Credit Risk In Banks.anudeep Shah Standard Chartered

A Project Report On

Submitted in the partial fulfillment of the continous evaluation of MBA(General) Class of 2007-09 Submitted to : : Ms.Pooja Kashyap Faculty Guide, No:AURO71015 ABS,AU, Rajasthan (GENERAL)

Submitted by Anudeep Shah Enroll MBA

AMITY BUSINESS SCHOOL “Analysis of Credit Risk & Back End Operations in banks” 1

AMITY UNIVERSITY RAJASTHAN

“Analysis of Credit Risk & Back End Operations in banks” 2

ACKNOWLEDGMENT

I would like to take this opportunity to extend my heartfelt gratitude to all those who have made this project a possibility and have guided me at every stage of this project. I owe enormous intellectual debt to Ms.Pooja Kashyap

Project Guide who has

augmented my knowledge in the field of Finance and for lacing his confidence in me. Giving me this opportunity and for his valuable contribution to the project.

I would also like to thanks the members of Standard Chartered Bank, New Delhi for their direct and indirect support and guidance, which in turn enriched my knowledge and thoughts in this field from different perspective. I fell indebted towards them for helping me in the successful completion of this study.

“Analysis of Credit Risk & Back End Operations in banks” 3

CERTIFICATE FROM FACULTY GUIDE

This is to certify that Mr. Anudeep Shah, Student of Master of Business Administration (MBA), Class of 2009, Amity Business School, Amity University Rajasthan (Bearing Enrolment No.AUR071015) has completed the Summer Training for 6 weeks starting from 30th June 2008 to 7th Aug, 2008 on the topic “Analysis of Credit Risk & Bank End Operations in Banks’’ under my guidance. He has also guide by Mr.Ashok Mehra, Manager Item Process Centre and Mr.Rajeev Khanna , of Standard Chartered Bank, New Delhi. This project report has been prepared in partial fulfillment of Master of Business Administration, to be awarded by Amity University, Rajasthan. To the best of knowledge, this piece of work is original. No part of this report has been submitted by student to any other Institute or University earlier.

Date :-11th July,2008.

Ms.Pooja Kashyap Faculty Guide. ABS,JAIPUR

“Analysis of Credit Risk & Back End Operations in banks” 4

EXECUTIVE SUMMARY The Indian Economy is booming on the back of strong economic policies and a healthy regulatory regime. The effects of this are far-reaching and have the potential to ultimately achieve the high growth rates that the country is yearning for. The banking system lies at the nucleus of a country’s development robust reforms are needed in India’s case to fulfill that. The BASEL II accord.from the Bank of International Settlements attempts tp put in the place sound frameworks of measuring and quantifying the risks associated with banking operations. The paper seeks to showcase the changes that will emerge as a result of banks adopting the international norms. The structure of the paper is three-fold, where we begin by projecting the risk management scenario and its

effects on internal operations of a bank, followed by the

changes brought about in the banking sector of India and finally the macro effects on the economy. This enables one to discern the complete scenario that will emerge in the years ahead. The Risk Management scenario will strengthen owing to the liberalization, regulation and integration with global markets. Management of risks will be carried out proactively and quality of credit will improve, leading to a stronger financial sector. In the present paper the operational efficiency of the bank and different parameters regarding Credit Rating & other constraints and attempt is made to make a cause & effect relationship between different variables to give the answer of different issues.

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CONTENT Pg.No : Acknowledgement Certificate from Faculty Guide Certificate from Industry Guide Executive summary…………………………………………………………….. 3 CHAPTER-1 INTRODUCTION ………………………………………………… 4 1.1 INDUSTRY Profile..……………………………………………………… 4 1.2 COMPANY Profile……………………………….……………………… 4 1.3 RESEARCH OBJECTIVE………………………………………………… 4 1.4 RESEARCH METHODOLOGY……………………………………………4 1.5 ABBREVIATION USED……………………………………………………4 1.6 REVIEW OF LITERATURE………………………………………………..4 1.7 LIMITATION OF THE STUDY……………………………………………..4

CHAPTER-2 CREDIT RISK MANAGEMENT……………………………………16 2.1 RATING METHODOLOGY……………………………………………………. 2.1.1 BUSINESS RISK………………………………………………………… 2.1.2 INDUSTRY RISK………………………………………………………… 2.1.3 FINANCIAL RISK…………………………………………………………. 2.1.4 MANAGEMENT RISK…………………………………………………….. 2.2 TYPES OF BORROWERS 2.2.1 TRADERS……………………………………………………………… 2.2.2 CONTRACTORS……………………………………………………… 2.2.3 SME………………………………………………………………………… CHAPTER-3 LOAN……………………………………………………………………… 3.1 WHAT IS LOAN…………………………………………………………….. 3.2 TYPES OF LOAN…………………………………………………………… 3.2.1 RETAIL LENDING…………………………………………………………… 3.2.2 INDUSTRIAL AND COMMERICAL LENDING………………………… 3.3 PRINCIPLE OF SOUND LENDING POLICY……………………………… 3.4 HOW REPAYMENT IS DONE……………………………………………

CHAPTER-4 NPA……………………………………………………………………………… 4.1 WHAT IS NPA…………………………………………………………

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4.2 ASSET CLASSIFICATION……………………………………………… 4.2.1 SUB STANDARD ASSETS…………………………………………… 4.2.2 DOUBTFUL ASSETS………………………………………………… 4.2.3 LOSS ASSET………………………………………………………… 4.3 SYMPTOMS OF SICKNESS……………………………………………… CHAPTER-5 ANALYSIS AND INTERPRETATION………………………… 5.1 RISK CLASSIFICATION………………………………………… 5.2 TABLES………………………………………………………………………… CHAPTER-6 CONCLUSION AND RECOMMENDATION………………… REFERENCES ANNEXURE 1- TRADERS DATA ANNEXURE 2 – CONTARCTORS DATA ANNEXURE3 – SMEs DATA ANNEXURE 4- QUESTINNAIRE

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CHAPTER-1 INTRODUCTION 1.1. INDUSTRY PROFILE Banking industry has revolutionized the transaction and financial services system worldwide. Banking Industry services is nothing but the access of most of the banking related services (Such as verification of accounts details, going with the transactions etc.) In today’s world, progress of online services is available to all the customers of the concerned bank and can accessed at any point of time and from anywhere provided the place is equipped with the internet facility. Now-a-almost all the banks all over the world, especially the multinational ones, provide their customers with online banking facilities. The Indian Banking Industry can be categorized intoa) Non Scheduled Banks b) Scheduled Banks Scheduled Banks constitute banks and co-operative banks. There are about 67,000 branches of scheduled banks spread across India. During the first phase of financial reforms, there was a nationalization of 14 major banks in 1969. This crucial step led to a shift from Class banking to Mass Banking. Since. As far as the present scenario is concerned the banking industry is in a transition phase. The public Sector Banks (PSBs), which are the foundation of the Indian system account for more than 78 percent of the total banking industry assets. Unfortunately they are burdened with the excessive Non-Performing Assets (NPAs) massive manpower & lack of Modern Technology. On the other hand the Private Sector Banks in India are witnessing immense progress. They are leaders in Intent banking, mobile banking, phone Banking ATMs. On the other hand Public Sector Banks are still facing the problem of unhappy employees. There has been a decrease of 20 percent in the employee strength of the private sector in the wake of the Voluntary Retirement Schemes (VRS). As far as foreign banks are concerned they are likely to succeed in Indian.

“Analysis of Credit Risk & Back End Operations in banks” 8

Indus land bank was the first private bank to set up in India. IDBI, ING Vyasa Banks, SBI Commercial and International Bank Ltd. Karur Vysya Bank Ltd. Bank of Rajasthan etc.

1.2

COMPANY PROFILE :

About Standard Chartered Bank Standard Chartered has a long and proud history in South Asia, In 1858 in established its first branch opening in Kolkata- then the most important commercial city in India and the center of the jute and indigo trades. It have gone on to become the largest international bank in India in terms of branch network and profits. Today its number many of the emerging Indian multinationals amongst our clients and are expanding our strategic and advisory capabilities to keep pace with their financial needs and understanding of the evolving needs of our clients. This is backed by our strong capabilities across all product segments with a particular regional emphasis on convertible bonds and commodity derivatives, as well as project and asset backed finance, and cross-border M&A business. Standard Chartered have 83 branches in India and 17 in New Delhi were we assign our project, it has a presence in Bangladesh, Nepal and Sri Lanka.

Overview of Standard Chartered Bank Standard Chartered Bank has deep roots and a long heritage in international banking. Have an extensive history in some of the world’s most dynamic and fast-growing markets, such as Asia and the Middle East. No one has a better understanding of the wealth management needs of clients across these markets. Standard Chartered—a financial services giant—has top credit ratings and a 150 year history in banking with a long term commitment and financial investment in the Private Bank. The Standard Chartered Private Bank offers a full ranges of customized wealth management products and services, including those offered by our award - wining

“Analysis of Credit Risk & Back End Operations in banks” 9

commercial bank. In use a broad architecture approach to investment management to bring you some of the world’s leading money managers and financial products.

Some key facts about Standard Chartered Bank :

 Over 150 years in banking  Total Assets of US$329 Billion (as o March 2008)  Ranked 56th in Size among top 1000 world thanks (The Banker, July

2007

70,000+employees)  A+/A3/A+Credit rating (S&P/Moody’s/Fitch respectively, as of March 2008)  Listed on both London & Hong Kong exchanges  Ranks among the top 25 companies in the FTSE-100  Regulated by the UK FSA.

Products & Services In Standard Chartered Private Bank, Clients will receive individual attention from Private Banker who works with Investment, Fiduciary, Credit and Treasury specialists in the Local markets to create a carefully chosen portfolio of products and services designed to meet you wealth management needs.

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India Standard Chartered Indian Offers expertise and services in the following areas: • • • • • • • •

A.

Trade Finance Commodity trade finance Cash management Custody Foreign exchange Debt capital markets Corporate finance Supply chain finance

Fiduciary Services

It offer extensive estate planning and fiduciary services to give you greater control over you wealth, whatever you personal, family and business circumstances or the political situation In your home country. With Trust Company locations in both the Cayman Islands (Grand Gayman) and Guernsey (Channel Islands), we make the following services available to you to ensure a smooth transfer of assets from one generation to another : • • • •

B.

Full Trust Express Trust Registered Office Facility Private Investment Company

Insurance :- Insurance can provide continuity in your business, liquidity at a critical moment and maximum choices for you heirs. Our Fiduciary Specialists can provide an introduction to a licensed broker who is qualified to evaluate your needs and recommend a strategy.

C.

Credit Facilities

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Our secured loans can provide you with short-term liquidity without disrupting your long-term investments. They allow you to leverage your assets in one jurisdiction for use in another or your personal assets for use in you business. Pre-approved loan margins are in place for a wide range of assets. D.

Collateralised Trading Program

24-hour, self-directed trading of an extensive array of foreign exchange, interest rate, bond and equity products are available with around-the-clock service from major Trading Centres in Sigapore, London and Hong Kong.

Operations : Personal Banking , Private Banking, SME Banking ,Wholesale Banking  Accounts  Credit Cards  Debit & Prepaid Cards  Loans & Mortgages  NRI Banking  Exclusive Banking

STANDARD CHARTERED BANK IN INDIA : Standard Chartered Bank in India is the largest International Bank Group in India. The combined Balance Sheet (as at 31st March, 2007) of SCB Indian is Rs 293 billion (USD 6 billion) And is having a combined customer base 2.4 million in retail banking and over 1550 corporate customers. The Key Business of Standard Chartered Bank in India include consumer bankingPrimarily Credit Cards, Mortgages, Personal loans and wealth Management and wholesale Banking, where the bank specializes in the provision of cash Management, trade, finance, treasury and custody services.

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Standard chartered India was the first to issue first global credit card in India, the first to issue photo card, the picture Card and was the first Credit card issuer to be awarded by the ISO 8002 certification.

Basel II-

A Move to meet global standards

In India, the RBI has implemented the Basel II norms. Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. The purpose of Basel II, which was initially published in June 2004, is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. Advocates of Basel II believe that such an international standard can help project the international financial system from the types of problems that might arise should a manor bank or a series of banks collapse. In practice, Basel II attempts to accomplish this by setting up rigorous risk and capital management requirements designed to ensure that a bank holds capital reserves appropriate to the risk the bank exposes itself to through its lending and investment practices. Generally speaking, these rules mean that the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall economic. Basel II uses a “three pillars” concept-(1) minimum capital requirements (addressing risk), (2) supervisory review and (3) market discipline-to promote greater stability in the financial system. The first pillar The first pillar deals with maintenance of regulatory capital calculated for three major components of risk that a bank faces : credit risk, operational risk and market risk. Other risks are not considered fully quantifiable at this stage. The second pillar

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The second pillar deals with the regulatory response to the first pillar, giving regulators much improved “tools” over those available to them under Basel I . it also provides a framework for dealing with all the other risks a bank may face, such as systemic risk, pension risk concentration risk, strategic risk, reputation risk, liquidity risk and legal risk, which the accord combines under the title of residual risk.

The third Pillar The third pillar greatly increases the disclosures that

the bank must make. This is

designed to allow the market to have a better picture of the overall risk position of the bank and to allow the counter parties of the bank to price and deal appropriately. Advantages of Basel II in India. The plausible advantages that would have in store for India would be both banking as well as non-banking. • Banking Opportunities With second highest growth rate in the world and huge scientific and general work force, India is now well recognized as one of the fast emerging nations in the world. A sound and evolved banking system should thus be a prime requirement to support the hectic and enhanced levels of domestic and international economic activities in the country. Though India is credited with a strong banking system, still some better risk practices by Indian banks are required. A majority of Indian banks are either at

nascent or at a very low

level of competence in Credit, Market and Operational risk measurement and management system. They are lagging behind in use of modem risk methodologies and tools in comparison to their western counterparts. Economic reforms, higher market dynamics and large-scale globalization demand a robust risk management system in the Indian banks . as suggested by the recent Global Trust bank fiasco the current level of risk based supervision and market disclosures are also not very satisfactory in the Indian banking system. Basel II gives an opportunity and a framework for improvement to the Indian

banks. A Basel II compliant banking system will further enhance the image of

India in the League of Nations. The country rating of Indian will wurely improve, and

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consequently facilitate a higher capital inflow in the country. This will tremendously help India to move on the higher growth trajectory in the coming decades. • Non-Banking Opportunities The major advantage of Basel II to India is going to be in the area of services. Predominantly, It and manpower. The banks all over

the world will have to make huge

investments in order to be the Basel II compliant. These investments will be mainly in the areas of information technology system (Software tools Database management, Business Intelligence, Hardware), training etc. to

create risk infrastructure to address the three

compliance pillars of the Basel II. Here is the opportunity for consultancy and IT companies in India and abroad. Indian IT companies with an established reputation of system implementations

and service support

can and must use this opportunity to

enhance their business from the financial services domain. IT/ITES industry in banking and financial services sector can enhance the present level of revenue from both on and off site services related to Basel II compliance. Some of the Indian IT majors like Flexm, Infosys and wipro are believed to be, in the advanced stage of preparation in terms of product and services, to embark upon the business opportunities provided by Basel II.

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1.3.

ABBREVATIONS USED

DBC

Discounted Bills Cheques

BDD

Bankers Draft Discounted

LC

Letter of Credit

PCL

Packing Credit Limit

FDBN

Foreign Documentary bills Negotiable

FDBD

Foreign Documentary bills Discounted

FDBP

Foreign Documentary bills Payable

1.4. REVIEW OF LITERATURE • Willaim B. English & William R. Nelson in their article bank risk rating of business loan, published in 1998 based on federal research survey of 100 banks said that use of risk rating system is quite widespread but smaller bank generally have less detailed than do larger bank. New survey also allows them to asses the relationship between loan risk rating & loan term Riskier loan generally carry higher rate of interest, even after taking account of other term loan. There are more complex relationship between loan risk & other loan term. • Marwan Elkhoury in their discussion paper Credit Rating Agencies And Their Potential Impact on Developing Countries, published in Jan’ 2008 said that Credit rating agencies (CRAs) play a key rolein financial markets by helping to reduce the informative asymmetry between lenders and investors, on one side,

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and issuers on the other side, about the creditworthiness of companies or countries. CRAs’ role has expanded with financial

globalization and has

received an additional boost from Basel II which incorporates the rating of CRAs into the rules for setting weights for credit risk. Rating tend to be sticky, lagging markets, and overreact when they do change. This overreaction may have aggravated financial crises in the recent past, contributing financial instability and cross-country contagion. • Tor Jacobson jesper Linde Kasper Roszbach in their paper Credit Risk Versus Capital requirements under Basel (( : are SME loans and retail credit really different ? published in 2nd feb’2004 discuss about SME loan & retail credit & realize that Much of the work done on the differences

between the risk

properties of retail, SME and corporate credit has been based on parameterized model of credit risk. He has used new quantitative evidence on the implied credit loss distributions for two Swedish banks using aparametric Monte Carlo re-sampling method following Carey {1998}. He said that that retail credit and SME loans will receive a special treatment in recognition of the fact that the riskiness of such exposure treatment in recognition of the fact that the riskiness of such exposure derives to a greater extent from idiosyncratic risk and much less from common factor risk. • Ms. Roopa Kudva, Executive Director and Chief Rating Officer,CRISIL said that CRISIL bank loan rating mark a new era for use of credit rating by banks. Hitherto, credit ratings were assigned mostly to capital market instruments such as debentures, bonds and commercial paper. The use of CRISIL rating by banks reflects the confidence the market has gained in using credit rating as an advanced tool for measuring and managing credit risk, CRISIL expects that Bank Loan Ratings will be a key input for appropriate pricing of credit risk by banks.” • Lyn C. Thomas in their article A survey of credit and behavioral Scoring : forecasting financial risk of lending to consumers, published on 31st may 2000 said that Credit scoring and behavioral scoring are the techniques that help organizations decide whether or not to grant credit to consumers who apply to

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them. This article surveys the techniques used-both statistical and operational research based- to support these decisions. It

also discusses the need to

incorporate economic conditions into the scoring systems and the way the systems could change from estimating the probability of a consumer defaulting to estimating the profit a consumer will bring to the lending organization-two of the major

developments being attempted in the area. It points out how

successful has been this under-researched area of forecasting risk.. • Barry Eichengreen and Ashoka

Mody

in their paper Lending booms,

reserves and the sustainability of short-term debt: inferences from the pricing of syndicated bank loans, published in 28th Aug.’ 2008 analyse that the determinants of spreads on syndicated bank lending to emerging

markets,

treating the loan-extension and pricing decisions as jointly determined. Compared to the bond market, their findings highlight the role of international banks in providing credit to smaller borrowers about whom information is least complete and, more generally, support the interpretation of bank finance as dominating that segment of international financial markets characterized by the most pronounced information asymmetries. Domestic lending booms and law reserves in relation to short-term debt have been priced in the expected manner by international banks. The high level of short-term debt in East Asia was supported by high growth rates but was characterized by a knife-edge quality

1.5. LIMITATIONS OF THE STUDY While conducting my research, I has to face with several limitations : Borrower name can not be disclosed.  I was not allowed to take all information of the borrower.  I was not allowed to get the questionnaire filled.  Accurate analyzation becomes very difficult because many of the factors were

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unpredictable .  Less time for doing research work for Summer Internship Programme .

1.2.

OBJECTIVE OF THE STUDY

 Analysis of Credit Risk Management.  To know the various Parameters/Risks taken for consideration while loan  To know the process of the Back End Operation. i) Payment System ii) C.L.P.U (Central Loan Processing Unit) iii) Internal Services

1.3. RESEARCH METHODOLOGY 1.3.1. Sample Size: [Credit Risk analysis] Traders

: 16 Companies

Contractors

: 6 Companies

SME

: 18 Companies.

1.3.2. Research Method :The Project is consists of :1. Primary Data 2. Secondary Data 1. Primary Data : Primary Data is collected from the borrowers profile availed in the bank and telephonic interview.

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2. Secondary Data Secondary Data is collected from the website of Standard Chartered Bank and other concern agencies as well as studies available. The information for the literature survey has been obtained mainly from : News published in Indian & International news paper on the subject of Payment Systems.

Chapter - 2 CREDIT RISK MANAGEMENT Credit Risk is simply defined as the risk of non payment due to a loan in time. The service include payment of interest and other charges & repayment of principal account by installment or otherwise. If these are not paid as & when due credit risk is involved because the bank loses not only the cost of funds to carry this for a further purpose but also the profit that would have been earned on simultaneous investment of this amount. A default therefore reduces the present value of the loan & consequently the value of the bank’s business. According to prudential norms, a loan assets becomes a sub-standard asset where there is a two-quarter on interest & installment payment. A substandard asset immediately entails provisioning for losses. The bank is not entitled to book profit for unpaid interest. The technical capacity for business to service its loan is estimated by its debt coverage ratio or priority obligation ratio.

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2.1. RATING METHODOLOGY : The Rating Methodology involves an analysis of industry risk, the issuers business financial & Management risk. A rating is assigned after assessing all the factors that could affect the credit worthiness of the entity. Typically industry risk assessment sets the stage for analyzing more specific company risks factor & establishing the priority of these factors in the overall

evaluation. For instance, if the industry is highly competitive,

careful assessment of the issuer’s market position is stressed. If the company has large capital requirement, the current information provided by the issuers or facts from reliable sources. The main elements for rating methodology for banks/Fls are :2.1.1 Business Risk 2.1.2 Industry Risk 2.1.3 Financial Risk 2.1.4 Management Risk 2.1.1 Business Risk

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This is defined as the inability of the business or project to service its debt in time. This inability emerge from income generation capacity of the business, which is affected by the nature of the business or the product it sells, the external economic or market environment & the internal manufacturing organization & product mix of an enterprise . if all these variables are in a steady state, the business suffers from no risk. But if any one of them is not in steady , the business will suffer from volatility. 2.1.2 Industry Risk It consist of nature & basis competition, key success factors, demand & supply position, structure of industry, cyclical/seasonal factors, government polices & so on. A lender should always keep in mind that it is the financially week companies that become insolvent during the cyclically induced decline of the industry. The incidence of solvency is also high at the bottom of the boom phase & recovery phase from a recession, because in the former case, labour cost & interest continue to remain or become high against a fall in sale & in latter case, & interest continue to remain or become high against a fall in sale & in latter case, the firms are unable to support a rising demand of their product due to erosion of capital base during recession. It is important therefore, to capture cyclical trend in an Industry to evaluate borrowing risk. Financial Risk After evaluating the issuer’s competitive position & operating environment, the analyst proceeds to analyse the financial strength of the issuer. Financial risk is analysed largely through quantitative means, particularly by using financial ratios. While the past financial performance of the issuer is important, emphasis is placed on the ability of the issuer to maintain /improve its future financial performance. As ratings rely on audited data, the analysis of the audited financial results begins with a review of accounting quality. The purpose is to determine whether ratios & statistics derived from financial statements can be used to accurately measure a company’s performance& its position. Relative to both its peer group & large universe of companies. Management Risk A proper assessment of debt protection levels requires an evaluation of the management philosophies & its strategies. The analyst compares the company’s business strategies &

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financial plans to provide insights into a management’s abilities with

respect to

forecasting & implementing of plans.

TYPES OF BORROWER There are several types of borrowers, but I have taken only three types of borrowers for my study. These are :1- Traders 2- Contractor 3- SME 2.2.1- Traders A trader is a person who buys or sells goods. He did not manufacture goods. He purchases goods from manufacture & sells to retailers. He can be a person who is dealing in import or export.

2.2.2- Contractor A person who undertakes to work on contract basis is a contractor. Ex. A person undertake a contract to prepare a road on certain time period. 2.2.3. SME The Term ‘ enterprise’ has been defined under section 2 (e) so as to mean any industrial undertaking or a business concern or any other establishment, by whatever name called, engaged in production or manufacture of goods, in any manner pertaining to any industry specified in the first schedule to the industries (development & regulation) Act, 1951 or engaged in providing of rendering of any service of services’. For the purpose of the Act, any class or classes of enterprises may be classified as micro, small or medium enterprises by a notification issued in this behalf.

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The Classification of enterprises as micro, small & medium as envisaged under section 7 (1) & notified vide Min. of SSI Notification No. S.O. 1642 (E) Dt. 29-9-2006 is depicted in the following chart.

Chart

CHAPTER -3 WHAT IS LOAN Lending of funds to the constituents, mainly traders, business & industrial enterprises, constitutes the main business of the banking company. The major portion of a bank’s funds is employed by way of loans & advances, which is the most profitable employment of its funds. The major part bank’s income is earned from interest & discount on the funds so lent. The business of lending, nevertheless, is not without certain inherent risks. While lending his funds, a banker, therefore, follow a very

cautious policy & conducts his

business on the basis of the well-known principles of sound lending in order to minimize the risks. Crop Bank offers a variety of loans to choose from. The various retail loans are given as ‘Crop Schemes’ highlighting the traditional Crop Bank commitment on giving the bestin terms of service, speedy disposal and of course at a very competitive interest

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rates. Crop Bank offers Housing loans, Educations Loans, Consumer Loans for purchase of consumer durables like, TV, washing machines, music systems and other electronic goods, loans against future rent receivables on leased out building/premises, loans to purchase two-wheelers & four-wheelers, loans against shares, loans for purchase of medical and other such sophisticated equipments, loan to acquire office premises/building & furniture, personal loans, loans to women to buy pure gold/jewellery, loan against mortgage of property etc. The Bank’s

Benchmark PLR, Known as COBAR

(Corporation Bank Benchmark

Advance Rate) stands revised at 13.00% per annum, with effect from 15.03.2008 Interest calculation on credit facilities will be done on the basis

of 365 days only,

irrespective of whether the year is leap year or not. 3.2. TYPES OF LOAN 3.2.1 Retail lending 3.2.2 Industrial & Commercial lending

3.2.1 Retail lending 1. Crop personal

: To meet personal financial needs.

2. Crop site

: Loan for application money

3. Crop home

: Home loan

4. Crop flexi home loan

: The flexible home loan

5. Crop mortgage

: Loan against property

6. Crop Consumer

: To purchase consumer durables.

7. Crop byte

: Computer Loan

8. Crop mitra

: For the insurance sector personal

9. Crop mitra gold

: For buying gold from our bank

10. Crop plus

: The overdraft facility

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11. Crop vidya

: The educational Loan

12. crop mobile

: The vehicle loan

13. Crop cash demat

:Loan against share

14. Crop Mahila gold

: Loan for buying gold

15.Corp professional

: To acquire office premises

16. Crop meditech

: To purchase medical equipment

17. Crop vyapar

: loan against Rent Receivables

3.2.2 Industrial & commercial lending Cash Credit Cash credit is the main method of lending by banks in India & accounts for about 70%of total bank credit. Under this system, the banker specifies a limit, called cash credit limit, for each customer, up to which the customer is permitted to borrow against the security of tangible assets or guarantees. The customer withdraws from his cash credit account as & when he needs the funds & deposits any amount of money Which he finds surplus with him on any day. The cash credit account is thus an active & running account to which deposits & withdrawals may be affected frequently.

DBC/BDD DBC/BDD stands for discounted bill purchase facility under which the proceeds of cheques, bank draft & instruments of such nature like, interest warrants, dividend warrants, refund orders etc., are credited to an account holder without waiting for realization of the relative instruments.

Forward Contract-purchase & sale Forward contract is a contract which affords adequate protection to an exporter or an importer against exchange risk. Under these contracts, a banker & a customer enter into a agreement to but or sell a fixed amount of foreign currency on a future specified date at a

“Analysis of Credit Risk & Back End Operations in banks” 26

pre-determined rate of exchange. Exporter for instance sells foreign exchange of specified amount & currency at a specified future date which assures to but the same amont & currency at a specified future date which assures to but the same amount & currency at a predetermined rate which assures him definite availability of foreign exchange. Import/inland LC cum BG Letter of commercial credit plays an important role in the trade of the country. In most cases the exporter are not personally very well aware about the importers In foreign country. In such cases the exporters bear great risk if they draw bills on the importers, after dispatching the goods as per their order, because if the importer default in making the payment, the exporter will suffer heavy loses. To avoid such risk, the exporter ask the importers to arrange a letter of credit from importer’s bank in favour of the exporter, informing him that the issuing bank undertakes to accept the bills drawn in respect to exports made to the foreign buyer specified therein.

Bills of exchange A bill of exchange is an important instrument widely used in the discharge of business obligations-both in case of home trade 7 foreign trade. It is generally written by a creditor on his debtor & is presented to the latter for acceptance, if it is not payable on demand. After signing his acceptance, the debtor (or the drawee of the bills) is called the acceptor for payment on the due date. Generally, the accepted bills are discounted by the drawer with

a banker who presents it before the acceptor for payment on the due date. If the

latter fails to make its payment. Bill is treated as dishonored.

CC-PCL-FDBN/FDBP/FDBD PCL (Packing credit limit) pre shipment means any loan or advance grantedor any other credit provided by a bank to

an exporter for financing

the purchase, processing,

manufacturing or packing of goods prior to shipment/ working capital expenses towards

“Analysis of Credit Risk & Back End Operations in banks” 27

rendering of services on the basis of letter of credit opened in his favour or in favour of some other person, by an overseas buyer or a confirmed

& irrevocable order for the

export of goods/services from India or any other evidence of an order for export from India having been placed on the exporter or some other person, unless lodgment of export orders or letter of credit with the bank has been waived. The PCL granted to an exporter may be liquidated out of proceeds of bills drawn for the exported commodities on its purchase, discount etc. thereby converting pre-shipment credit into post shipment credit. Overdraft When a current account holder is permitted by the banker to draw more than what stands to his credit, such an advance is called an over draft. The banker

may take some

collateral security or may grant such advances on the personal security of the borrower. The customer is permitted to withdraw the amount as & when he needs it & to repay it by means of deposit in his account as & when it is feasible for him. Interest is charged on the exact amount overdrawn by the customer & for the period of its actual utilization.

Bank Guarantee According to Indian contract Act, 1872, Guarantee is a “contract to perform the promise or discharge

the

liability

of

a

third

person

in

case

of

his

default.”

the person who undertakes the above obligation to discharge the liability of a third person is called the guarantor or the surety. The person in respect of whose default the guarantee is given is called the principal debtor & person to whom the guarantee.

Term loan Tern loan is a credit facility granted for the purpose of acquisition of capital assets, such as purchase of land, construction of building, purchase of machinery, modernization, renovation and rationalization of plant, furniture & fixtures which is repayable form the future earning of the enterprise. Hence repayment is mde in installments,as per a prearranged schedule normally not exceeding 7

years, except in respect of certain

“Analysis of Credit Risk & Back End Operations in banks” 28

approved schemes,

where it can

go beyond 7 years, vix., Crop rental, infrastructure

lending, projects with long gestation, etc.

3.3 PRINCIPLE OF SOUND LENDING There are certain principles of bank lending that have been followed by banks since long. These principles are :a) Safety As the bank lends the funds entrusted to it by the depositors, the first & foremost principle of lending is to ensure the safety of the funds lent. By safety is mean that borrower is in a position to repay the loan contract. The repayment of loan depends upon the :a) Borrower’s capacity to pay b) Borrower’s ability to pay

b) Liquidity Banks are essentially intermediaries for short tern funds. Therefore, they lend funs for short periods & mainly for working capital purposes. the loans are therefore largely payable on demand. The banker must ensure that the borrower is able to repay the loan on demand or within a short period.

Profitability The banks must employ their funds profitably so as to earn sufficient income out of which to pay interest to the depositors, salaries to the staff & to meet vaiours

their

establishment expenses & distribute dividends to the shareholders. Banks are free charge their own rate of interest on advances of above Rs. 21 lakhs. A customer with high reputation is charged the lower rte of interest as compared to an ordinary customer. The

“Analysis of Credit Risk & Back End Operations in banks” 29

sound principle of lending is not to sacrifice safety or liquidity for the ske of higher profitability.

The Purpose of the loan While lending his funds, the banker enquires from the borrower the purpose for which he seeks loan. Banks do not grant loan for each & every purpose, they ensure the safety & liquidity of their funds by granting loans for productive purposes only, viz., for meeting working capital,

needs of an enterprise. Loans are not advanced for speculative &

ceremonies or for pleasure tips or for repayment of a prior loan. The principle of diversifications of Risks This is also a cardinal principle of sound lending. A prudent banker always tries to select the borrower very carefully & takes tangible assets as securities to safeguard his interests. Tangible asset are no doubt valuable yet some risk is involved therein. An industry or trade may face depressing condition or the natural calamities like floods & earthquakes, political disturbances in

certain part of the country may ruin even

a

prosperous business. To safeguard his interest against such unforeseen contingencies. The banker follow the principle of diversification of risks based on the famous maxim ‘do not keep all the cggs in one basket’ it means the banker should not grant loans only to big firms or few industries or in a few cities or regions of the country only. The advance on the other hand, should be over a reasonably wide area, distributed amongst a good number of customers belonging to different trades 7 industries.

3.4. HOW REPAYMENT IS DONE ? a) Cash credit

: Repayable on demand

b) DBC/BDD

: Repayable is done according to the tenor of the bill.

c) Forward purchase contract

:

d) Forward sale contract

:

e) Import/ inland LC cum BG

:

“Analysis of Credit Risk & Back End Operations in banks” 30

f) Bills of exchange (BE)

: According to the tenor of the bill

g) CC-PCL-FDBN/FDBP/FDBD : Repayment should be made within 90 days h) Overdraft

: Repayable on demand

i) Bank guarantee (BG)

:

j) Term Loan

: Repayable in installment

CHAPTER -4 NPA 4.1. WHAT IS NPA An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank. A “non performing asset” (NPA) was defined as a credit facility in respect of which the interest &/or installment of principal has remained ‘past due’ for a specified period of time. The specified period was reduced in a phased manner as under: Year ending Mar 31 1993 1994 1995 onwards

Specified periods four quarters three quarters two quarters

An amount due under any credit facility is treated as ‘past due’ when it has not been paid within 30 days from the due date. Due to the improvements in the payment & settlement systems, recovery climate, up gradation of technology in the banking system, etc., it was decided to dispense with ‘past due’ concept, with effect from mar 31, 2001. Accordingly, as from that date, a NPA shall be an advance where. a) Interest &/or instalment of principal of principal remain overdue for a period of more than 90 days in respect of a term loan.

“Analysis of Credit Risk & Back End Operations in banks” 31

b) The account remains ‘out of order’ for a period of more than 90 days, in respect of an overdraft/cash credit (OD/CC) c) The bill remains overdue for a period of more than 90 days in case of bills purchased & discounted. d) Interest &/or installment of principal of principal remain overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purposes. 4.2. ASSET CLASSIFICATION Branches are required to classify non performing assets further into the following three bases on the period for which the asset has remained non performing & the reliability of the dues. 4.2.1. Sub Standard Assets- Asset Code B A Sub Standard asset is one, which has remained NPA for a period of less or equal to 12 months in such cases, the current net worth of the borrower/ guarantor or the current market value of the security charged is not enough to ensure recovery of the dues to the banks in full.

4.2.2. Doubtful Assets- Asset Code C An asset is to be classified as doubtful, if it remained NPA for a period exceeding 12 months. A loan is classified as doubtful has all the weaknesses internet in assets that were classified as sub-standard, with the added characteristic that the weaknesses makes collection or liquidation in full, on the basis of currency known facts, conditions & value highly questionable & improbable.

Doubtful assets are further classified into 3 categories as follows: Code a) Doubtful unto 1 year

:

C1

b) Doubtful from 1 to 3 years

:

C2

c) Doubtful for more than 3 years

:

C3

“Analysis of Credit Risk & Back End Operations in banks” 32

4.2.3. Loss Assets – Asset Code D

Loss Asset are considered uncollectible & of such little that their continuance as bankable assets are not warranted, although there may be some salvage or recovery value. In such cases loss has been identified by the bank or internal of external auditors or RBI inspectors abut the amount has not been written off wholly. 4.3. SYMPTOMS OF SICKNESS (Early Warning Signals of potential NPA Account)

Financial (in bank account) 1. Static outstanding/persistent irregularity in account- outstanding mostly greater than drawing power. 2. Defaults in repayments obligations- inability to meet periodic interest/ installments. 3. Lower credit summation in accounts. 4. Development of L/C liabilities/irregular statements, non-moving/slow moving stock. 5. Frequent request for adhoc limits. 6. Stock statement – Improper/irregular statements, non-moving/slow moving stock. 7. Raising accommodation bills. 8. Bills/cheques generally dishonored. 9. Sales Transactions not routed via-cash credit A/c. 10. Opening of account with other banks-non compliance of terms & condition of sanction. 11. Declining Current Ratio, erosion of tangible net worth-operating losses/net losses.

“Analysis of Credit Risk & Back End Operations in banks” 33

12. Increase in debt/equity ratio-increase in outstanding borrowing decline in net profit/sales ration-increase in fixed costs-lack of details age wise sundry debtors.

At the unit / Factory Decline in sales turnover, order position delayed, delivery schedule customer complaints about quality. Low productivity unutilized capacity, high labour turnover-poor maintenance of machinery, closure of unit.

Loss of Market Credit Court-cases against unit, inability to raise on usual credit terms.

Operational & Physical 1.

Low activity levels in factory & in bank Accounts

2.

Disorderly diversification/frequent changes in plans

3.

Low inventory movement-Frequent labour troubles

4.

Loss of critical important customers-frequent return of finished goods.

Attitudinal Changes 1.

Dissension among Partners/promoters

2.

Borrowers avoiding contact with bank

3.

Non – delayed submission of DATA & financials

“Analysis of Credit Risk & Back End Operations in banks” 34

Others 1.

Adverse changes in Government Policies

2.

Emergence of new competition/technology-infrastructural bottle –necksnon-availability of/irregular supply of critical raw material or other inputschronic power shortage

3.

Transport bottlenecks.

CHAPTER- 5 ANALYSIS & INTERPRETATION 5.1. Risk is classified into: a) Business Risks b) Financial Risk c) Industry Risk d) Management Risk 5.2. Tables: Table 1: Average Risk of Borrower Type of Risk

Type of Borrower Trader

Contractor

SME

Business Risk

6.21

5.85

6.83

Financial Risk

5.17

5.56

4.78

“Analysis of Credit Risk & Back End Operations in banks” 35

Industry Risk

7.12

6.43

6.98

7.02

6.66

6.66

25.52

24.5

25.25

6.12

6.31

Management Risk Total Total Risk

Average 6.38

Average Risk of Borrower 30 25

Type of Risk

20

Business Risk

Type of Risks 15

Financial Risk Industry Risk

10

Managment Risk

5 0

Total Traders

Contractors

SME

Total Average Risk

Type of Borrower

ANALYSIS : We can analysis that traders are having maximum Industry Risk i.e. 7.12 as compared to Contractor & SME where it is 6.43 & 6.98 because structure of industry, cyclical factors, government policies etc. are uncertain & unpredictable, so traders have no control over it as compared to contractor & SME who have little control. Because of this industry Risk, Repayment can be affected.

SME are having maximum Business Risk as compared to Trader & Contractor because SMEs are dealing in small & medium Business, they at the same time, are having Risk both from other SMEs & large Enterprises dealing in same business. And they are small they do not have large amount of funds to fulfill there losses, if they fails. This will affect their repayment capacity. They are also having maximum management Risk because what most of the traders do, they said they are dealing in export (they have all documents

“Analysis of Credit Risk & Back End Operations in banks” 36

proving this) while they are dealing in domestic business only. So if trader is lying that they are in export business while they are not, they might not able to repay the loan.

Contractors are having more Financial Risk because they work on contract basis, they don’t have huge pool of resources, they buy the resources at the same time they receive the contract. So if they fail to fulfill the contract on time & the party cancels the contract, they might be not in a position to repay the loan.

Composition of Average Risk of Trader Financial Risk 20%

Management Risk 28%

Management Risk Business Risk Industry Risk Financial Risk Industry Risk 28% Business Risk 24%

Analysis: As far as average risk if Trader is concerned, they are having more management & industry risk i.e. 28% each because of structure of industry, cyclical factors, government policies etc. which are uncertain & unpredictable, and Trader have least control over it. Traders are having maximum control on their financial position, that is why they are having least financial risk. They are also having control over business position which is greater than management & industry risk by lesser than financial risk.

“Analysis of Credit Risk & Back End Operations in banks” 37

Composition of Average Risk of SME Management Risk 27%

Business Risk 25%

Financial Risk 19%

Business Risk Financial Risk Industry Risk Management Risk

Industry Risk 29%

Analysis: SMEs are also having maximum industry risk because industry in uncertain, on one has control over it. After industry, SMEs are having maximum business risk because they are having competition from both small enterprises & large enterprises. Then comes to management risk, their percentage is also high. As they are small enterprises, they don’t have effectively coordinated management. They are also having less financial risk.

“Analysis of Credit Risk & Back End Operations in banks” 38

Composition of Average Risk of Contrator Management Risk 27%

Financial Risk 23%

Management Risk Business Risk Industry Risk Financial Risk

Industry Risk 26%

Business Risk 24%

Analysis : As Traders, Contractor is also having maximum management risk & least financial Risk i.e. 27% & 23%. We can say they are having maximum control on their financial position. But their industry risk in low as compared to management risk i.e. 26%. Their business risk is 24%, which means that they are having control on business risk but less than financial risk & more than industry & management risk.

Table 2: Number of Forms of loan taken by borrower Forms of loans

Type of borrower Trader

Cash Credit

13

DBC/BDD

1

Contractor

SME 12

1

3

Forward purchase contract

3

Forward sale contract

2

Import/inland LC cum BG Bills of exchange

5

1

3 1

“Analysis of Credit Risk & Back End Operations in banks” 39

CC-PCLFDBN/FDBP/FDBD

1

4

Corp mobile

1

1

Overdraft

4

6

Bank Guarantee

4

2

2

Term loan

1

1

7

Total

30

11

38

No of forms of loan taken by borrower 40 35 30 25 Forms of Loans 20 15 10 5 0

Cash Credit DBC/BDD Forward purchase Forward sale Import/inland Lccum BG Bills of exchange CC-PCLFDBN/FDBP/FDBD Corp Mobile

Trader Contractor

SME

Overdraft

Type of Borrower

Bank Guarantee Term Loan

Analysis:

TOTAL

According to this table, we can analyse that most of the traders & SMEs prefer to take Cash credit Limit because under this they can draw upto the prescribed limit & repayment can be made whenever interest is also determined on the basis of running balance.

However in SMEs, borrowers also prefer to take term loan to finance their fixed Asset. In Contractor, most of them prefer to take overdraft facility because by this they want to exceed the limit of their loan. Traders also prefer to take Import LC so they can easily import something.

Table 3: Total Amount of loans granted by banks to borrowers as per facility taken Forms of loans

Type of borrower Trader

Contractor

SME

“Analysis of Credit Risk & Back End Operations in banks” 40

Cash Credit

9.34

DBC/BDD

0.1

61.62 0.05

1.55

Forward purchase contract

45.4

Forward sale contract

45

Import/inland LC cum BG

10.71

0.5

Bills of exchange

31.51 1.3

CC-PCLFDBN/FDBP/FDBD

0.77

22.65

Corp mobile

0.06

0.06

Overdraft

0.9

4.6

Bank Guarantee

1.12

1.19

1.03

Term loan

0.09

0.08

0.5

Total

23.09

6.42

215.12 (in crores)

Total Amount of Loan granted by banks to Borrower(in crore) 250

Cash Credit DBC/BDD Forward purchase

200 Forward sale

150 100

Import/inland Lccum BG

50 Bills of exchange

0 Contractor

SME

Trader Type of Borrower

Analysis:

CC-PCLFDBN/FDBP/FDBD Corp Mobile Overdraft

We cam analysis that while the number of borrowers on trading category who took import/inland LC cum BG are lesser than cash credit, the amount are more than cash credit. So we can say that while the people are not frequently opt for import inland LC cum BG, but if they opt, they opt for larger amount. In SMEs, 61.62 crores are land to 12 borrowers while only 45.4 crores of forward purchase contract, 22.65 of CC-PCL-FDBN/FDBD/FDBP is lended & term loan accounts for only 50 lakhs. Because as SMEs are not dealing in very high scale they don’t have big

“Analysis of Credit Risk & Back End Operations in banks” 41

amount of Fixed Assets like Plant & machinery, Furniture & Fixture So they largely go for cash credit to perform their day to day operation smoothly. In Contractors, the overdraft facility is taken big quantity i.e 4.6 crores as compared to others. Table 4 : Average interest rate charge from borrower as per facility taken Forms of loans

Type of borrower Trade

Cash credit

12.35 %

DBC/BDD

14 %

Contractor

SME

12.90 % 13.80%

Forward purchase contract Forward Sale Contract Import/ inland LC cum BG

14.25%

13.75%

Bills of exchange CC-PCL-

13.75%

FDBN/FDBP/FDBD

11.68%

Corp mobile

12%

Overdraft

13.25%

12% 13.58%

Bank Guarantee Term loan

14.50%

Average Interest rate

13.22%

1 13.04% 13.86%

“Analysis of Credit Risk & Back End Operations in banks” 42

3.

12.99%

Average interest rate charged 16 14 12 10 figures in %age 8 6 4 2 0

Cash Credit DBC/BDD Forward purchase Forward sale

SME Trader

Contractor

Import/inland Lccum BG Bills of exchange

Type of borrowers

CC-PCLFDBN/FDBP/FDB D Corp Mobile

Analysis :

Overdraft Average interest rate of contractor is higher as compared to Trader & SMEs. In

Contractor higher average interest rate is 14.2% which is charged for import/inland I.C Bank Guarantee

cum BG & lowest rate is 13.58% which is charged for overdraft facility.

Term Loan

Table 5 : Total Risk & Amount disbursed Total Risk CB 1 CB 2 CB 3 CB 4 CB 5 CB 6 CB 7 CB 8

Creditability Status Marks Secured Above 90 89 to 90 87 to 88 85 to 86 83 to 84 80 to 82 60 to 79 Below 60

Average Interest Rate

Type of Borrower Trader

Contractor

SME

3.77 17.61 2.61

2.34 3 1.08

201.19 11.76 1.99

“Analysis of Credit Risk & Back End Operations in banks” 43

Analysis : Here we can say that maximum borrower range between of CB 4 to CB 6 i.e. the borrower scord marks between 82 & 85. Bank do not grant loan to a person scoring below 60. We can see that maximum amount of loan. I.e. 201.19 crore aregranted to SMEs at CB 4 Risk while the minimum amount of loan is granted at CB risk & minumum in CB 6. Table 6 : Growth in revenue & forms of loan (Contractor)

Borrower

% Growth

Forms of loan

A

50.59 %

Overdraft

B

29.01 %

Term Loan, Demand Loan & overdraft

C

32.33%

Overdraft

D

30.62%

Overdraft

E

25%

Overdraft

F

10.27%

Overdraft

Analysis : Here we can say that as revenue of all borrowers is increasing, they are in a good position to repay the loan. We can say that Borrower A has very strong position as compared to all. While borrower F is at lover position.

Table 8: Facility of Loan & its Purpose.

“Analysis of Credit Risk & Back End Operations in banks” 44

Facility Trader Cash Credit

Purpose Contractor

To Meet WC finance, Receivables Finance

BDD/BDC Receivables Finance Forward Purchase Contract Forward Sale Contract

Receivables Finance

Import/Inland For Import of Timber LC , Cum BG Sewing Machine & for importing defense related Communication System Bills of exchange CC-PCLFDBN/FDBP/ FDBN Corp Mob To Purchase brand new Toyota Car Overdraft WC Needs To Meet WC Finance & Temporary cash Mismatch Bank To issue BGs in To issue BGs in Guarantee favour of central favour of govt. excise, for issue of agencies in lieu of BG in lieu of EMD to security deposit, for issue performance issue of performance guarantee/EMD financial guarantee Term Loan Purchasing Office Finance Project of Equipment setting up to Gymnasium

“Analysis of Credit Risk & Back End Operations in banks” 45

SME To Meet WC, Receivables & inventory Finance Receivables Finance To Mitigate Exchange Risk Involved on Export To Mitigate Exchange Risk involved on Import For purchase of import of Cable, for procurement of RM

Receivables Finance Pre & Post Shipment finance To Purchase brand new safari car

EMD

For purchase of 2 injection moulding machine & accessories Including installation & commissioning, for import of 1 multicolor label printing machine, for purchase of machineries, for part

financing the cost of construction of factory Building, to part finance machine purchased to be purchased by the firm having the total cost of Rs. 11.81 lakhs. Analysis:

Both Trader & SMEs opt for Cash credit for same purpose i.e. for working capital & receivable finance. SMEs also opt for inventory finance. Contractors did not opt for Cash credit. All three types of borrowers took DBC/BDD for receivables finance. Only SMEs opt for forward purchase & sale contract. Import/inland LC cum BG is taken by both Trader & SMEs. Bills of exchange & CC-PCL-FDBN/FBBP/FDBD are taken only by SMEs. Crop Mob is taken by Trader & SMEs for purchase of new car only. No overdraft facility is taken by SMEs; it is taken by Trader & contractor for Working Capital Needs. Bank Guarantee is taken by all three borrowers. Term Loan is also taken by all three borrowers, but it is taken by SME in large quantity.

CHAPTER-5 CONCLUSION

“Analysis of Credit Risk & Back End Operations in banks” 46

Traders Traders are the one involved in selling and purchasing of goods and services. For this, they need cash; so that they can purchase goods otherwise their business will collapse. So they take loan to continue their business effectively & efficiently.

Traders normally do not want long term finance because they are into purchasing & selling, they don’t want fixed Asset like Plant & Machinery, Furniture & fixture, Land & building etc. The whole purpose is to act as a mediator between manufacturer & ultimate consumer. For this they need short term finance to meet their working capital needs & to run their business efficiently. Traders generally take three types of loan-

1. Cash Credit 2. Inland/Import LC 3. Overdraft 4. BG

1. Cash Credit Traders need cash credit to meet their Working Capital needs & Receivable needs.

2. Inland/Import LC Sometimes the exporter or other party are not very well personally aware about the Trader. In such cases the exporters bear great risk if they draw bills on the importers, after dispatching the goods as per their order, because if the importer default in making the payment, the exporter will suffer heavy loses. To avoid such risk, the exporter ask the importers to arrange a letter of credit from importer’s bank in favour of the exporter, informing him that the issuing bank undertakes to accept the bills drawn. So Traders ask for this facility.

3. Bank Guarantee

“Analysis of Credit Risk & Back End Operations in banks” 47

Trader want cash to purchase goods or services. If Trader is new in the market, manufacturers will not agree to lend him the goods on credit. They ask either for cash or the manufacturer, that bank will make payment, if traders fail to pay.

4. Overdraft If Trader is having Current Account with bank, they can also asked for overdraft facility instead of taking new loan. In this bank exceeds the limit of the account & borrower can withdraw unto that limit.

Contractors Contractors are the one who works on contract basis. Their contract period can be of 1 month, 2 month, 1 year, 5 year or more depend upon the need of the part giving contract. They want long term finance once in their long course of business. They only want short term finance. For this takea) Overdraft b) Bank Guarantee

SME SME stands for small & medium enterprises. A small enterprise is an enterprise where the investment in plant & machinery in more than Rs. 25 Lakhs but less than Rs. 5 crores. A medium Enterprise is an enterprise where investment in plant & machinery is more than 5 crore but less than Rs. 10 crore. SME is one of the priorities for the bank. Banks deal differently with SMEs. They even charged lower rate of interest from SMEs.

SMEs from almost 95% of all industrial units in the country. They need loan for both long & short term purposes.

“Analysis of Credit Risk & Back End Operations in banks” 48

a) Long Term Finance SMEs needs long term finance to establish their business. For this they take Term Loan.

SMEs need term loan for the purpose of acquisition of capital assets, such as purchase of land, construction of building, purchase of machinery, modernzation, renovation and rationalization of plant, furniture & fixtures. This loan will be repaid by the future earning of the firm.

b) Short Term Finance Apart from loan term finance, SMEs also need funds for short term purpose to continue their business effectively & efficiently. For this they mainly take Cash Credit. They want Cash credit to meet their working Capital finance, inventory finance & Receivable Finance.

Apart from Cash Credit, SMEs also takei)

CC-PCL-FDBN/FDBP/FDBD

ii)

DBC/BDD

iii)

Forward Purchase Contract

iv)

Forward Sale Contract

v)

Import/Inland LC

vi)

Bank Guarantee

e) Any amount to be received remains overdue for of more than 30 days in respect of other accounts.

Where any one or more of the stipulated irregularities persist for 90 days then the 91st day is to be considered as the date of NPA.

PART-II “Analysis of Credit Risk & Back End Operations in banks” 49

BACK-END OPERATION

1.1.

PAYMENT SYSTEM : Cheque truncation System (CTS)

Key point : • Payment systems need to become more efficient and Cheque truncation is a step in this direction. • Cheque truncation is the next logical step in Payments system after MICR, ECS, EFT & RTGS. This would put India on the global map.

• Reasons for Cheque truncation o Banking becoming more complex & transaction intensive o Growing share of retail banking • Cheque truncation will reduce costs for the country as a whole and also reduce liquidity risks • Amendments have been made to the IT Act, Negotiable instrument Act and other legislations to enable implementation of Cheque truncation • Customers will be the biggest beneficiaries of cheque truncation because of reduction in time for clearing • Bank Floats would disappear. • Data and information collected through the Cheque Truncation system will be used for reducing frauds.

“Analysis of Credit Risk & Back End Operations in banks” 50

Image based cheque clearing system or Cheque Truncation System (CTS) is a project undertaken by central banks of many countries such as India (Reserve Bank of India-RBI), UAE (Central bank), Saudi Arabia (Saudi Arabia Monitoring Agency-SAMA) ect. For faster clearing of cheques. CTS promises to bring multiple benefits to customers by substantially reducing the time taken to clear the cheques as well as to the banks by enabling them to offer better customer services and increasing operational efficiency by cutting down on overheads in physical clearing. In addition, CTS also offers better reconciliation and fraud prevention CTS uses cheque image, instead of the physical cheque itself, for clearing of the cheque The cheque image is truncated at the presenting bank. Subsequently, the cheque image moves through various steps in the cheque-clearing cycle and transactions are settled on the basis of images and electronic data. The solution suite consists of following components. Software Component Description

“Analysis of Credit Risk & Back End Operations in banks” 51

Cheque Flow

For Handling Head Office/high volume Client/Server-based multiBranches Out ward and inward Clearing User system, with rightsbased access management, built on Newgen’s BPM Platform. Suited for large volume branches as well as central branch Cheque Flow Lite For handling branch Outward and Workstation-based system Inward processing. suited for low-volume branches Cheque Exchange For Image Sorting and settlement Client/Server-Based multiat the Central bank user system. This is a rulebased sorting and settlement switch, built on Newgen’s BPM platform. Omni Transport Upload/Download inter faces for the The transmission is Branches and head office. This is performed on a secure Required when the branches want network over SSL, with Communicate with the head office on a industry-standard Secure network. encryption. OmniDocs Cheque archival and retrieval system Client/Server-based multi For storage of images and data at a user system.Comes with out central location, with capability to of-box integration with deploy remote image servers at multiple Cheque Flow and locations for faste image access. Cheque Exchange. Records Available as an add-on component to Management System OmniDocs for managing complete lifecycle of physical and electronic documents as per the Records Management policies laid down by the organization and those required by law. The solution suite has been developed on the strong backbone of Newgen Imaging and workflow solutions i.e.

• OmniFlow- A versatile, rule-based workflow engine • OmniDocs-A strong and robust document management system • Batch Scan-A batch mode scanning application with MICR data display and Image quality analysis • Imaging Libraries- For image-quality analysis and verify

“Analysis of Credit Risk & Back End Operations in banks” 52

2.1. C.L.PU : Central Loan Processing Unit It Consists of :  Mortgages  Loans  Personal

1.1 MORTGAGES : MORTGAGES IS CLASIFIED AS UNDER :  Normal home loan  Home saver  Loan against property Residential Commercial Fixed V/s Variable Mortgage product offers two interest rate options to the customer-Fixed and Variable. Fixed Interest Rate Loans implies that the interest rate advised to the customer at the time of initial loan draw down will not change for the entire tenor of the loan. Variable interest Rate loans implies that the interest rate is variable and subject to change during the tenor of the loan. For variable interest rate loans, the interest rates will be reviewed and changed

once

every 6 months based on the interest rates advised by Finance each month. Customer, however, has the option to change from a Fixed Interest rate to variable interest and vice versa during the tenor of the loan. Processing Fees In Mortgage product, the loan processing fees is collected in two stages. Loan Processing Fee at the time of sanction or administrative fee is collected at the time of sourcing the mortgage application from the customer for an in-principal sanction of the loan. This fee is normally 0.5% of the total processing fee payable by the customer and is nonrefundable.

“Analysis of Credit Risk & Back End Operations in banks” 53

Loan Processing Fee at the time of disbursement is collected at the time of the full./initial disbursement. This fee is to the extent of the remaining 1.5% of the total processing fee payable by the customer.

Disbursement Types : Essentially, mortgage disbursements are of two types- Partial Disbursement an full Disbursement. They are further broken down into five types as detailed in the table given below : Disbursement Sub-Types of Types Disbursement Partial

Loan Brief Description

Initial Disbursement (Interest The First disbursement which is Only Loans) released on booking of the loan Applicable to loans where property is incomplete and construction renovation is under progress . Subsequent Disbursement Subsequent disbursal of loan (for (Interest Only Loans) the above) as per the progress construction/renovation and/or as per a disbursement schedule. Final Disbursement (EMI Loan)

Disbursement Sub-Types of Types Disbursement Full

The disbursement of remaining loan on completion of construction renovation of the property .

Loan Brief Description

Up-front/one Time The entire loan approved is Disbursement (EMI Loan) disbursed for property which complete, purchase of land, Balance take-overs from ot financial institution/Banks. EMI commences immediately. Mixed Disbursement (Interest • Loans which include purchase of Only for the construction loan property and construction EMI loan for the property ) renovation/extension thereon. Such loans are split into Property Loan and Construction/Renovation/Extens Loan.

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MORTGAGE OPERATING MODEL The operating model of mortgage product in SCB is aligned to a centralized service delivery model in line with other asset products of the Bank. The mortgage loans will be sourced by the local sales team. The Unit is lead by RSM (Regional sales manager) with area sales managers under him/her. The sales model for this is DSA (Direct selling agents), OBST (Out Bound sales Team), DST (Direct sales Team). Customer is explained the broad features of the product. The following information must be gathered from the customer : -

Name and contact phone of the customer

-

Whether customer is NR or resident

-

Customer’s Need-self construction/ Plot purchase/Resale/New flat

DSE visits the customer or corresponds with the customer by e-mail (if applicant is a Non Resident). The product features are explained in detail and customer needs are under stood. Application forms and product brochure are given. Thereafter complete customer file is collected and logged in with CAU team . On receipt of files from Sales, CAU performs the following checks :  Checks Administrative Fee cheque as per the pricing approval.  Checks whether the Property has been identified.  Checks type of loan required- self-construction/resale/under-construction etc.  All Document provided are as per PDD and complete in all respect.  All document copies are attested by the DSE or by Bank Officer.  Checks Applicant profiles (not in the Negative List or Caution List etc.)  Checks Employer profile (non MNC profile; family business etc.)  Confirms that the Builder and Project for the property identified is Approved from the list of approved builder/projects.  Checks whether the applicant is a Non resident or a Resident (If NR, whether GpoA contact details is given)  Debt Servicing Ratio (DSR) as per PPG.

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 Loan to Value Ratio (LTV) as per PPG.  As given in the Application From if property is identified/unidentified.  As given in the Builder Exposure

spreadsheet if the property is identified and

approved.  Checks for external Loan obligations and cheque bounces in the statement. Post the checks performed, the file is thereafter sent across to Area Operations for Disbursal Activities Done at Area Operations On receipt of files from CAU service delivery proceeds with the disbursement of the case, subject to the following checks. Disbursement Team  Authorization of Credit on the file.  All documents are as per the requirement in the file.  Check for the clearance of the LPC cheque and availability of the customer funds submitted by the customer to the CAU at the time of Sanction as well as disbursal of the loan.  Disbursement sheet consists of the details of the loan along with the payee details in whose favour the pay order is to be issued.  Safe Keeping Record (SKR) is properly filled and all the documents are as per the SKR.  Loan agreement is properly filled in and duly signed by the customer.  Loan approved as per Credit authority delegation.  Repayment mode of the Loan should be clearly annotated on the Disbursement Sheet Further, the safe custody takes custody of the customers title documents and does the following activities:

Safe Custody Team -

Lodges all the documents in a lodgement sheet and stores the customer documents in a water proof jacket at a fire proof locations-Sends a confirmation letter to the

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customer confirming the receipt of the property documents of the customer.- On receipt of the Welcome kit from CLPU, sending across the same to the customer subject to credit approval- Maintaining the customer documents and storing all the subsequent property documents in the same customer jackets. RISK

Control

Here can be possibility of excess A Maker checker concept is in place, with every disbursements due clerical errors file being duly checked and approved by the Manager, before disbursement. Case wherein LPC fund not available, LPC fund availability is checked prior to login getting processed . of the files at the Disbursement Team, Area Operations. Correct Lodgment of document can A maker checker concept is again in place, lead to stoner issues. wherein any lodgment done for the property documents is checked by both the custodians independently. Sk of the title documents The title documents are stored in water proof gettingdamaged with the usage if jacket separately for each customer, and time. thereafter lodged in a fire proof cabinet

2.2.What is Operational Risk ? “ The risk of direct or indirect loss resulting from inadequate or failed internal processes, and systems or from external events”

3.1 INTERNAL SERVICES List of Activities handled by Internal Services :           

Output control ATM Reconciliation (Moved to Chennai) and Site Visit Legal Cases Customer disputes Enquiries from Regulatory bodies. Deceased Case Vetting Internal Safe Custody CBOS (Cheque book Ordering System) Combipack and Dining Card Archival and Retrievals of Vouchers PAN data Updation Debit card PIN dispatch and returning

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      

4.1

Command Queries Generation of Interest TDS Generation of Duplicate Statement Signature Capturing for C & IB and Priority Banking. KCS / KCSA Checking Statement dispatch related work TC’s Reconciliation

Chapter :

Operational Risk

4.1.2.What cause Operational Risk. • Processes • People • Systems • Legal Systems • External Events Process Risk arises because : • Bank’s procedures are ignored. • Unclear policies and procedures leading to multiple interpretations. • Lack of internal checks leading to errors and fraud going unnoticed. • Control lapses not corrected • Unauthorized transactions approved without delegated authority • Physical assets not safeguarded • Omissions, errors and fraudulent activities not detected in a timely manner. • Conflict of interests is not monitored • Failure to inform change in regulations • Delays (notifying limits/treasury transactions)

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Internal People Risk • Unintentional Errors • Judgment can be affected by o Incompetence (cannot do) o Carelessness (can do but forgot) o Ignorance (did not know the need) o Indifference/Poor motivation (can do but don’t want to) • Transactions conducted by individuals, acting beyond their capacity. • Lack of clarity of role • Inadequate staff-leads to stress and oversight • Inadequate segregation of duties External People Risk • Customer also pose risks to the Bank o “Know Your Customer” o Be alert and vigilant • How do they begin o Opening a fraudulent account o Making a fraudulent enquiry o Intercepting/diverting/suppressing mail o Submitting a forged authority System Risks :• Unauthorized manipulation of data • Questionable data Integrity • Poor IT Security (sharing of passwords/not logging off)

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• System freezes when transactions reach peak volumes • System not available for processing transactions live resulting in backlogs . • Inadequate system functionality/Programming bugs. • Theft/Virus/Power Outage. • Leased line outage. • Insufficient contingency planning Legal Risk :Legal Risk is the risk of loss from a contract that cannot be legally enforced. It arises because :• Uncertainty of the laws and regulations • Legal actions Errors/inadequacies in documentation

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REFERENCES : 1. William B. English & Willian R. Nelson (1998), Research paper on “Bank Risk Rating of Business Loan.” 2. Jesper Tor Jacobson & Kasper Roszbach Linde (2004), Research paper on “Credit risk versus capital

requirements under Basel II: are SME loans and retal credit really

different ?” 3. Barry Eichengreen and Ashoka Mody, Research paper “Lending booms, reserves and the sustainability of short-term debt: inferences from the pricing of syndicated bank loans, available online on 28 august 2000. 4. Marwan Elkhoury (2008), discussion paper “Credit Rating Agencies And Their Potential impact on Developing Countries.” United nation conference. 5. Lyn C. Thomas (2000), article “Asurvey of credit and behavioral scoring: forecasting financial risk of lending to consumers” 6. Richard Cantor and Frank Packer (1997), journl on “Differences of opinion and selection bias in the credit rating industry” 7. Suk Hun Lee (2002), journal of development economics “ Are the credit ratings assigned by bankers based on the willingness of LDC borrowers to repay ?” 8. Richard Cantor and Frank Packer (1996), economic policy review “Determinantsand impact of Sovereign Credit Ratings” 9. Michael B. Gordy (1998), research paper “A Comparative Anatomy Models” 10. Press release “CRISIL assigns first Bank Loan Raings under Basel II”

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of Credit Risk

11. Linda Allen & Antnoy Saunders, Research paper “A Survey of Cyclical Efects in credit Risk Measurement Models” 12. Mark Carey (1998), “Credit Risk in Private Debt Protfolios” 13. Pamela Nickell, Willian Perraudin and Simone Varotto, “Ratings versus equity-based credit risk modeling: an empirical analysis”. 14. Arnoud

W.A. Boot and Todd T Mibourn (2002), paper “Credit Ratings as

Coordination Mechanisms” 15. Article (Feb, 2008), “Demand for SMEs credit rating on the rise. “ 16. Hrishikes Bhattacharya, (1998), Banking Strategy, Credit Appraisal & Lending Decision. 17. P.L. Varshney, (2008), Banking Law & Practice. (sultan chand publication) 18. Khan & Jain (2007) “Financial Management” 19. N.S. Toor (2008). :Handbook on banking information. “ 20. 22. 23. 24.
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QUESTIONNAIRE

Name of the borrower : Age : Sex : Address : Name of the Organization : Type of Organization : Year of Establishment : Q1. How much amount of loan you required ? Q2. Your presenr area of activities? Q3. You wants short term Or long term loan? Q4. What is the purpose of taking loan? Q5. What type of facility you prefer for taking short term loan?(if taken) a) Cash Credit

b) DBC/BDD

d) Bills of Exchange e) CC-PCL

c) Forward Contract f) Bank Guarantee

g) Import/Inland L/C h) Overdraft Q6. At what rate of interest, you want to take a loan? Q7. What rate of interest bank is charging from you? Q8. Do you think , bank is charging the correct rate of interst?

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a) Yes

b) No

Q9. What is ROI? Q10. What is your rating , according to Risk ? a) CB 1

b) CB 2

c)CB 3

d) CB 4

e) CB 5

f) CB 6

g) CB 7

h) CB 8

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