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ABSTRACT OF CONTENTS

Sr.No. TOPICS PAGE NO.

1. Executive Summary I

Ch. 1 : Introduction to Banking sector 1

2.1.1 Meaning of Banking1.2 History of Banking1.3 Structure of Banking in India

1

1

3

Ch. 2 : Introduction to State Bank of India (SBI) 8

3. 2.1 Origin2.2 First Five Year Pan2.3 About SBI2.4 Annual Result FY 08

8

13

14

16

Ch. 3 : Introduction of Loans and Advances 18

4.

3.1 Meaning of Lending3.2 Basic Principles of Lending

3.3 Why Bank Credit3.4 Importance of Lending3.5 Methods of Lending3.6 Priority Sector Advances3.7 Credit Risk Assessment (CRA)3.8 Credit Sanction Process

18

18

2121

22

23

24

24

5. Ch. 4 : Issues concerning to Banking system 28

Ch. 5 : Small and Medium Scale Enterprises (SMEs) 34

6.

5.1 Introduction5.2 SMEs in India5.3 SMEs Model of Socio Economic Policies of Govt.5.4 Financing SMEs Why?5.5 Financing SMEs Advantages to Banks5.6 Opportunities for Financing SMEs5.7 Classification of Micro, Small and Medium Enterprises5.8 SMEs Govt. Initiatives5.9 SMEs in Gujarat

3434

36

39

39

40

40

41

42


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5.10 SMEs at SBI5.11 Specific Products for SMEs

43

44

Ch. 6 : Non Performing Assets (NPAs) 38

7.

6.1 Introduction6.2 What is NPAs6.3 RBI Guidelines on Interest Recognition6.4 Nature of Loan6.5 Norms for Assets Classification6.6 Analysis of NPA Factors6.7 Causes of NPA6.8 Impact of NPA6.9 RBI Guidelines for Recovery of NPA6.10 ARCs Issues of Concerns

45

45

46

47

48

49

51

51

52

53

Ch. 7 : Project 1 Reasons behind defaults by SME

Borrowers and Strategy to recover NPA.56

8.

7.1 Survey Report

7.2 Findings of the Survey7.3 Analysis of the Survey7.4 Suggested Strategies to reduce NPA7.5 Conclusions7.6 Comparative Study

57

5862

75

83

84

Ch. 8 : Subprime Crisis85

9. 8.1 Causes of Crisis8.2 Effects of Crisis8.3 Action to Manage the Crisis

85

87

88

Ch. 9 : Project 2 Survey to find the Reasons why

traders refuses to Bank with SBI91

10.9.1 GVMSAV Odhav9.2 Findings of the Survey9.3 Analysis of the Survey9.4 Suggestions9.5 Conclusions

91

92

94

96

98

11. Ch. 10 : Learnings from the Project 99

Ch. 11 : Bibliography and References101

12.11.1 Books11.2 Website

101

101

Annexure 102

13.Questionnaire Format 1Questionnaire Format 2

102

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PREFACE

The following project has been submitted as a part of the curriculum of the M.B.A. course ofGujarat University.

At each and every stage of life we require some sort of theoretical knowledge as well aspractical knowledge too. It means only classroom lecture may not be enough to get properknowledge. It has to be supplemented with practical experience also. Master ofAdministration (MBA) course is one such course that organizes this aspect of education. Thefollowing project is the representation of everything that as a group we learned andexperienced, while undertaking the practical study and it depicts our reflections.

This project report was prepared by three of us, which gave us the opportunity to participateand assume leadership roles and also the benefits of multiple ideas and views. It taught us theintricacies of group dynamics.

The topic allotted to us was REASON BEHIND DEFAULTS BY SME BORROWERS INREGION-1 & STRATEGY TO RECOVER NPA. We decided to do a survey on this topicas NPAs is one of the major problems facing Banking Industry today. We have also focusedon the strategies which helps bank to reduce NPAs.

The analysis of our project is supported by information found on internet, through books,

magazines and via survey.


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ACKNOWLEDGEMENT

The hu r d l e s w er e t oo d i f f i c u l t an d deep ,

Bu t w e had p r om i ses t o keep ,

An d m i l es t o g o be f o r e w e sl eep. .

First of all, we take this opportunity to thank our Heavenly Lord Almighty for all Hisabundant blessings that He has descended upon us throughout our training period and the

preparation of this project report.

We are very grateful to our loving parents for their kind support and encouragement to carryout this project successfully.

Through this acknowledgment, we express our sincere gratitude towards all those people who

helped us with the preparation of this project, which has been a tremendous learningexperience.

We would like to express our immense gratitude to Mr. Sukomal Chakrabarti (DGM SME)and Mr. Anil Kumar Gupta (AGM REGION 1) for giving us the valuable opportunity to

pursue summer training in this highly esteemed organization.

We express our sincere thanks to:-Mr. P.C.Patel, Mr. Harsh Dalal, Mr. Amish Parmar of region I of Ambavadi Branch, BranchManager B.R.Shah of Naroda Branch, Branch Manager J.V.Patel of Sahijpur Bogha Branch,Branch Manager Ranjan Karan of Bapunagar Branch, Branch Manager Sanjay Vasvada ofShahibaug Branch, Branch Manager Girish Soni of Girdharnagar Branch, Branch ManagerS.K.Rohit of Khanpur Branch, Assistant Manager Sunil Metha of Madhupura Branchwho gave their valuable time to guide us. By their uncompromising demand for quality andtheir insistence for meeting the deadline we could do such an excellent work.

We are very thankful to all staff members of various SBI H.O.for their help and guidance, byextending their valuable time to help us to make this project.

We would like to thank the Director of AES Dr. A. H. Kalro, our supportive faculties, ourlibrarians and our computer lab instructor, Hitanshu Sir for their invaluable and preciouscontribution.

We would also like to thank SBIs customers and every person who have helped us and co-operated us during our training period.

Many others have directly or indirectly provided valuable insights, collegial support, andongoing encouragement. We all are very thankful to them.


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OBJECTIVE OF THE PROJECT

Rea c h h i g h f o r st a r s l i e h i d d en i n y o u r so u l .

D r eam deep ,

F o r eve r y d r eam p r ecedes t he goa l.

If you dont know your goal, then any road can take you there, but we were very clear about

our goal and the destination to reach which is as given below:-

The objective of the project aims to find the reasons behind defaults by SME borrowers in

Region 1, Ahmedabad and to recommend the strategies to recover NPA. Through thisproject we aim to find the causes behind loan defaults, analyze the findings and also suggest

various strategies that can be successfully adopted by the banks in order to arrest the spiraling

proportion of NPAs which is eroding the profits of the bank.

The purpose of project 2 is to survey the traders who refused to bank with SBI in the

industrial estate of GVM Odhav and to study their banking requirements. It was also

undertaken to know the services availed by the traders from their present banks, to find out

the level of satisfaction from the present bank and to assess their further requirements from

the bank. Through this project an attempt has been made to get an idea whether the present

banking facilities at SBI is able to fulfill these requirements or not. We have also suggested

further recommendations for the bank that can be implemented by it in order to provide the

traders of the industrial estate with more satisfying services and which will help remove their

grievances.


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METHODOLOGY OF THE PROJECT

Before going to the technicalities of the project and its survey, a brief description has beengiven on various topics for the better understanding of the readers on each subject and whichwill throw further insight on the project.

METHOD OF SURVEY:

Preparation of Questionnaire: After having a healthy discussion with our project guide andour AGM Mr. Anil Kumar Gupta, we prepared the questionnaires. The copy of the same isattached in annexure.

Database Collection: We were allotted the Region 1 of Ahmedabad by L.H.O for the

purpose to conduct our survey. Out of the total 26 areas in Region - 1, 10 areas formed thedatabase from where the survey was conducted and the necessary conclusions were derivedabout the scenario of NPAs. In Project 2 i.e. survey of traders who refused to bank withSBI, the industrial estate of GVM Odhav formed the database from where the necessaryinformation was collected and based on which we formulated our findings, recommendationsand conclusions.

Selection of Area: The areas for conducting the survey was allotted to us by the Zonal office,Ambawadi and our AGM selected the following areas for the purpose of survey:-

1. Bapunagar2. Sahijpur Bogha3. Naroda4. GIDC Odhav5. Madhupura6. Shahibaug7. Khanpur8. Girdharnagar9. Railwaypura10.Rakhiyal

For the purpose of Project 2, we were allotted the region of GVM Odhav in order toconduct the survey on the banking habits of industrial estates.


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EXECUTIVE SUMMARY

Banking has been a right hand of any business since a long time. Every time a companyenters into a monetary transaction with a customer, the transaction takes place through a

bank. Credit provided by banks is an important driver of national economy. The quantum ofcredit extended by the PSBs increased by about 160 times after nationalization. Such a hugeexpansion of credit extension without any proper appraisal and verification process and lateron the inefficiency on the part of banks to maintain the follow-up procedures of the

borrowers accounts resulted into a major proportion of NPAs which is one of the seriousconcerns facing banks today.

Keeping this objective in mind an attempt has been made with the guidance of SBI bank tostudy the reasons of default by SME borrowers and the strategy to contain them. We haveundertaken a survey on the Region 1 of Ahmedabad for the same. Out of the total 26

branches, we have conducted the survey on 10 areas. Strategies were formed after taking intoconsideration the findings and reasons that were given by the defaulters. Based on ourfindings we have also prepared an analysis of the survey which will provide more insight intothe matter. We have also suggested the various strategies that have been successfullyimplemented by other banks.

Our second project talks about the survey conducted at the industrial estate of GVMSAVOdhav which throws light on the reasons why the traders of the industrial estate refuse to

bank with SBI and prefer other cooperative and commercial banks instead. In that industrialestate, there were about 297 industries of which 185 do not have a single account with SBI.The findings are based on the survey and different suggestions have been provided by uswhich can be inculcated by SBI in order to improve their services and attract more traders.

Other than our survey report, findings, analysis, suggestions and conclusions, we have alsoincluded topics like the history of banking; brief about SBI; introduction to loans andadvances; issues concerning the banking system; SMEs; NPAs; and we also have talkedabout the Subprime crisis that is faced internationally by the US economy.

I


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CH. 1: INTRODUCTION TO BANKING SECTOR

1. 1 MEANING OF BANKING

The banking activities in India are regulated by the banking regulation act, 1949. Under sec

5(b) of the said act, banking means, the accepting, for the purpose of lending or investment,of deposits of money from the public, repayable on demand, or this business in India is calleda banking company.

1. 2 HISTORY OF BANKING

The first bank in India, though conservative, was established in 1786. From 1786 till today,the journey of Indian Banking System can be segregated into three distinct phases. They areas mentioned below:-

Early phase from 1786 to 1969 of Indian Banks Nationalization of Indian Banks and up to 1991 prior to Indian banking sector Reforms. New phase of Indian Banking System with the advent of Indian Financial & Banking Sector

Reforms after 1991.

Phase I

The General Bank of India was set up in the year 1786. Next came Bank of Hindustan andBengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay(1840) and Bank of Madras (1843) as independent units and called it Presidency Banks.These three banks were amalgamated in 1920 and Imperial Bank of India was establishedwhich started as private shareholders banks, mostly Europeans shareholders.

In 1865 Allahabad Bank was established and first time exclusively by Indians, PunjabNational Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913,Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bankof Mysore were set up. Reserve Bank of India came in 1935.

During the first phase the growth was very slow and banks also experienced periodic failuresbetween 1913 and 1948. There were approximately 1100 banks, mostly small. To streamlinethe functioning and activities of commercial banks, the Government of India came up withThe Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested withextensive powers for the supervision of banking in India as the Central Banking Authority.

During those days public has lesser confidence in the banks. As an aftermath depositmobilization was slow. Abreast of it the savings bank facility provided by the Postaldepartment was comparatively safer. Moreover, funds were largely given to traders.

Phase II

Government took major steps in this Indian Banking Sector Reform after independence. In


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1955, it nationalized Imperial Bank of India with extensive banking facilities on a large scaleespecially in rural and semi-urban areas. It formed State Bank of India to actas the principal agent of RBI and to handle banking transactions of the Union and StateGovernments all over the country.

Seven banks forming subsidiary of State Bank of India was nationalized in 1960 on 19th July,

1969, major process of nationalization was carried out. It was the effort of the then PrimeMinister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country werenationalized.

Second phase of nationalization Indian Banking Sector Reform was carried out in 1980 withseven more banks. This step brought 80% of the banking segment in India under Governmentownership.

The following are the steps taken by the Government of India to Regulate BankingInstitutions in the Country:

1949: Enactment of Banking Regulation Act.

1955: Nationalization of State Bank of India. 1959: Nationalization of SBI subsidiaries. 1961: Insurance cover extended to deposits. 1969: Nationalization of 14 major banks. 1971: Creation of credit guarantee corporation. 1975: Creation of regional rural banks. 1980: Nationalization of seven banks with deposits over 200 crore.

After the nationalization of banks, the branches of the public sector bank India rose toapproximately 800% in deposits and advances took a huge jump by 11,000%.

Banking in the sunshine of Government ownership gave the public implicit faith andimmense confidence about the sustainability of these institutions.

Phase III

This phase has introduced many more products and facilities in the banking sector in itsreforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up

by his name which worked for the liberalization of banking practices.

The country is flooded with foreign banks and their ATM stations. Efforts are being put togive a satisfactory service to customers. Phone banking and net banking is introduced. Theentire system became more convenient and swift. Time is given more importance than

money.

The financial system of India has shown a great deal of resilience. It is sheltered from anycrisis triggered by any external macroeconomics shock as other East Asian Countriessuffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, thecapital account is not yet fully convertible, and banks and their customers have limitedforeign exchange exposure.


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1. 3 STRUCTURE OF BANKING IN INDIA

COMMERCIALBANKS

In organized sector, commercial banks are the oldest institutions. They have wide network ofbranches and command utmost public confidence. In the total banking operations commercial

banks have the biggest share. These banks were established as corporate bodies withshareholdings by private individuals. Later on these banks were put under state ownershipand control. Formerly, the main function of commercial banks was financing organized trade,commerce and industry. But now they provide finance to agriculture, small scale businessand borrowers also.

PUBLIC SECTOR BANKS

To come to its present position in Indian Banking the public sector has undergone threestages. In the first stage, the Imperial bank of India was converted into State Bank of India in1955and soon its seven subsidiary banks were also established. In second stage, there wasnationalized of 14 major commercial banks in july 1969. In the last stage there wasnationalization of 6 more commercial banks in 1980. one of the bank, the New bank of India,was sub subsequently merged with the Punjab National Bank. The nationalized banksconstitute at present the public sector of Indian Commercial Banking.

NEW PRIVATE BANKS

After nationalization of banks, new banks in the private sector could not be established inIndia, yet there was no legal bar to that effect. Narasimham Committee on financial sectormade a recommendation for setting up new private sector banks in the country. Such bankscan be classified as Indian banks and foreign banks. Indian banks owned and controlled byIndian Entrepreneurs while foreign banks are incorporated outside India but have a place of

business in India.

REGIONAL RURAL BNAKS

Such banks have been established under the Regional Rural Banks Act, 1976. They havebeen set up fro the development of rural economy by providing credit and other facilities tosmall and marginal farmers, agriculturists, artisans and small entrepreneurs. Every RegionalRural Bank must have the authorized capital of 5 crores and issued capital of 1 crore. Fifty

percent of the issued capital is to be subscribed by the central government, while 15% by thestate government and 35% by the sponsor bank.

COOPERATIVE BANKS

A cooperative credit institution is a voluntary association of members for self-help. It meetsthe financial needs on a mutual basis. In the field of rural credit, cooperatives are animportant constituent of multi-agency approach. The cooperative structure in India comprisesof State Cooperative Banks (SCBs) at state level, District Central Cooperative Banks (DCBs)at district level and Primary Agriculture Credit Societies (PACs) at village level. UrbanCooperative Banks finance small business in urban areas. The Credit Guarantee Scheme ofReserve Bank of India has been extended to cooperative banks to enhance public confidence


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in cooperative banking system.

INDUSTRIAL DEVELOPMENT BANK OF INDIA

This bank, the supreme banking institution for long term industrial finance, was established

in 1964. it was then a wholly owned subsidiary of the Reserve Bank but in 1976 its entireshare capital was transferred to the central government. It was then delinked form theReserve Bank. Today it is the principal financial institution to coordinate the functions andactivities of all India term-lending institutions and, to a certain extent, the public sector banks

Development banks are of two types: -

1. All India Development Banks which include the Industrial Finance Corporation of India(IFCI), the Industrial Credit & Investment Corporation of India (ICICI) and the smallIndustries Development Bank of India (SIDBI)

2. The state level Development Bank which include the State Financial Corporations

(SFCs) and State Industrial Development Corporations (SIDCs).

LAND DEVELOPMENT BANKS

The long term credit needs of agricultural sector are met by another type of cooperativeinstitutions known as Land Development Banks. The structure of these banks is two tire one

at State Level, there are Central Development Banks and at the district level there arePrimary Land Development Banks.

INDUSTRIAL INVESTMENT BANK OF INDIA

The Industrial Reconstruction Bank of India Ltd. was set up in 1971 as a primary agency forrehabilitation of sick units. It was renamed as the Industrial Reconstruction Bank of India(IRBI) by an Act of Parliament with effect from march 20, 1985.IRBI functions as the

principal credit and reconstruction agency for industrial revival by undertakingmodernization, expansion, reorganization, diversification or rationalization of industry andalso coordinates similar work of other institutions engaged therein and to assists andrehabilitate industrial concerns.

STRUCTURE OF BANKING IN INDIA


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CH. 2: INTRODUCTION TO STATE BANK OF INDIA (SBI)

2. 1 ORIGIN


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The origin of the State Bank of India goes back to the first decade of the nineteenth centurywith the establishment of the Bank of Calcutta in Calcutta on 2 June 1806. Three years laterthe bank received its charter and was re-designed as the Bank of Bengal (2 January 1809). Aunique institution, it was the first joint-stock bank of British India sponsored by theGovernment of Bengal. The Bank of Bombay (15 April 1840) and the Bank of Madras (1July 1843) followed the Bank of Bengal. These three banks remained at the apex of modern

banking in India till their amalgamation as the Imperial Bank of India on 27 January 1921.

Primarily Anglo-Indian creations, the three presidency banks came into existence either as aresult of the compulsions of imperial finance or by the felt needs of local Europeancommerce and were not imposed from outside in an arbitrary manner to modernize India'seconomy. Their evolution was, however, shaped by ideas culled from similar developmentsin Europe and England, and was influenced by changes occurring in the structure of both thelocal trading environment and those in the relations of the Indian economy to the economy ofEurope and the global economic framework.

BANK OF BENGAL:

Head Office

Establishment

The establishment of the Bank of Bengal marked the advent of limited liability, joint-stockbanking in India. So was the associated innovation in banking, viz. the decision to allow theBank of Bengal to issue notes, which would be accepted for payment of public revenueswithin a restricted geographical area. This right of note issue was very valuable not only forthe Bank of Bengal but also its two siblings, the Banks of Bombay and Madras. It meant anaccretion to the capital of the banks, a capital on which the proprietors did not have to payany interest. The concept of deposit banking was also an innovation because the practice ofaccepting money for safekeeping (and in some cases, even investment on behalf of theclients) by the indigenous bankers had not spread as a general habit in most parts of India.But, for a long time, and especially upto the time that the three presidency banks had a rightof note issue, bank notes and government balances made up the bulk of the investibleresources of the banks.

The three banks were governed by royal charters, which were revised from time to time. Eachcharter provided for a share capital, four-fifth of which were privately subscribed and the restowned by the provincial government. The members of the board of directors, which managedthe affairs of each bank, were mostly proprietary directors representing the large Europeanmanaging agency houses in India. The rest were government nominees, invariably civilservants, one of whom was elected as the president of the board.


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Group Photograph of Central Board (1921)

Business

The business of the banks was initially confined to discounting of bills of exchange or othernegotiable private securities, keeping cash accounts and receiving deposits and issuing andcirculating cash notes. Loans were restricted to Rs.one lakh and the period of accommodationconfined to three months only. The security for such loans was public securities, commonlycalled Company's Paper, bullion, treasure, plate, jewels, or goods 'not of a perishable nature'and no interest could be charged beyond a rate of twelve per cent. Loans against goods like

opium, indigo, salt woolens, cotton, cotton piece goods, mule twist and silk goods were alsogranted but such finance by way of cash credits gained momentum only from the third decadeof the nineteenth century. All commodities, including tea, sugar and jute, which began to befinanced later, were either pledged or hypothecated to the bank. Demand promissory noteswere signed by the borrower in favor of the guarantor, which was in turn endorsed to the

bank. Lending against shares of the banks or on the mortgage of houses, land or other realproperty was, however, forbidden.

Indians were the principal borrowers against deposit of Company's paper, while the businessof discounts on private as well as salary bills was almost the exclusive monopoly ofindividuals Europeans and their partnership firms. But the main function of the three banks,as far as the government was concerned, was to help the latter raise loans from time to timeand also provide a degree of stability to the prices of government securities.

Old Bank of Bengal

Major change in the conditions

A major change in the conditions of operation of the Banks of Bengal, Bombay and Madrasoccurred after 1860. With the passing of the Paper Currency Act of 1861, the right of noteissue of the presidency banks was abolished and the Government of India assumed from 1March 1862 the sole power of issuing paper currency within British India. The task ofmanagement and circulation of the new currency notes was conferred on the presidency

banks and the Government undertook to transfer the Treasury balances to the banks at placeswhere the banks would open branches. None of the three banks had till then any branches


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(except the sole attempt and that too a short-lived one by the Bank of Bengal at Mirzapore in1839) although the charters had given them such authority. But as soon as the three

presidency bands were assured of the free use of government Treasury balances at placeswhere they would open branches, they embarked on branch expansion at a rapid pace. By1876, the branches, agencies and sub agencies of the three presidency banks covered most ofthe major parts and many of the inland trade centers in India. While the Bank of Bengal had

eighteen branches including its head office, seasonal branches and sub agencies, the Banks ofBombay and Madras had fifteen each.

Bank of Madras Note Dated 1861 for Rs.10

PRESIDENCY BANKS ACT:

The presidency Banks Act, which came into operation on 1 May 1876, brought the threepresidency banks under a common statute with similar restrictions on business. Theproprietary connection of the Government was, however, terminated, though the bankscontinued to hold charge of the public debt offices in the three presidency towns, and thecustody of a part of the government balances. The Act also stipulated the creation of ReserveTreasuries at Calcutta, Bombay and Madras into which sums above the specified minimum

balances promised to the presidency banks at only their head offices were to be lodged. TheGovernment could lend to the presidency banks from such Reserve Treasuries but the latter

could look upon them more as a favor than as a right.

Bank of Madras

The decision of the Government to keep the surplus balances in Reserve Treasuries outsidethe normal control of the presidency banks and the connected decision not to guaranteeminimum government balances at new places where branches were to be opened effectivelychecked the growth of new branches after 1876. The pace of expansion witnessed in the

previous decade fell sharply although, in the case of the Bank of Madras, it continued on amodest scale as the profits of that bank were mainly derived from trade dispersed among anumber of port towns and inland centers of the presidency.


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India witnessed rapid commercialisation in the last quarter of the nineteenth century as itsrailway network expanded to cover all the major regions of the country. New irrigationnetworks in Madras, Punjab and Sind accelerated the process of conversion of subsistencecrops into cash crops, a portion of which found its way into the foreign markets. Tea andcoffee plantations transformed large areas of the eastern Terais, the hills of Assam and the

Nilgiris into regions of estate agriculture par excellence. All these resulted in the expansionof India's international trade more than six-fold. The three presidency banks were both

beneficiaries and promoters of this commercialisation process as they became involved in thefinancing of practically every trading, manufacturing and mining activity in the sub-continent. While the Banks of Bengal and Bombay were engaged in the financing of largemodern manufacturing industries, the Bank of Madras went into the financing of largemodern manufacturing industries; the Bank of Madras went into the financing of small-scaleindustries in a way which had no parallel elsewhere. But the three banks were rigorouslyexcluded from any business involving foreign exchange. Not only was such businessconsidered risky for these banks, which held government deposits, it was also feared thatthese banks enjoying government patronage would offer unfair competition to the exchange

banks which had by then arrived in India. This exclusion continued till the creation of the

Reserve Bank of India in 1935.

Presidency Banks of Bengal

The presidency Banks of Bengal, Bombay and Madras with their 70 branches were merged in1921 to form the Imperial Bank of India. The triad had been transformed into a monolith anda giant among Indian commercial banks had emerged. The new bank took on the triple role ofa commercial bank, a banker's bank and a banker to the government.

But this creation was preceded by years of deliberations on the need for a 'State Bank ofIndia'. What eventually emerged was a 'half-way house' combining the functions of acommercial bank and a quasi-central bank.

The establishment of the Reserve Bank of India as the central bank of the country in 1935

ended the quasi-central banking role of the Imperial Bank. The latter ceased to be bankers tothe Government of India and instead became agent of the Reserve Bank for the transaction ofgovernment business at centers at which the central bank was not established. But itcontinued to maintain currency chests and small coin depots and operate the remittancefacilities scheme for other banks and the public on terms stipulated by the Reserve Bank. Italso acted as a bankers' bank by holding their surplus cash and granting them advancesagainst authorized securities. The management of the bank clearing houses also continuedwith it at many places where the Reserve Bank did not have offices. The bank was also the

biggest tendered at the Treasury bill auctions conducted by the Reserve Bank on behalf of the


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Government.

The establishment of the Reserve Bank simultaneously saw important amendments beingmade to the constitution of the Imperial Bank converting it into a purely commercial bank.The earlier restrictions on its business were removed and the bank was permitted to undertakeforeign exchange business and executor and trustee business for the first time.

IMPERIAL BANK:

The Imperial Bank during the three and a half decades of its existence recorded an impressivegrowth in terms of offices, reserves, deposits, investments and advances, the increases insome cases amounting to more than six-fold. The financial status and security inherited fromits forerunners no doubt provided a firm and durable platform. But the lofty traditions of

banking which the Imperial Bank consistently maintained and the high standard of integrity itobserved in its operations inspired confidence in its depositors that no other bank in Indiacould perhaps then equal. All these enabled the Imperial Bank to acquire a pre-eminent

position in the Indian banking industry and also secure a vital place in the country's economiclife.

Stamp of Imperial Bank of India

When India attained freedom, the Imperial Bank had a capital base (including reserves) ofRs.11.85 crores, deposits and advances of Rs.275.14 crores and Rs.72.94 crores respectivelyand a network of 172 branches and more than 200 sub offices extending all over the country.

2. 2 FIRST FIVE YEAR PLAN

In 1951, when the First Five Year Plan was launched, the development of rural India was

given the highest priority. The commercial banks of the country including the Imperial Bankof India had till then confined their operations to the urban sector and were not equipped torespond to the emergent needs of economic regeneration of the rural areas. In order,therefore, to serve the economy in general and the rural sector in particular, the All IndiaRural Credit Survey Committee recommended the creation of a state-partnered and state-sponsored bank by taking over the Imperial Bank of India, and integrating with it, the formerstate-owned or state-associate banks. An act was accordingly passed in Parliament in May1955 and the State Bank of India was constituted on 1 July 1955. More than a quarter of theresources of the Indian banking system thus passed under the direct control of the State.


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Later, the State Bank of India (Subsidiary Banks) Act was passed in 1959, enabling the StateBank of India to take over eight former State-associated banks as its subsidiaries (later namedAssociates).

The State Bank of India was thus born with a new sense of social purpose aided by the 480offices comprising branches, sub offices and three Local Head Offices inherited from the

Imperial Bank. The concept of banking as mere repositories of the community's savings andlenders to creditworthy parties was soon to give way to the concept of purposeful bankingsub serving the growing and diversified financial needs of planned economic development.The State Bank of India was destined to act as the pacesetter in this respect and lead theIndian banking system into the exciting field of national development

2. 3 ABOUT SBI

State Bank of India (SBI) is the largest bank in India. If one measures by the number ofbranch offices and employees, SBI is the largest bankin the world. Established in 1806 asBank of Bengal, it is the oldest commercial bank in the Indian Subcontinent. SBI providesvarious domestic, international and NRI products and services, through its vast network inIndia and overseas. With an asset base of $126 billion and its reach, it is a regional banking

behemoth. The government nationalized the bank in 1955, with the Reserve Bank of Indiataking a 59% ownership stake.

SBI MISSION

To retain the banks position as the premier Indian financial services group, with world classstandards and significant global business, committed to excellence in customer, shareholderand employee satisfaction and to play a leading role in the expanding and diversifyingfinancial services sector while continuing emphasis on its development banking role.

ASSOCIATE BANKS

There are seven other associate banks that fall under SBI. They all use the "State Bank of"name followed by the regional headquarters' name. These were originally banks belonging to

princely states before the government nationalized them in 1959. In tune with the first FiveYear Plan, emphasizing the development of rural India, the government integrated these

banks with the State Bank of India to expand its rural outreach. The State Bank group refersto the seven associates and the parent bank. All the banks use the same logo of a bluekeyhole. Currently, the group is merging all the associate banks into SBI, which will create a"mega bank", and one hopes, streamline operations and unlock value.

1-State Bank of Bikaner and Jaipur (SBBJ)

2-State Bank of Hyderabad (SBH)

3-State Bank of Indore (SBIR)

4-State Bank of Mysore (SBM)

5-State Bank of Patiala (SBP)

6-State Bank of Saurashtra (SBS)

7-State Bank of Travancore (SBT)


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Today, State Bank of India (SBI) has spread its arms around the world and has a network ofbranches spanning all time zones. SBI's International Banking Group delivers the full rangeof cross-border finance solutions through its four wings - the Domestic division, the ForeignOffices division, the Foreign Department and the International Services division.

FOREIGN OFFICES

State Bank of India is present in 32 countries, where it has 84 offices serving the internationalneeds of the bank's foreign customers, and in some cases conducts retail operations. Thefocus of these offices is India-related business.

FOREIGN BRANCHES

SBI has branches in these countries:-

Australia Bahrain Bangladesh Belgium Canada France Germany Hong Kong Israel Japan People's Republic of China Republic of Maldives Singapore South Africa Sri Lanka Sultanate of Oman The Bahamas United Arab Emirates U.K. U.S.A

GROWTH

State Bank of India has often acted as guarantor to the Indian Government, most notably

during Chandra Shekhar's tenure as Prime Minister of India. With 10,000 branches, and afurther 4000+ associate bank branches, the SBI has extensive coverage. Following its arch-rival ICICI Bank, State Bank of India has electronically networked most of its metropolitan,urban and semi-urban branches under its Core Banking System(CBS), with over 4500

branches being incorporated so far. The bank has the largest ATM network in the countryhaving more than 5600 ATMs. The State Bank of India has had steady growth over itshistory, though the Harshad Mehta scam in 1992 marred its image.


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In recent years, the bank has sought to expand its overseas operations by buying foreignbanks. It is the only Indian bank to feature in the top 100 world banks in the Fortune Global500 rating and various other rankings. According to the Forbes 2000 listing it tops all Indiancompanies.

FORTUNE GLOBAL 500 RANKING 2007

SBI debuted in the Fortune Global 500 at 498in 2006. In 2007 it moved up to 495.

GROUP COMPANIES

SBI Capital Markets Ltd SBI Mutual Fund(A Trust) SBI Factors and Commercial Services Ltd SBI DFHI Ltd SBI Cards and Payment Services Pvt Ltd SBI Life Insurance Co. Ltd- Bancassurance(Life Insurance) SBI Funds Management Pvt Ltd SBI Canada

2. 4 ANNUAL RESULTS FY 08

1. SBI GROUP NET PROFIT AT RS 8,960 CRORE (USD 2.24 BN)

2. SBI STAND ALONE NET PROFIT FOR FY 08 CROSSES RS 6,700 CRORE

Net Profit for FY 08 at Rs 6,729 crore, up by 48.2% from Rs 4,541 crore in FY 07

Net Profit for Q4 08 at Rs 1,883 crore, up by 26.1% from Rs 1,493 crore in Q4 07

3. TOTAL BUSINESS GROWTH OF OVER RS 1, 81,000 CRORE

Deposits up by Rs 1,01,885 crore, a 23.4% growth from Rs 4,35,521 crore in FY 07to Rs 5,37,406 crore in FY 08;

Market share in deposits has increased from 14.8% to 15.4% driven by lowcost deposits where market share has increased from 13.9% to 17.4%

Advances up by Rs 79,949 crore, a 23.4% growth from Rs 3,42,232 crore in FY 07to Rs 4,22,181 crore in FY 08

Mid corporate advances grow by 24.4%

SME advances grow by 26.3%Agriculture advances grow at 24.6%, bank achieves 18% benchmarkHome loans grow by 18.7%, auto loans by 29.9% and education loans by

33.6%

International advances up by 50.4% y-o-y; SBI largest non-rupee provider ofcorporate syndicate credit to Indian corporates.

4. OPERATING PROFIT INCREASED BY 31.1% TO RS 13,107 CRORE IN FY 08


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NII increased by 13.0% for the financial year to Rs. 17,021 crore in FY 08Advances interest increased by 41.8%, driven by growth and increase in yieldsIncome from investments increased by 7.9%

Interest expense increased by 43.9%; interest expense includesRs.1,710 crore of interest on Tier 2 capital bonds which will be contained

going forward as rights issue will create capital cushion in the shortterm.

NIM at 3.07% for FY 08 vs. 3.09% (excluding one time items) for FY 07

Other income increased by 28.5% to Rs. 8,695 crore; core fee income increasedby Rs. 1,110 crore. FY 08 saw a decline in dividend income by Rs. 401 crore

Operating costs increased by only 6.6% to Rs 12,609 crore, despite redesign of2,000 metro and urban branches, addition of nearly 1,000 branches leading to

branch network crossing the 10,000 mark, increase in number of ATMs bynearly 1,500 to a total of 5,842 and rollout of core banking system to cover 9,390

branches and 98.3% of businessMigration to new efficient operating architecture (redesigned branches tofocus on sales and service, 400 central processing centers) is almostcomplete; customer service in branch and outside has improved even as

productivity and efficiency have increasedQ-o-QGrowth FY 07 FY 08-o-YGrowth Comment

5. PERFORMANCE OF ASSOCIATES AND SUBSIDIARIES HAS BEEN

STRONG

Associate bank net profit increased 12.1% to Rs 2,277 crore

SBI Life grew NBP by 108%, of which Rs 1,450 crore was through the SBI

bancassurance channel. SBI Life was one of the few private sector companies tomake profits- FY 08 profit of Rs. 34.3 crore

SBI MF improved its position to 6th with a growth rate of 58% in AUMs; netprofit of Rs. 69.7 crore in FY 08

SBI CAPS increased profit by nearly 100% to Rs 142 crore; retained position asthe largest rupee syndicator of Project Finance

Post acquisition of GTF, SBI group has more than 70% share in factoring andnet profits from the business in excess of Rs 100 crore

SBI Factors: net profit of Rs. 28.4 crore in FY 08GTF: net profit of Rs. 73.6 crore in FY 08

CH. 3: INTRODUCTION TO LOANS AND ADVANCES

3. 1 MEANING OF LENDING


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As per the definition in Indian Banking Act, Banking is a service regarding the acceptanceof financial deposits from the public with the objective of giving advances with the conditionto return this on demand or on some fixed date as agreed before.

Thus the very definition of banking stresses the importance of lending function. When itdefines banking as Borrowing for the purpose of lending. Hence the basic objective of

bank is presupposed to be lending & for that purpose, it is expected to mobilize resources byborrowing from the public.

When a bank agrees to place funds at the disposal of the borrower either against a tangiblesecurity or not, but against promise to repay the amount at a future date with the interest forthe amount used for the period, bank is said to have lent the money.

Lending of money is one of the two basic function of a banking company, the other beingacceptance of deposits. It is also a principle source of income for the bank because 80% ofrevenue of bank is derived from interest and discount. The strength of the bank is judged

primarily by the soundness and quality of its advances portfolio. Advances constitute a verylarge proportion of the banks total assets and along with investment form the backbone of the

banks structure.

Besides, this banks advance is not only intended to generate profits for the banks but also topromote the development of national economy. All types of business activity that is trade,industry & agriculture are largely dependent on bank finance in one form or the other. Bychannelising saving of the non productive areas into productive uses, banks help in creatingmore avenues for employment and thus raising the standard of living of the people of India.

3. 2 BASIC PRINCIPLES OF LENDING

The concept of principle of lending has changed over the years. The traditional principles of

good lending popularly known as 4Cs are:-

1)

Character

Character is the most important asset of a person. It signifies to repay a loan. If a personsintegrity is questionable, even if he offers a good security, a banker will avoid him. Apartfrom honesty, character also signifies the sobriety, good habits, personality, the ability andwillingness to carry a project with efficiency as well as the reputation of the people withwhom he deals.

2)

Capacity

The capacity of a borrower refers to his experience in the business, the insight he hasacquired over the years, his knowledge of business & his capacity to judge people. If acustomer has no capacity to run his business, there are greater chances of making losses thanof profits.

3) Capital


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A borrower must bring in his own capital as his stake in the business, as there can not be anyabsolute certainty of the business and in case if there is a loss, the customers capital shouldenable him to meet the challenge without putting the losses on his creditors.

4)

Collateral

Banks usually support their loans and advances by asking the borrower to provide approvedsecurities to guard against unforeseen contingencies which provides a cushion to fall back incase of emergency. It may however be noted that tangible security provided may not fetchsufficient funds to recover the loans. Moreover in case of forced sale, the security faces alow price.

The above principles still hold good and will continue to remain the canons of good lendingin the changed banking and economic environment. Safety, liquidity, purpose, security &

profitability have emerged as the other key factors relating to sound lending decision & theseare briefly elaborated in the following paragraph:-

Since the growth and prosperity of the bank largely depends to a large extent on the quality ofadvances, individual banks frame appropriate credit policies in accordance with the national

priority guidelines of RBI. The basic norms of good lending are:-

Safety Liquidity Purpose Profitability

The lending or placement of funds is either by way of Demand Loan or Term Loan. It canalso be by the way of an old loan where the credit limit up to the amount to be lent is set inthe credit account or a cash credit account, where against security of stocks or receivablesLIMIT up to sectional level of lending is made available to the borrowers in the form ofrunning account allowing withdrawals up to limit as per his requirements. Lending can alsotake form of bill discounting. All these lending transactions narrated above involve fund

based credit deployed.

There are certain kinds of advances which dont indulge in deployment of funds at least in theinitial stages. These are called as non fund based credit. A performance guarantee and letterof credit are some of the example of this type of finance which will be dealt with separately atlater stage:-

1)

Safety

As per the norms, the banks lend the funds constructed in it by the depositors, and the first &the foremost principle of lending is to ensure the safety of the funds lent. By safety, itsmeant that the borrower is in a position to repay the loan, along with the interest according tothe terms & conditions of the loan contract. The repayment of loan depends upon the

borrowers:-


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Capacity to pay:It depends upon his tangible assets and the success of his business; if he issuccessful in his efforts, he earns profit & can repay the loan promptly or the loan isrecovered from the sale proceeds of his tangible assets.

Willingness to Pay: It depends upon the honesty & the character of the borrower. Thebanker should therefore take utmost care in ensuring that the enterprise or business for which

the loan is sought is a sound one and the borrower is capable of carrying it out successfully.

2)

Liquidity

Since the banks use public funds for lending operations, it is essential for it to repay thedeposits on demand or on maturity. It is for this reason that banks lending are essentiallyshort term in nature. This ensures that banks dont enter into asset liability mismatch bylending for usually long periods and the funds are recycled properly & periodically. Manytypes of banks advances are self liquidating in nature. Such bills are purchased or bills arediscounted where the amount lent against bills are recovered on payment of the bills by thedrawers. Likewise advances by the way of cash credit against the agriculture commodities inany case before the advent of the new crop.

3)

Purpose

Another important criterion for lending loans is to examine whether the purpose for which thefunds lent is in conformity with the economic policies of the government and the RBI. Bankshave to reorient their lending policies, suitably to achieve the objectives set by authority. Theadvance should be granted as per the lending policy and credit risk policy of the bank may beapproved from time to time.

4) Profitability

Commercial banks are profit earning institutions; the nationalized banks are no exception tothis. They must employ their funds profitability so as to earn efficient income out of which;to pay interest to the depositors, salaries to staff & meet various other establishment expenses& distributes dividends to the shareholders. The rates of interest changed by banks were infact primarily dependent on the directives issued by RBI. Now banks are free to determinetheir own interest rate over 2 lakhs. The variations in the interest rates changed fromdifferent customers depend upon the degree of risk involved in lending to them.

A customer with a high reputation is charged low rate of interest compared to an ordinarycustomer. The sound principles of lending are not sacrifice safety or liquidity for the sake ofhigh profitability. That is to say that the bank should not grant advances to unsound partieswith undoubtful repaying capacity, even if they are ready to pay a very high rate of interest.

3. 3 WHY BANK CREDIT ?

Credit provided by commercial banks is an important driver of national economy. In theolden days, when the commercial banking had not taken the present shape, individual orfamilies traditionally doing the banking business provided credit to the needy. However, the

present day economy is vastly different from old economy. The olden economy is driven bythe technology and the most important variable of the economy is the consumption demandof vast population as well as the supply machineries to meet the demand. The sources of


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supply no longer confine to the areas where the demand exist with the improvement in thetransport and communication system. This demand can be easily met by supplies made fromthe sources located in the far-flung areas. Today, the total output by our industrial & nonindustrial sector is very large. So the role of modern commercial banks has changed as

providers of credit to the economy.

3. 4 IMPORTANCE OF LENDING

Lending by the banking sector assumes greater importance, because only banks can makecredit available to the needy borrowers. Banks have to play an important role in employmentgeneration, poverty alleviation & nation building. Lending by banks has helped manyindustries to sustain their business.

With liberalization & deregulation government is steadily withdrawing from many areas andis encouraging private enterprises. Infrastructure projects are now being taken up by privatecorporate sector. Government funding which was available in oil, transport, or telecomsector is being reduced, with the new opportunities now available to the private sector, thereis a challenge before them to raise resources to fund these projects. Besides other avenuesthere is a great demand from banking sector for financing new projects. Hence, lendingfunction will continue to occupy a prime position in any bank. The list of some of theimportant aspects of lending is as below:-

It constitutes major part of bank assets. It earns maximum incomes to the banks by the way of interest, discount & commission. The borrowers to whom bank finance, generally give deposits & other ancillary but

remuneration business to the bank, like remittances, collection, foreign exchange, merchantbanking etc.

Banks also get non-fund based credit business from these customers like guarantee, letters ofcredit etc. on which bank can earn handsome interest.

Its very essential to note that credit is a very dynamic area which undergoes many changesbased on the various economic factors, but the basic tents of any lending like character/capacity/ capital/ security/ safety of advances remain constant.

Bank has to follow them carefully to efficiently, profitably manage its credit portfolio &maximize its yield.

Loans are given against or in exchange of the ownership of various types of tangibles items.Some of the securities against which the banks lend are:-

Commodities Debts Financial Instruments

Real Estate Automobiles Consumer Durables Goods Document of Title

Apart from the above categories, the banks also lend to people on the basis of their perceivedpersonal worth. Such loans are called clean loans and the banks are understandably cautiousabout extending such loans.


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3. 5 METHODS OF LENDING

TANDON COMMITTEE

Like many other activities of the banks, method and quantum of short-term finance that canbe granted to a corporate was mandated by the Reserve Bank of India till 1994. This control

was exercised on the lines suggested by the recommendations of a study group headed byShri Prakash Tandon.

The study group headed by Shri Prakash Tandon, the then Chairman of Punjab NationalBank, was constituted by the RBI in July 1974 with eminent personalities drawn from leading

banks, financial institutions and a wide cross-section of the Industry with a view to study theentire gamut of Bank's finance for working capital and suggest ways for optimum utilizationof Bank credit. This was the first elaborate attempt by the central bank to organize the Bankcredit. The report of this group is widely known as Tandon Committee report. Most banks inIndia even today continue to look at the needs of the corporates in the light of methodologyrecommended by the Group.

As per the recommendations of Tandon Committee, the corporates should be discouragedfrom accumulating too much of stocks of current assets and should move towards very leaninventories and receivable levels. The committee even suggested the maximum levels of RawMaterial, Stock-in-process and Finished Goods which a corporate operating in an industryshould be allowed to accumulate these levels were termed as inventory and receivable norms

NAYAK COMMITTEE

Another group headed by Sh. P.R. Nayak (Nayak Committee) was entrusted the job oflooking into the difficulties faced by Small Scale Industries due to the sophisticated nature ofTandon & Chore Committee recommendations. His report is applicable to units with credit

requirements of less than Rs.50 lacs.

CASH FLOW METHOD

Cash Flow Analysis is designed specifically for credit union Professionals involved inbusiness lending. This study will delve further into the analytical techniques required todetermine the most fundamental skill in business lending whether sufficient cash flowexists to repay the proposed debt. While this sounds simple on the surface, cash flow analysisis a skill that often takes years to perfect. Cash Flow Statement helps to:-

Have a better understanding of all the details behind the debt service ratio Be able to calculate cash flow ratios from business tax returns and financial statements Understand book-tax differences and cash flow timing issues Learn various types of unusual tax items and how to address them in your analysis Save the credit union money through better screening of business lending opportunities Be able to defend your loan analysis and decisions with confidence to Examiners

PROJECTED BALANCESHEET

The question is how to implement projected cash flows. This can be overcome by building upindustry wise data and the financials of the borrower. Information such as credit exposure in


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terms of sector, industry, security and region wise to all the credit appraisers in the institutionshould be uniformly made available with reasonable up-date so as to enable them to price,dispense, manage and monitor. This information is then studied in detail and loan issanctioned accordingly.

3. 6 PRIORITY SECTOR ADVANCES

The priority sector advances broadly comprise advances to (i) agriculture, (ii) small scaleindustries, (iii) other activities/borrowers such as small transport operators, retail trade, small

business, professional & self employed persons, housing, education, micro-credit, etc.

The Bank has been financing priority sector activities in a focussed manner besides providingassistance by way of management inputs and equity support to the deserving units. In order toqualify for the Banks assistance under priority sector advances, the following two basic

parameters are to be complied with:-

a) the unit must be engaged in one or more of the activities listed by the ReserveBank of India (RBI) under different segments of priority sector; and

b) it must satisfy the tenets of the Banks loan policy.

3. 7 CREDIT RISK ASSESSMENT (CRA)

The credit risk assessment (CRA) is central to the credit appraisal drill and pricing of thecredit. Assets classified as Standard Assets only are expected to be risk rated. The majorfactors that go into appraising the risk associated with a loan are categorized broadly underFINANCIAL, INDUSTRIAL, and MANAGEMENT RISKS, and rated separately. Inorder to arrive at the overall risk rating, the factors duly weighted are required to beaggregated and calibrated to arrive at a single point indicator of the risk associated with thecredit decision.

3. 8 CREDIT SANCTION PROCESS

PRE-SANCTION CREDIT PROCESS (PCP):

The pre-sanction credit process comprises three stages viz., appraisal & recommendation,assessment and sanction.

1) Appraisal:The list of steps involves are as follows:-a. Preliminary Appraisal

b. Detailed Appraisalc. Present relationship with Bankd. Credit risk ratinge. Opinion reportsf. Existing charges on assets of the unitg. Structure of facilities and terms of sanctionh. Review of the proposali. Proposal for sanction

j. Assistance to assessment


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2) Assessment:The activities involved is this stage are as given below:-

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

Interact with the borrower and the appraiser.

Carry out pre-sanction visit to the applicant company and their project/factory site.

Peruse the financial analysis (Balance Sheet/ Operating Statement/ Ratio Analysis/ FundFlow Statement/ Working Capital assessment/Project cost & sources/ Break Evenanalysis/Debt Service/Security Cover, etc.) to see if this is prima facie in order. If anydeficiencies are seen, arrange with the appraiser for the analysis on the correct lines.

Examine critically the following aspects of the proposed exposure.

Bank's lending policy and other guidelines issued by the Bank from time totime

RBI guidelines

Background of promoters/ senior management

Inter-firm comparison

Technology in use in the company

Market conditions

Projected performance of the borrower vis--vis past estimates andperformance

Viability of the project

Strengths and Weaknesses of the borrower entity.

Proposed structure of facilities.

Adequacy/ correctness of limits/ sub limits, margins, moratorium andrepayment schedule

Adequacy of proposed security cover

Credit risk rating

Pricing and other charges and concessions, if any, proposed for thefacilities

Risk factors of the proposal and steps proposed to mitigate the risk

Deviations proposed from the norms of the Bank and justificationstherefore.

To the extent the inputs/comments are inadequate or require modification, arrange foradditional inputs/ modifications to be incorporated in the proposal, with any requiredmodification to the initial recommendation by the Appraiser

Arrange with the Appraiser to draw up the proposal in the final form.

Recommendation for sanction: Recapitulate briefly the conclusions of the appraisal and statewhether the proposal is economically viable. Recount briefly the value of the companys (andthe Groups) connections. State whether, all considered, the proposal is a fair banking risk.


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Finally, give recommendations for grant of the requisite fund-based and non-fund basedcredit facilities.

3) Sanction:The activities involved in the sanction function are as follows:-

Peruse the proposal to see if the reportprima faciepresents the proposal in a comprehensivemanner as required. If any critical information is not provided in the proposal, remit it back tothe Assessor for supply of the required data/clarifications.

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

Bank's lending policy and other relevant guidelines

RBI guidelines

Borrower's status in the industry Industry prospects

Experience of the Bank with other units in similar industry

Overall strength of the borrower

Projected level of operations

Risk factors critical to the exposure and adequacy of safeguards proposedthere against.

Value of the existing connection with the borrower

Credit risk rating

Security, pricing, charges and concessions proposed for the exposure andcovenants stipulated vis--vis the risk perception.

Accord sanction of the proposal on the terms proposed or by stipulating modified oradditional conditions/ safeguards, or Defer decision on the proposal and return it foradditional data/clarifications, or Reject the proposal, if it is not acceptable, setting out thereasons therefore.

POST SANCTION CREDIT PROCESS:

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

the three functions are as under:-a) Follow up function

To ensure the end-use of funds.

To relate the outstandings to the assets level on a continuous basis.

To correlate the activity level to the projections made at the time of the sanction/renewal ofthe credit facilities.

To detect deviation from terms of sanction.


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To make periodic assessment of the health of the advances by noting some of the keyindicators of performance like profitability, activity level, and management of the unit andensure that that the assets created are effectively utilised for productive purposes and are wellmaintained.

To ensure recovery of the instalments of the principal in case of term loan as per thescheduled repayment programme and all interest.

To identify early warning signals, if any, and initiate remedial measures thereby averting theincidence of incipient sickness.

To ensure compliance with all internal and external reporting requirements covering thecredit area.

b) Supervision function

To ensure that effective follow up of advances is in place and asset quality of good order ismaintained.

To look for early warning signals, identify incipient sickness and initiate proactive remedial

measures.

c) Monitoring function

To ensure that effective supervision is maintained on loans/advances and appropriateresponses are initiated wherever early warning signals are seen.

To monitor on an ongoing basis the asset portfolio by tracking changes from time to time;

Chalking-out and arranging for carrying out specific actions to ensure high percentage ofStandard Assets.


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CH. 4: ISSUES CONCERNING TO BANKING SYSTEM

The enhanced role of the banking sector in the Indian economy, the increasing levels ofderegulation and the increasing levels of competition have placed numerous demands on

banks. Operating in this demanding environment has exposed banks to various challenges.They are as follows:-

1)

Customer service

It is no longer adequate for banks to provide only traditional banking services. Apart fromproviding the conventional banking services, banks have begun offering a bouquet offinancial services to their clients, including cross selling of financial products. The aim is tooffer a one-stop-shop for meeting varied customers financial needs. Some banks have begunemploying customer relationship management systems to not only retain the existingcustomers but also to attract new customers.

The establishment of new private sector banks and foreign banks have rapidly changed thecompetitive landscape in the Indian consumer banking industry and placed greater demandson banks to gear themselves up to meet the increasing needs of customers. For the discerningcurrent day bank customers, it is not only relevant to offer a wide menu of services, but also

provide these in an increasingly efficient manner in terms of cost, time and convenience.

While banks are focusing on the methodologies of meeting the increasing demands placed onthem, there are legitimate concerns in regard to the banking practices that tend to excluderather than attract vast section of population, in part pensioners, self employed and thoseemployed in unorganized sector. While commercial customers are no doubt important, bandshave been bestowed with several privileges, especially of seeking public deposits on a highlyleveraged basis and consequently they should be obliged to provide banking services to all

segments of the population on equitable basis.

2) Branch banking

Traditional banks have been looking to expansion of their branch network to increase theirbusiness. Against this background, it is interesting to observe that the new private sectorbanks as well as the foreign banks have been able to achieve business expansion throughother means. It has been realized that it might not be necessary to establish a wider brick andmortar network to reach a wider population.

Banks are therefore examining the potential benefits that may accrue by tapping the agencyarrangement route and the outsourcing route. While proceeding in this direction banks oughtnot to loose sight of the new risks that they might be assuming and hence put in placeappropriate strategies and systems for managing these new risks.

3)

Competition


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With the ever increasing pace and extent of globalization of the Indian economy and thesystematic opening up of the Indian banking system to global competitors, banks need toequip themselves to operate in the increasingly competitive environment. This will make itimperative for the banks to enhance their systems and procedures to international standardsand also simultaneously fortify their financial positions.

4)

Technology

A few banks which have impressive branch networks have not been able to meet theircustomer expectations due to inefficiencies arising out of inadequate investment intechnology and consequently faced an erosion of their market shares. The beneficiaries arethose banks which have invested in technology.

Another distinct advantage of use of technology is the ability to effectively use quantitativetechniques and models which can enhance the quality of the banks risk management systems.Recognizing the benefits of modernizing their technology infrastructure, banks is taking theright initiatives. The challenge in this regard will be for banks to ensure that they derivemaximum advantage out of their investment in technology and to avoid wasteful expenditure

which might arise on account of:-

Uncoordinated and piecemeal adoption of technology Adoption of inappropriate\inconsistent technology Adoption of obsolete technology

5)

Basel II implementation

Basel II is the revised framework for capital adequacy for banks. Implementation of Basel IIis seen as one of the significant challenges facing the banking sector in many jurisdictions.With the introduction of capital charge for market risks with effect from the year endedMarch 31, in the year 2005, banks in India are compliant with all elements of Basel I.

Commercial banks in India will start implementing Basel II with effect from March 31, 2007.They will initially approach the Standardized Approach for credit risk and the Basic IndicatorApproach for operational risk. After adequate skills are developed, both by the banks and also

by the supervisors, some banks may be allowed to migrate to the Internal Rating Based (IRB)Approach.

Implementation of Basel II will require more capital for banks in India due to the fact thatoperational risk is not captured under Basel I, and the capital charge for market risk was not

prescribed until recently.

With a view to ensuring migration to Basel II in a non disruptive manner, a consultative andparticipative approach has been adopted for both designing and implementing Basel II inIndia. A Steering Committee comprising of senior officials from 14 banks (public, privateand foreign) has been constituted wherein representation from the Indian Banks Associationand the RBI has also been ensured. The Steering Committee had formed sub groups toaddress specific issues. Though Basel II implementation is considered as a challengegenerally, the above approach has lightened the burden on banks in India.


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Notwithstanding the above, capacity building, both in banks and the regulatory bodies is aserious challenge, especially with regard to adoption of the advanced approaches.

6)

Improving risk management systems

With the increasing degree of deregulation and exposure of banks to various types of risks,

efficient risk management systems have become essential. As a step towards furtherenhancing and fine tuning risk management systems in banks, RBI has issued guidelines onasset liability management and risk management systems in banks and Guidance Note onCredit Risk Management and Market Risk Management and the Guidance Note onOperational risk management. Though Basel II focuses significantly on risks itsimplementation should not be seen as an end in itself. It should be seen as a medium wherebythe risk management systems in banks are constantly upgraded to address the changingenvironment.

At the initial stages of development of the risk management systems, banks were managingeach risk in isolation. The current business environment demands a more integrated approachto risk management. It is no longer sufficient to manage each risk independently or in

functional silos. Enterprises worldwide are, therefore, now putting in place an integratedframework for risk management which is proactive, systematic and spans across the entireorganization. Banks in India are also moving from the individual silo system to an enterprisewide risk management system. This is placing greater demands on the risk management skillsin banks and has brought to the forefront the need for capacity building. While the firstmilestone would be risk integration across the entity, banks are also aware of the desirabilityof risk aggregation across the group both in the specific risk areas as also across the risks.Banks would be required to allocate significant resources towards this objective over the nextfew years.

The RBI has adopted the risk based approach to supervise since 2003 and has brought about23 banks under the fold of risk based supervision (RBS) on a pilot basis. On the basis of thefeedback received from the pilot project, the RBS framework has now been reviewed. Therisk based approach to supervision is also serving as a catalyst to banks migration to theintegrated risk management systems. In view of the relevance of improved risk managementsystems under the changing circumstances and the larger emphasis placed on riskmanagement systems in banks under Basel II, it is essential that the RBS stabilizes at an earlydate and serves as an important feedback not only to bank managements but also to RBI.However, taking into account the diversity in the Indian banking system, stabilizing the RBSas an effective supervisory mechanism will be a challenge to the RBI.

7)

Implementation of new accounting standards

Derivative activity in banks has been increasing at a brisk pace. While the risk managementframework for derivative trading, which is a relatively new area for Indian banks, is anessential pre-requisite, the absence of clear accounting guidelines in this area is matter ofsignificant concern. It is widely accepted that as the volume of transactions increases, whichis happening in the Indian banking system, the need to upgrade the accounting frameworkneeds no emphasis. The World Banks ROSC on Accounting and Auditing in India hascommented on the absence of an accounting standard which deals with recognition,measurement and disclosures pertaining to financial instruments.


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The Accounting Standards Board of the Institute of Chartered Accountants of India (ICAI) isconsidering issue of Accounting Standards on the above aspects pertaining to financialinstruments. These will be the Indian parallel to international accounting standards 32 and 39.The proposed accounting standards will be of considerable significance for financial entitiesand could therefore have implications for the financial sector. The formal introduction ofthese accounting standards by the ICAI is likely to take some time in view of the processes

involved. In the meanwhile, the Reserve Bank is considering the need for banks and financialentities adopting the broad underlying principles of IAS 39. Since this is likely to give rise tosome regulatory\prudential issues all relevant aspects are being comprehensively examined.The proposals in this regard would, as is normal, be discussed with the market participants

before introduction. Adoption and implementation of these principles are likely to pose agreat challenge to both the banks and the Reserve Bank.

8)

Transparency and Disclosures

In pursuance of the financial sector reforms introduced since 1991 and in order to bring aboutmeaningful disclosure of the true financial position of banks to enable the users of financialstatements to study and have a meaningful comparison of their positions, a series of measures

were initiated. The disclosure requirements broadly covered the following aspects:-

Capital adequacy Asset quality Maturity distribution of select items of assets and liabilities Profitability Country risk exposure Risk exposures in derivatives Segment reporting Related party disclosures

With a view to moving closer towards international best practices including internationalaccounting standards (IAS) and the disclosure requirements under Pillar 3 of Basel II,Reserve Bank has proposed enhanced disclosures which lay a greater emphasis on disclosureof certain qualitative aspects. Transparency and disclosure standards are also recognized asimportant constituents of a sound corporate governance mechanism. Banks are required toformulate a formal disclosure policy approved by the Board of directors that addresses the

banks approach for determining what disclosures it will make and the internal controls overthe disclosure process. In addition, banks would implement a process for assessing theappropriateness of their disclosures, including validation and frequency.

9)

Supervision of financial conglomerates

In view of increased focus on empowering supervisors to undertake consolidated supervisionof bank groups and since the Core Principles for effective banking supervision issued by theBasel Committee on banking supervision have underscored consolidated supervision as anindependent principle, the Reserve Bank had introduced, as an initial step, consolidatedaccounting and other quantitative methods to facilitate consolidated supervision. Thecomponents of consolidated supervision include, consolidated financial statements intendedfor public disclosure, consolidated prudential reports intended for supervisory assessment ofrisks and application of certain prudential regulations on group basis. In due course,consolidated supervision as introduced above would evolve to cover bands in nixed


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conglomerates, where the parent may be non-financial entities or parents may be financialentities coming under the jurisdiction of other regulators.

The financial landscape is increasingly witnessing entry of some of the bigger banks intoother financial segments like merchant banking, insurance etc., which has made themfinancial conglomerates. Emergence of several new players with diversified presence across

major segments and possibility of some of the non banking institutions in the financial sectoracquiring large enough proportions to have systematic impact make it imperative forsupervision to be spread across various segments of the financial sector.

In this direction, an inter-regulatory working group was constituted with members from RBI,SEBI and IRDA. The framework proposed by the group will be complementary to theexisting regulatory structure wherein the individual entities are regulated by the respectiveregulators and it identifies financial conglomerates would be subjected to focused regulatoryoversight through a mechanism of inter-regulatory exchange of information. As a first step inthis direction, an inter-agency working group on financial conglomerated (FC) comprisingthe above three supervisory bodies identified 23 FCs and a pilot process for obtaininginformation from these conglomerates has been initiated. The complexities involved in the

supervision of financial conglomerates are a challenge not only to the RBI but also to theother regulatory agencies, which need to have a close and continued coordination on an on-going basis.

10)

Know Your Customer (KYC) Guidelines Anti Money Laundering Standards

Banks were advised in 2002 to follow certain customer identification procedure for openingof accounts and monitoring transactions of a suspicious nature for the purpose of reporting itto appropriate authority. These Know Your Customer guidelines were revisited in thecontext of the recommendations made by the financial action task force of anti moneylaundering standards and on combating financing of terrorism. These standards have becomethe international benchmark for framing anti money laundering and combating financing ofterrorism policies by the regulatory authorities. Compliance with these standards both by the

banks\financial institutions and the country has become necessary for international financialrelationships.

Detailed guidelines based on the recommendations of the financial action task force and thepaper issued on customer due diligence for banks by the Basel committee on bankingsupervision, with indicative suggestions wherever considered necessary, were issued to

banks. Banks were required to ensure that a proper policy framework on Know yourCustomer and anti-money laundering measures is formulated and put in place with theapproval of the Board within three months and be fully compliant with these guidelines

before December 31, 2005. Compliance with the above is a significant challenge to the entire

banking industry to fortify itself against misuse by anti-social persons\ entities and thusproject a picture of solidarity and financial integrity of the Indian banking system to theinternational community.

11)

Corporate Governance

Banks are special as they not only accept and deploy large amount of uncollateralizedpublic funds in fiduciary capacity, but they also leverage such funds through credit creation.Banks are also important for the smooth functioning of the payment system.


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In view of the above, legal prescriptions for ownership and governance of banks laid down inBanking Regulation Act, 1949, have been supplemented by regulatory prescriptions issued byRBI from time to time. In this context, one must remember that profit motive should not bethe sole criterion for business decisions. Flow of bank finance for productive purposes mustalways take priority over the granting of credit for speculative investment no matter how

profitable the latter may be. If bank finance flows increasingly to finance speculativeactivities, it will be to the detriment of teal productive investment for research, developmentand the production of real goods\services.

One might conclude that such uncontrolled flow would ultimately affect economic growth.Hence, funding of speculative activities must be subject to prudential limits, even though itmight yield attractive returns. This will be a significant challenge to banks where the

priorities and incentives might not be well balanced by the operation of sound principles ofcorporate governance. If the internal imbalanced are not re-balanced immediately, thecorrection may evolve through external forces and may be painful and costly to allstakeholders. The focus, therefore, should be on enhancing and fortifying operation of the

principles of sound corporate governance.

CH.5 : SMALL AND MEDIUM SCALE ENTERPRISES (SMEs)

5. 1 INTRODUCTION

Small and medium enterprises (SMEs), particularly in developing countries, are the backboneof the nation's economy. They constitute the bulk of the industrial base and also contributesignificantly to their exports as well as to their Gross Domestic Product (GDP) or Gross

National Product (GNP).

5. 2 SMEs IN INDIA

India has nearly three million SMEs, which account for almost 50 percent of industrial outputand 42 percent of Indias total exports.Special roles for SMEs were earmarked in the Indian economy with the advent of plannedeconomy from 1951 and the subsequent industrial policy followed by government. By andlarge, SMEs developed in a manner, which made it possible for them to achieve theobjectivesof:-

High contribution to domestic production Significant export earnings Low investment requirements Operational flexibility Low intensive imports Capacity to develop appropriate indigenous technology Import substitution Technology-oriented industries Competitiveness in domestic and export markets


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It is the most important employment-generating sector and is an effective tool for promotionof balanced regional development. These account for 50 % of private sector employment and30 to 40 % of value-addition in manufacturing. It produces a diverse range of products (about8000 odd items), including consumer items, capital and intermediate goods.

SMEs have been established in almost all-major sectorsin the Indian industry such as:-

Food Processing Agricultural Inputs Chemicals & Pharmaceuticals Engineering; Electricals; Electronics Electro-medical equipment Textiles and Garments Leather and leather goods Meat products Bio-engineering Sports goods

Plastics products Computer Software, etc.

SMEs always represented the model of socio-economic policies of Government of Indiawhich emphasized judicious use of foreign exchange for import of capital goods and inputs;labor intensive mode of production; employment generation; nonconcentration of diffusion ofeconomic power in the hands of few (as in the case of big houses); discouraging monopolistic

practices of production and marketing; and finally effective contribution to foreign exchangeearning of the nation with low import-intensive operations. It was also coupled with the

policy of de-concentration of industrial activities in few geographical centers.

As a result of globalizationand liberalization, coupled with WTOregime, SMEs have beenpassing through a transitional period. With enhanced competition from China and a few lowcost centers of production from abroad many units have of late been facing a tough time.

However, those SMEs who had a strong technological base, international business outlook,competitive spirit and willingness to restructure themselves withstood the current challengesand came out successful to make their own contribution to the Indian economy.

But however, the SMEs in India, which constitute more than 80 % of the total number ofindustrial enterprises and form the backbone of industrial development, are as yet, intechnological backwaters vis--vis advances in science and technology. While most of the

large companies, even in developing countries, have financial as well as technical capacity toidentify technological sources and evaluate alternate technologies that would suit theirrequirements, unfortunately, this capacity is conspicuously missing in most SMEs.

It is these features of SMEs that make them an ideal target for technological upgradationthrough technological cooperation with foreign and local enterprises, with R&D institutionsand centers of technology development.So, what these SMEs need today is primarily access to new technology. Poor financialsituations and low

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