risk, banks may graduate to standardised approach by April 1, 2010 and RBI can approve the plan by September 30, 2010. After that, they can graduate to advanced measurement approach for operational risk by April 1, 2011 and get RBI approval by March 31, 2013. While advanced measurement approach (AMA) sets the framework for banks to develop their own empirical model to quantify required capital for operational risk, it can be used after they get regulatory clearances. Under the standardised approach, a bank's activities are divided into eight business lines: corporate finance, trading and sales, retail banking, commercial banking , payment and settlement, agency services, asset management and retail brokerage. Within each57

business line, gross income is a broad indicator for the scale of business operations and so, the scale of operational risk exposure within each of these business lines. The capital charge for each business line is calculated by multiplying gross income by a factor . Currently, banks are using the basic indicator approach as per which they must hold capital for operational risk equal to the average over the previous three years of a fixed percentage of positive annual gross income. For credit risk, banks can use internal ratings-based approach which allows them to develop their own model to estimate the probability of default for individual clients or groups of clients. Currently, banks use standardised approach where they are required to use ratings from external credit rating agencies to quantify the required capital for credit risk.

CHAPTER: 4

CRM STRATEGIES FOR CORPORATE BANKING 4.1 RAROCRisk-Adjusted Return on Capital RAROC is a measure of the expected return on Economic Capital over the life of an investment. This prospective measure of riskadjusted profitability allows for apples-to-apples comparison of activities across risk types of business. RAROC helps senior management maximize shareholder value by addressing strategic business questions such as:58

How much capital is needed to support the companys enterprise-wide risks? Is the company over or under capitalized? Are individual business units creating or destroying shareholder value? What opportunities for growth or diversification exist within the company? How should the economics of the business be managed within regulatory and rating agency capital constraints? What is an optimal strategy for reinsurance?

RAROC allows for both relative comparisons between business units and absolute comparisons to shareholders minimum required return on risk, or hurdle rate. A business line is value-neutral if its RAROC is equal to the hurdle rate. It creates value if its RAROC is higher than the hurdle rate and destroys value if it is lower.

COMPUTATION RAROC is computed by dividing risk-adjusted net income by the total amount of economic capital assigned based on the risk calculation. RAROC allocates a capital charge to a transaction or a line of business at an amount equal to the maximum expected loss (at a 99% confidence leve