Indian Overseas Bank Sip Report: Loans And Advances Management

A REPORT ON ADVANCES MANAGEMENT

BY

Soniya Sinha ICFAI BUSINESS SCHOOL

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A REPORT ON ADVANCES MANAGEMENT

BY

Soniya Sinha INDIAN OVERSEAS BANK

Date of Submission: 17th MAY, 2009

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AUTHORISATION The report is submitted as partial fulfillment of the Masters in Business Administration (MBA) Program of ICFAI Business School, Kolkata.

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ACKNOWLEDGEMENT I would like to thank Indian Overseas Bank for providing me an opportunity to work with them and giving necessary guidance in completing the project to the best of my abilities. I am obliged to Mr. Pal Basnotra, Chief Manager, Indian Overseas Bank, New Alipore, Kolkata, who provided me the essential information and extended his best support. I would like to extend special gratitude to Mr. Rakesh Kumar Niraj, Assistant Manager, Loans and Advances Department, Indian Overseas Bank, New Alipore, Kolkata, for being my company guide and providing me an insight into various issues pertaining to cases mentioned in the report. This is his sincere support and consistent guidance that led to the completion of the project. I am highly indebted to Prof. Dipanker Dey, for his mentorship and valuable suggestions that gave an entirely new dimension to the project under consideration. His guidance gave immense confidence and encouragement that helped me to put in my best. Lastly, I would like to thank my colleague, Varun Vij for helping me with the project work.

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LIST OF ILLUSTRATIONS The illustrations are enlisted below along with their area of concern to bring forth an elucidate understanding of the topics studied during the training period.

i)

XYZ INFOTECH: Financial Analysis of Lending

ii)

LIBERTY MARINE SYNDICATE LTD.: Financial Analysis, Packing Credit

iii)

PRATIBHA CONSTRUCTIONS: Non Performing Asset, Legal Procedure

iv)

Mr. NEAL RAJPUT: Education Loan, Non Performing Asset

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TABLE OF CONTENTS Authorization …………………………………………………………………………...

i

Acknowledgement …………………………………………………………………......

ii

List of Illustrations …………………………………………………………………….

iii

1. Abstract ……………………………………………………………...................

8

2. Introduction ………………………………………………………………….....

10

2.1

Indian Banking History

2.2

Indian Overseas Bank

2.3

Scope of Study

2.4

Objective

2.5

Methodology

2.6

Outline of work

3. Main Text ………………………………………………………………………. 20 3.1

General Principles of Loans and Advances

3.2

Principles of Lending

3.3

BASEL II ACCORD: A Measure of Risk Adequacy

3.4

Lending and….

3.5

Types of Advances

3.6

What does a Transaction look like?

3.7

Financial Analysis of Lending

3.8

Method of Credit Rating

3.9

Method of Assigning Credit Limit and Drawing Power

3.10 Securities Used Against Lending 3.11 Calculation of EMI 3.12 Documentation 4. Case Analysis (XYZ Infotech) …………………………………………………. . 43

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5. Export Credit ……………………………………………………………………. 60 6. Case Study (Liberty Marine Syndicate Ltd.) …………………………………… 61 7. Non Performing Assets …………………………………………………………. 70 8. Case Analysis …………………………………………………………………… 72 (i)

Miscellaneous Cash Credit

(ii)

Educational Loan

9. Some Problems related to Pre & Post Advances ……………………………….. 81 10. Conclusion ……………………………………………………………………… 82 11. Attachments …………………………………………………………………...... 83 12. References ………………………………………………………………………. 84 13. Glossary …………………………………………………………………………. 85

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ABSTRACT Financial sector reform in India has progressed rapidly on aspects like interest rate deregulation, reduction in reserve requirements, prudential norms and supervision of risk. Though the progress on the structural institutional aspects have been comparatively slower, major changes required to take the Loans and Advances problem has gained importance. Chennai based Indian Overseas Bank is one of the nationalized bank in India, that has a substantive history since 1937. The bank not only deals in retail banking providing utility services to its customers but has also expanded its area of operation in multidimensional services like merchant banking, agri business consultancy and e-banking. It recently registered a core profit of Rs. 1325 crores in the financial year March‟08-March‟09. The report deals with a clear understanding of the lending procedures followed by Indian Overseas Bank. It not only explains the basic concepts and the terminologies used in the banking sector but also gives an insight into the legal aspects and the paper work required for final sanction of a loan proposal. Different types of advances, method of assigning credit limit and drawing power to individuals and business units has been a part of the study during the internship period. The credit rating methods applied by the banks to rate the credibility of the prospective clients, securities accepted against lending and calculation of Equated Monthly Installments have also been discussed to give an overview of the lending concept of the bank. The most important part of the study includes case analysis of XYZ Infotech. This explains the significance of financial ratios and credit rating of the client in a precise manner. The forecasting of pecuniary status of the prospective borrower is shown by the study of balance sheets sand other financial details furnished by the borrower and the bank. Later, the report includes the final sanction of the loans, their regular monitoring and conversion of accounts into standard or bad debts. The treatment of those Non Performing Assets and the recovery of the same along with the legal procedure followed by the bank are discussed in great detail.

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A compendious note on NPAs brings about a clear understanding of the issues associated with the recovery procedure of such assets and final treatment. The same has been explained lucidly with the help of two cases that were witnessed during the Summer Internship Program. Problems observed while rendering financial assistance to prospective borrowers are also mentioned in brief. Finally, conclusion and recommendation as per the analysis during the training period winds up the report.

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INTRODUCTION 2.1

INDIAN BANKING INDUSTRY

Banks are the financial backbone of any country‟s economy. Without a sound banking system a country cannot have a healthy economy. A bank is a financial institution which deals with money and credit. It accepts deposits from individuals, firms and companies at a lower rate of interest and gives it at a higher rate of interest to those who need them. The difference between the terms at which it borrows and which it lends forms the source of profit, thus bank being a profit earning institute. For the past three decades India‟s banking system has several outstanding achievements to its credit. The most striking is its extensive reach to customers. It is no longer confined to only metropolitans or cosmopolitans in India. In fact the Indian banking system has reached even to the remote corners of the country. This is one of the main reasons for the India‟s growth process. 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 are: PHASE 1: early phase from 1786 to 1969 of Indian banks. PHASE 2: nationalization of Indian banks and up to 1991 prior to Indian banking sector reforms. PHASE 3: new phase of Indian banking system with the advent of Indian banking and financial reforms after 1991. The Indian banking can be broadly categorized into nationalized (government owned), private banks and specialized banking institutions. The RBI acts as a centralized body monitoring any discrepancies and shortcomings of the system. It is the foremost monitoring body in the Indian financial sector. Since the nationalization of banks in 1969, the public sector banks have realized the need to become highly customer centric that forced the slow moving public sector banks to adopt a fast track approach.

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The Indian Banking market is growing at an astonishing rate, with assets expected to reach US$ 1 trillion by 2010. An expanding economy, middle class and technological innovations are all contributing to this growth. The country‟s middle class accounts for over 330 million people. In correlation with the growth of the economy, rising income levels, increased standard of living and affordability of banking products are promising factors of continued expansion.

GROWTH OF INDIAN BANKING ASSETS (US$ billion)

1000

2000

900

2001

800

2002

700

2003

600

2004

500

2005

400

2006

300

2008

200

2010 E

100 0

WORTH OF ASSETS

The unleashing of products and services through the net has galvanized players at all levels of the banking and financial institutions market grid to look new at their existing portfolio offering. The Indian banking system has finally worked up to the competitive dynamics of the „new‟ Indian market and is addressing relevant issues to take on the multifarious challenges nationalized banks have acquired a place of prominence. Banking in India is highly fragmented with 30 banking units contributing to almost 50% of the deposits and 60% of the advances. The nationalized banks (i.e. government owned banks) continue to dominate the Indian banking arena. They continue to be the major lenders in the

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economy due to their share size and penetrative networks which assures them high deposit mobilization. Industry estimates indicate that out of 274 commercial banks operating in India, 223 banks are in public sector and 51 are in private sector. The private sector bank grid also includes 24 foreign banks that have started their operations in India.

2.2 INDIAN OVERSEAS BANK Indian Overseas Bank (IOB) was founded on 10th February 1937 and had distinction of three branches at Chennai, Kasaikudi and Rangoon simultaneously commencing business on the inaugural day. The founder Chairman was M.Ct.Chidambaram Chettiyar. It was started with a vision to specialize in foreign exchange and overseas banking business in India. Before 1969, it had ventured into consumer credit, had begun with computerization and had 195 branches in India. In 1969, when it was nationalized, the bank had 208 branches and business mix of Rs 156 crores. IOB has gained AA rating by CRISIL for its primary issue and a rating of P1+ for its term deposits. IOB is currently one of the major banks based in Chennai, with 1845 domestic branches and 12 branches overseas. IOB also has an ISO certified in house information technology department, which has developed the software that most of its branches use to provide online banking to customers. IOB has a network of more than 500 ATMs all over India and IOB‟s international visa debit card is accepted at all the ATMs. IOB offers internet banking (E-see banking) and is one of the banks that the government of India has approved for online payment of taxes. IOB provides various banking services, including saving bank, current account, credit facilities and other services. IOB also provides non-residential Indian (NRI) services, personal banking, foreign exchange reserves (FOREX) collections services, agri-business consultancy, credit card and e-banking services. The bank is also engaged in merchant banking. IOB is the first public sector bank in the country to introduce mobile banking services using wireless application protocol (WAP). It was also the first public sector bank to introduce anywhere banking at its 129 branches in the four metros and is extending the connectivity to 100 other branches in Hyderabad, Bangalore, Ahmadabad and Ludhiana.

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In year 2000, it came out with a public issue of 11,12,00,000 shares of Rs 10 each for cash at par aggregating Rs 111.20 crores. It also raised Rs 125 crores through bonds issue in year 2001. It gained the rating of AA for the issue. Being ranked as the best public sector bank in India in 2007, it‟s key trade centers now include Singapore, Seoul, Hong Kong, Bangkok and Germany. The Balance Sheet of the bank (Attachment -I) distinctly indicates the increase in both the advances and deposits.

TOTAL ADVANCES AND DEPOSITS OF THE BANK 90000 80000

Rs. IN CRORES

70000 60000 50000 40000 30000 20000 10000 0

March' 05

March' 06

March' 07

March' 08

ADVANCES

26274

35759

47923

61748

DEPOSITS

44241

50529

68746

83204

In 2006, total business of the bank crossed Rs. 100,000 crores where as the total net profit exceeded the same figure in 2007. As of September 2008, there were 1424 branches under Core Banking Solution, 522 branches under Total Branch Automation and a number of branches linked under services like NEFT and RTGS. IOB has been upgraded to „BBB‟ (long term) rating by Standard and Poor‟s, third bank in India after SBI and ICICI. The bank has a very strong foundation with a high profit margin and a low risk. The efficiency in their management of funds is reflected in their past records where the balance sheets of last five

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year‟s show that the net Non Performing Assets has been decreasing. The rate of deposits is not as high as provided by the industry‟s giant State bank of India but by at the same time the loans sanctioned by the bank have proved to be secured and successful. This in turn has led to a further increase in total profit of the organization thereby fulfilling its prime objective of being a profit earning enterprise. The latest audited reports reveal that the bank registered a net profit of Rs. 1325 crores in the financial year that ended on March, 2009 with an increase of almost 21% in its total business.

2.3 SCOPE AND PURPOSE OF STUDY The purpose of preparation of this report is to focus on the Lending function of banks with specific reference to Indian Overseas Bank. The report states the following points: The study gives an insight into the procedure followed by the Bank as per the norms of the Reserve Bank of India and the Authority that governs the functioning of Indian Overseas Bank. It also explains certain terminologies commonly used in the banking industry. The report states the different types of advances that are financed by the bank and their classification as fund and non fund based advances. The financial analysis of lending i.e. the study of balance sheets and other financial accounts, to judge the credibility and repaying capacity of the prospective borrower is done in great detail. The same is illustrated with the help of a practical case analysis (XYZ Infotech) to build a better understanding of the importance and the procedure of such a financial analysis. It also helps us infer the risk involved in sanctioning of advances by imputing the bankruptcy chances of the proposed borrower in quantitative terms applying Multiple Discriminant Analysis. It also helps us understand the whole process of financial analysis involved in appraising a loan. This brings forth the method to assess the credit worthiness of the borrowers and estimate the net worth of the assets owned by him, which assists the bank to ascertain the amount

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that can be sanctioned to them. The extent to which the credit limit can be sanctioned and drawing power be enhanced are also mentioned. Other than this, the project deals with the securities that can be used against lending and the calculation of Equated monthly Installments (EMI). Moreover procedure of follow up, the repayment of loan in form of EMIs and credit monitoring lie under the realm of scope of the study. Further the documentation of the proposed advances and their final sanction forms another major area that is taken into consideration. Credit monitoring, identification of Non Performing Assets (NPA) and legal procedure adopted by the bank in recovery of those advances forms the most significant part of the study. The same is exhibited in various case studies that are included in the project to give a better view, comprising of an integral part of the report. The last topic discussed as per the schedule of the project involves an in depth study of the problems related to pre and post sanction of advances and their possible solutions. Certain conclusions and recommendations are made as per the analysis of the cases.

2.4 OBJECTIVE The objective of the proposed project is to understand the entire process involved in successful lending by the bank beginning from the financial analysis of lending of, identification of reliable potential customer, legal sanction to monitoring of those accounts and their final recovery procedure through scheduled EMI structure. This aims at analyzing the ways in which the bank manages its Non Performing Assets (NPA). It includes identification of the problems associated with pre and post advances and simultaneously finding out viable solutions and alternatives to address those issues. The project is likely to help organization understand the various issues related to the advances, giving it certain solutions to reduce the loses due to non recovery of loans and maintain a

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healthy trend line of decreasing net NPA thereby helping it to maintain a balance between its deposits and advances and an increase in its percentage yield.

2.5 METHODOLOGY AND SOURCES OF DATA The proposed methodology for fulfilling the objectives of the project is as follows: The study of guidelines laid by the Reserve Bank of India and the governing authorities of Indian Overseas Bank to be adhered to (pertaining to advances) as published in the journals issued by these authorities from time to time. The secondary data is deduced from the books of accounts maintained by the bank (without disclosure of any personal details of the borrower). The data from the official books as maintained by the bank, reference books, news letters published by financial institutions and websites have been utilized for the analytical study of advances made by bank. The methodology includes a detailed study of the data collected from the bank, pre and post requisites of lending, calculation of interest on loans and equated monthly installments and documentation of the same. The observation of advances sanctioned by the bank in the past few years that resulted successful lending constitutes the most substantial part of the project work. It also involves active participation in banking transactions and internal functioning of the Advances Department of the branch. An elaborate study of loans and advances granted by the branch and analysis of the same has been the most significant component of the project. Information mentioned in the cases are deduced from the books of accounts as maintained by the bank branch, the figures and facts given being realistic in nature. Finally, identification of the problems associated with advances by bank and the solution of the same with certain recommendations is to be provided after analyzing certain loans (stated as illustrations in the project) to help the advances department of the bank.

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2.6 LIMITATIONS OF THE STUDY The study of Advances Management pertaining to Indian Overseas Bank is subject to certain limitations that are identified as follows: As far as the illustrations and the case analysis included in the report are concerned, the scope of study is limited to Indian Overseas Bank, New Alipore Branch, Kolkata. The personal details related to the borrowers (cases under study that have also been incorporated in the report) have intentionally not been revealed as per the norms of the bank. Specific crucial financial details of the clients have also not been disclosed. The secondary data collected and taken into consideration in order to fulfill the objectives of the project includes published data from the journals, magazines and data available from the website of the bank and other companies for general public. It also includes the data gathered and observed during the daily functioning of the Advances Department of above mentioned bank (excluding the data marked as critical and confidential by the bank). The data used for analysis includes the facts and figures from March,2004-March,2009 and at the same time the latest guidelines as laid down by the Reserve Bank of India are strictly followed. The scope is limited to the types of advances funded by bank branch and not all types of advances. So Agricultural advances and advances against Shares and Unit Trust of India (UTI) do not fall in the ambit of the study, therefore they have been excluded. Further, the study serves the Advances Department of the bank branch to identify the issues related to advances, maintain a decreasing trend in the net value of the Non Performing Assets in future and minimize the formation of the same. All Summer Internship Program (SIP) regulations laid down by the bank have been duly complied with.

LITERATURE SURVEY

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2.6 OUTLINE OF THE WORK The project proposed deals in Advances Management of Indian Overseas Bank, New Alipore, Kolkata. The project is completed and discussed in detail as per the schedule stated in the project proposal. In the first phase, the project highlights the general concepts of loans and advances, which familiarizes us with the terms used in this context. It then covers principles and practices of lending as per the instructions laid down by the Reserve Bank of India and as received by the bank from its governing authority. The types of advances are classified as fund based and non fund based are described, giving an overview of the various categories of advances. This section describes the term deposits, demand loans, secured and unsecured loans including letter of credit and bank guarantee. Later, it explains the financial analysis of different types of advances considering both the business concerns and the advances to the individuals. The overdraft facility provided by the bank, cash credit and estimation of drawing power along with the way it is to be calculated is mentioned. The financial analysis of lending forms an integral section of the report where an attempt is made to explain the evaluation procedure of any proposal in hand. This analysis is distinctly illustrated with the help of a case study where the financials of a company (that had requested for the enhancement of its credit limit) are assessed to forecast its financial health and its capacity to repay to in near future. The credit rating method followed by the bank to ascertain the credit worthiness in case of both individuals and business enterprises is discussed. The different parameters of judging the same are mentioned along with the format used by the bank to rate any business concern and assess its financial position.

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As far as the short term credits are concerned the project incorporates the methods and concepts applied by the bank to find credit rating of the customer, assigning of the credit limits and calculation of drawing power. The credit worthiness of the potential customer and his repayment capacity is estimated. Calculation of Equated Monthly Installments (EMI) based on the amount of loan to be sanctioned and the time duration required for repayment, including the prevailing interest rates as per the norms of the RBI are expounded. The securities accepted against lending, the collateral that the customer offers the bank, modes of charging securities (lien, hypothecation, pledge, assignment, mortgage) and bank guarantee required for particular credits is also studied under the project. Credit documentation and sanction forms another major area of the study where all the documents pertaining to the advances are enlisted along with their legal significance and the final advance proposal is approved by the sanctioning authority. Categorization of advance accounts as Non Performance Assets, factors leading to such a consequence, its provision and treatment of such accounts are studied. The legal procedure of their recovery through SARFESI Act 2002 and ultimately their management has been included to give a more comprehensive idea of the subject matter.

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MAIN TEXT

3.1 GENERAL CONCEPTS OF LOANS AND ADVANCES BORROWER: A borrower being a party in the loan agreement that receives money and promises to repay it. He may bring a very attractive lending proposition. The banker needs to know about the character, capacity and capital of the prospect. The borrower may comprise of an individual, a firm, a company, an HUF or any other business concern. PURPOSE: The purpose for which a borrower seeks finance should not be anti social and anti national. The finance required should be proposed to be used for a good cause, the objective being legal in the eyes of law. BORROWER’S STAKE OR MARGIN: The term margin refers to that portion of the loan that needs to be contributed by the borrower. This is most likely to sustain commitment of the borrower throughout the life of the venture. The percentage of margin is fixed by considering certain factors like borrower‟s capacity to bring in capital, nature of business, level of risk, guidelines of RBI, etc. INTEREST: Interest income refers to the profit that any lending would generate. It is the return on the advances granted by the bank. The interest amount should be sufficient enough to cover the cost of lending i.e. it should cover the estimated risk involved and simultaneously generate enough revenue to fulfill banks prime objective of being profitable. SECURITY: The banker advances loan keeping certain security which may either be collateral in nature or in the form of personal guarantee. Each lending is backed by adequate security that creates a binding on the part of the borrower to repay. Security acts as an assurance, an alternative to recover the amount by liquidation but the bank‟s basic motto remains recovery of advances from the income of the borrower. The security must qualify the parameter of being

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marketable, ascertainable, transferrable and stable. This means that the security should be easy enough to sell without incurring much cost in selling. The assets must be easy to identify and must not result in much loss of value. It should be stable over a significant period of time and easily transferrable.

3.2 PRINCIPLES OF LENDING According to general principles of lending, all mortgage originators should act in "good faith and with fair dealings" in any transaction. A reliable customer forms the basis of a successful lending. The following principles act as the foundation of a judicious lending: Safety of funds ensures that the bank, although being a profit generating unit, continues to build and retain the trust of the public at large. Security accepted from the borrower as an alternative for recovery of advances in case of default must be of significant value. Purpose or the objective of advances should remain in favor of nation‟s security. It should not be anti- social or illegal. Profitability and yield on advances should be in line with the banks objective, so the advances made must be successful. Liquidity of advances made by the bank indicates its ability to meet its deposit liabilities, so the advances made should be adequately liquid. Integrity of borrower is very vital to consider the loan proposal envisaged by him for further sanction. Adequacy of bank finance is of prime importance for a borrower to accomplish his project so both under and over financing should be avoided by the bank. Timely availability of funds to the borrowers helps the bank grow in the current scenario. These principles strengthen the bank finance eventually leading to safe advances.

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3.3 BASEL II ACCORD: A MEASURE OF RISK

ADEQUACY Basel II, also called The New Accord (correct full name is the International Convergence of Capital Measurement and Capital Standards - A Revised Framework) is the second Basel Accord and represents recommendations by bank supervisors and central bankers from the 13 countries making up the Basel Committee on Banking Supervision (BCBS) to revise the international standards for measuring the adequacy of a bank's capital. It was created to promote greater consistency in the way banks and banking regulators approach risk management across national borders. Basel II is a type of recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision that was initially published in June 2004.The objective of Basel II 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 bank face. THE ACCORD IN OPERATION: Basel II uses a “three pillars” conceptMinimum Capital Requirements Supervisory review Market Discipline

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1st Pillar-Minimum Capital Requirements The first pillar provides improved risk sensitivity in the way that capital requirements are calculated for three major components of risk that a bank faces: credit risk, operational risk and market risk. Under the Basel II Norms, banks should maintain a minimum capital adequacy requirement of 8% of risk assets. For India, the Reserve Bank of India has mandated maintaining of 9% minimum capital adequacy requirement. This requirement is popularly called as Capital Adequacy Ratio (CAR) or Capital to Risk Weighted Assets Ratio (CRAR).

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2nd Pillar-Supervisory Review 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 name risk, liquidity risk and legal risk, which the accord combines under the title of residual risk. 3rd Pillar-Market Discipline and Disclosure 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 counterparties of the bank to price and deal appropriately.

3.4 LENDING AND ADVANCES Banking system in India has gone through enormous changes. In addition banks are constrained from optimally diversifying their activities, thereby increasing the opportunity to reduce operating risk faced by industry, but the primary activity remains lending. Lending is the provision of monetary resources by the banker where the other party reimburses in installments or any other form of deferred payment, thereby by generating a debt. Loans and advances portfolio being the most significant asset of the bank has direct impact on its profitability. Increase in competition and emergence of new types of risks in the banking sector has lead to efficient loans and advances management. In order to ensure a strong portfolio banks need to implement necessary policies aiming at strengthening of pre sanction appraisal and post sanction monitoring system. In order to cope up with the changing scenario, banks in India are strengthening their organizational setup through specialized departments to meet the credit requirements of the borrowers and continuous analysis of the potential credit growth.

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The ideal advance is one that is granted to a „reliable‟ customer for a legal purpose where he has enough experience for efficient utilization of the amount and repays the amount within a given time frame as per the agreement.

3.6 What is the loan sanction procedure?

• comes up with a loan proposal • collateral security • financial details

LENDER (BANK) • verifies the purpose of loan • assess the credibility of borrower

BORROWER

• verifies the proposal • either approves (final sanction) or rejects

REGIONAL OFFICE

Banks extend loan facilities in form of fund based and non fund based facilities. The banks provide fund based facility by way of term loans, demand loans, bill discounted, cash credit, overdraft, etc. whereas the non fund based facilities include letter s of credit and bank guarantee. Indian Overseas Bank offers a wide range of services in the loans and advances segment some of which are indexed here: i)

Personal loan

ii)

Educational loans

iii)

loans on bank term deposits

iv)

loans against National Saving Certificates (NSC)

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v)

loans against Insurance Policies

vi)

loans against Gold Jewels

vii)

loans against Collateral Security, stocks and debtors

viii)

loans against Shares

3.5 TYPES OF ADVANCES CLASSIFICATION OF ADVANCES

FUND BASED

TYPES OF ADVANCES

NON FUND BASED

• Term Loan • Cash credit • Bill discounted • Demand loans • Overdraft

• Letter of Credit • Letter of Guarantee

The "term" of the loan refers to the length of time you have to repay the debt. Debt financing can be either long-term or short-term. Long term loan financing is commonly used to purchase, improve, or expand fixed assets such as your plant, facilities, major equipment, and real estate. If you are acquiring an asset with the loan proceeds, you (and your lender) will ordinarily want to match the length of the loan with the

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useful life of the asset. Short term loan is often used to raise cash for cyclical inventory needs, accounts payable, and working capital. In the current lending climate, interest rates on long-term financing tend to be higher than on short-term borrowing, and long-term financing usually requires more substantial collateral as security against the extended duration of the lender's risk. SECURED AND UNSECURED DEBT: Debt financing can also be secured or unsecured. A secured loan is a promise to pay a debt, where the promise is "secured" by granting the creditor an interest in specific property (collateral) of the debtor. If the debtor defaults on the loan, the creditor can recoup the money by seizing and liquidating the specific property used for collateral on the debt. For startup small businesses, lenders will usually require that both long- and shortterm loans be secured with adequate collateral. Because the value of pledged collateral is critical to a secured lender, loan conditions and covenants, such as insurance coverage, are always required of a borrower. You can also expect a lender to minimize its risk by conservatively valuing your collateral and by loaning only a percentage of its appraised value. The maximum loan amount, compared to the value of the collateral, is known as the loan-to-value ratio. An unsecured loan is also a promise to pay a debt. Unlike a secured loan, the promise is not supported by granting the creditor an interest in any specific property. The lender is relying upon the creditworthiness and reputation of the borrower to repay the obligation. An example of an unsecured loan is a revolving consumer credit card. Sometimes, working capital lines of credit are also unsecured. If the borrower defaults on an unsecured loan, the creditor has no priority claim against any particular property of the borrower. The creditor can try to obtain just a money judgment against the borrower. Until a small business has an established credit history, it cannot usually get unsecured loans because of the business's risk. LETTER OF CREDIT: It is recognized that letters of credit are an important form of collateral that have been widely used for many years across the securities lending industry. They have

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near-cash characteristics in that their value does not fluctuate with market conditions and they can be cashed in when presented to the issuing bank. There exists a contract between two parties subsequent to which the bank guarantees to pay the agreed amount on behalf of his client on the accepted terms and condition. Letters of credit carry low risk of settlement failure and are operationally efficient in applying across multiple trades. They are generally used in international transactions, where two nations differing in legal systems find difficulty in knowing each party personally. Thus this device facilitates trade. BANK GUARANTEE: Bank guarantee is a guarantee from a lending institution ensuring that the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank will cover it. A bank guarantee enables the customer (debtor) to acquire goods, buy equipment, or draw down loans, and thereby expand business activity. A bank guarantee, like a line of credit, guarantees a sum of money to a beneficiary. Unlike a line of credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations under the contract. This can be used to essentially insure a buyer or seller from loss or damage due to nonperformance by the other party in a contract. A bank guarantee might be used when a buyer obtains goods from a seller, runs into cash flow difficulties and can't pay the seller. The bank guarantee would pay an agreed-upon sum to the seller. Similarly, if the supplier was unable to provide the goods, the bank would then pay the purchaser the agreed amount. Essentially, the bank guarantee acts as a safety measure for the supposing party in the transaction.

SPECIFIC TYPES OF BANK LOANS: In addition to consumer loans and mortgages, the most common types of loans given by banks to startup and emerging small businesses are: working capital lines of credit for the ongoing cash needs of the business credit cards: higher-interest, unsecured revolving credit short-term commercial loans for one to three years longer-term commercial loans: generally secured by real estate or other major assets equipment leasing for assets you don't want to buy outright

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letters of credit for businesses engaged in international trade

3.7 FINANCIAL ANALYSIS OF LENDING Financial analysis is the systematic examination and interpretation of financial data to evaluate the past performance of a business, its present conditions and its future prospects. It refers to an assessment of the viability, stability and profitability of a business, sub-business or a project. Essentially, financial analysis moves from a preliminary investigation of the client to an in depth examination of operating performance, as interpreted from historical and projected financial statements. With financial analysis, the advances manager assesses the company‟s financial performance to arrive at a conclusion about the future prospects of the loan repayment. FINANCIAL ANALYSIS ASSESES THE FIRM’S: 1. Profitability - its ability to earn income and sustain growth in both short-term and long-term. A company's degree of profitability is usually based on the income statement, which reports on the company's results of operations; 2. Solvency - its ability to pay its obligation to creditors and other third parties in the long-term; 3. Liquidity - its ability to maintain positive cash flow, while satisfying immediate obligations; 4. Stability- the firm's ability to remain in business in the long run, without having to sustain significant losses in the conduct of its business. Assessing a company's stability requires the use of income statement and balance sheet, as well as other financial and non-financial indicators. STEPS INVOLVED IN FINANCIAL ANALYSIS OF LENDING Step 1: Company‟s financial statement for at least 3 to 5 years is acquired. The financial statement must include the following: Balance sheets Income statements Shareholders equity statement

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Cash flow statements Step 2: A quick scanning of all the statements is done to look for large movements in specific terms from one year to the next. If there is something suspicious, relevant research about the company is done from the information available to find out the reason. Notes accompanying the financial statements are also reviewed for additional information that may be significant to analysis. Step 3: This stage calls for an exhaustive scrutiny of the balance sheet. While examining, the advances manager looks for the large changes in overall components of company‟s assets and liabilities of equity. For example, have fixed assets grown rapidly in one or two years, due to acquisitions or new facilities? Has the portion of debt grown rapidly, to reflect a new financial strategy? Step 4: This level relates to an assessment of the income statement as furnished by the client. The advances manager looks for the trends overtime. Graphs and growth of the following entries over the past several years are calculated. Revenue (sales) Net income (profit, earnings) For each key expense components on the income statement, percentage of sales of each year is calculated. For example, percentage of cost of goods sold over sales, general and administrative expenses over sales and development over sales are computed. Favorable and unfavorable trends are highlighted. Manager determines whether the spending trends support the company‟s strategies. Step 5: The very phase pertains to an evaluation of the cash flow statement. It gives information about the cash inflows and outflows from operations, financing and investing. While the income statement provides information about both cash and non-cash items, the cash flow statement attempts to reconstruct that information to make it clear how cash is obtained and used by the business, since that is what investors really care about.

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CALCULATION OF FINANCIAL RATIOS Ratio analysis is a powerful tool of financial analysis. In financial analysis, a ratio is used as a benchmark for evaluating the financial position and performance of the firm. A ratio in itself has no meaning. It should be compared with some standard. Standards of comparison may consist of: Past ratios Competitors ratios Industry ratios Projected ratios The most frequently used ratios by bank and financial analysts are: Liquidity Ratio Degree of financial leverage of debt Profitability Efficiency Value a) ANALYZING LIQUIDITY: Liquid assets are those that can be converted into cash quickly. The short-term liquidity ratios show the firm‟s ability to meet its short-term obligations. Thus a higher ratio (#1 and #2) would indicate a greater liquidity and lower risk for short-term lenders. The Rules of Thumb for acceptable values are: Current Ratio (2:1), Quick Ratio (1:1). 1. Current Ratio = Total Current Assets / Total Current Liabilities 2. Quick Ratio = (Total Current Assets - Inventories) / Total Current Liabilities In the quick ratio, we subtract inventories from total current assets, since they are the least liquid among the current assets. b) ANALYZING DEBT: Debt ratios show the extent to which a firm is relying on debt to finance its investments and operations, and how well it can manage the debt obligation, i.e.

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repayment of principal and periodic interest. If the company is unable to pay its debt, it will be forced into bankruptcy. On the positive side, use of debt is beneficial as it provides tax benefits to the firm, and allows it to exploit business opportunities and grow. Note that total debt includes short-term debt (bank advances + the current portion of long-term debt) and long-term debt (bonds, leases, notes payable). 1. Leverage Ratios 1a. Debt to Equity Ratio = Total Debt / Total Equity This shows the firm‟s degree of leverage or its reliance on external debt for financing. 1b. Debt to Assets Ratio = Total Debt / Total assets In general, with either of the above ratios, the lower the ratio, the more conservative (and probably safer) the company is. However, if a company is not using debt, it may be foregoing investment and growth opportunities. This is a question that can be answered only by further company and industry research. 2. Interest Coverage (or Times Interest Earned) Ratio = Earnings before Interest and Taxes / Annual Interest Expense This shows the firm‟s ability to cover fixed interest charges (on both short-term and long-term debt) with current earnings. The margin of safety that is acceptable varies within and across industries, and also depends on the revenue generation history of a firm (especially the consistency of earnings from period to period and year to year). 3. Cash Flow Coverage = Net Cash Flow / Annual Interest Expense Net cash flow = Net Income is either subtracted from or added to non-cash items, as applicable (e.g. -equity income + minority interest in earnings of subsidiary + deferred income taxes + depreciation + depletion + amortization expenses)

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Since depreciation is usually the largest non-cash item in most companies, analysts often approximate Net cash flow as being equivalent to Net Income + Depreciation. Cash flow is a “critical variable” in assessing a company. If a company is showing high profits but has poor cash flow, one should investigate further before passing a favorable opinion on the company. Analysts prefer ratio #3 to ratio #2. c) ANALYZING PROFITABILITY: Profitability is a relative term. It is hard to say what percentage of profits represents a profitable firm, as profits depend on factors such as the position of the company and its products on the competitive life cycle (for example profits will be lower in the initial years when investment is high), on competitive conditions in the industry, and on borrowing costs. For decision-making, bank is mainly concerned with the present value of expected future profits. Past or current profits are important only as they help us to ascertain future profits, by identifying historical and forecasted trends of profits and sales. 1. Net Profit Margin = Profit after taxes / Sales 2. Return on Assets (ROA) = Profit after taxes / Total Assets 3. Return on Equity (ROE) = Profit after taxes / Shareholders‟ Equity (book value) 4. Earnings per Common share (EPS) = (Profits after taxes - Preferred Dividend) / (# of common shares outstanding) 5. Payout Ratio = Cash Dividends / Net Income. d) ANALYZING EFFECIENY: These ratios reflect how well the firm‟s assets are being managed. The inventory ratio shows how fast the inventory is being produced and sold. 1. Inventory Turnover = Cost of Goods Sold / Average Inventory

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This ratio shows how quickly the inventory is being turned over (or sold) to generate sales. A higher ratio implies the firm is more efficient in managing inventories by minimizing the investment in inventories. Thus a ratio of 12 would mean that the inventory turns over 12 times, or the average inventory is sold in a month. 2. Total Assets Turnover = Sales / Average Total Assets This ratio shows how much sales the firm is generating for every dollar of investment in assets. The higher the ratio, the better is the performance of the bank. 3. Accounts Receivable Turnover = Annual Credit Sales / Average Receivables 4. Average Collection period = Average Accounts Receivable / (Total Sales / 365) Ratios #3 and #4 show the firm‟s efficiency in collecting cash from its credit sales. While a low ratio is good, it could also mean that the firm is being very strict in its credit policy, which may not attract customers. 5. Days in Inventory = Days in a year / Inventory turnover Ratio #5 is referred to as the “shelf-life” i.e. how quickly the manufactured product is sold off the shelf. Thus #5 and #1 are related. e) VALUE RATIOS: Value ratios show the “embedded value” in stocks, and are used by investors as a screening device before making investments. 1. Price to Earnings Ratio (P/E) = Current Market Price per Share / After-tax Earnings per Share 2. Dividend Yield = Annual Dividends per Share / Current Market Price per Share f) DEBT SERVICE COVERAGE RATIO: The debt service coverage ratio (DSCR) is the ratio of cash available for debt servicing to interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity's (person or corporation) ability to produce enough cash to cover its debt (including

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lease) payments. The higher this ratio is, the easier it is to obtain a loan. The phrase is also used in commercial banking and may be expressed as a minimum ratio that is acceptable to a lender; it may be a loan condition or covenant. Breaching a DSCR covenant can, in some circumstances, be an act of default. In general, it is calculated by:

A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1 say 0.95 would mean that there is only enough net operating income to cover 95% of annual debt payments. For example, in the context of personal finance, this would mean that the borrower would have to delve into his or her personal funds every month to keep the project afloat. Generally, lenders frown on a negative cash flow, but some allow it if the borrower has strong outside income.

3.8 METHODS OF CREDIT RATING Bank uses credit rating methods to judge the credibility and the financial strength of any business unit that requests for loan. A set format is followed by the organization, where all the parameters that help in determination of credibility are mentioned. Method of credit rating is explained in great detail with the help of a case study in the later part of the report. For all the advance proposals up to Rs. 1 crore, bank relies on internal credit rating system while any proposal exceeding this amount calls for an authentic credit rating with the recommendation of CRISIL. CRISIL is India's leading Ratings, Research, Risk and Policy Advisory Company. CRISIL offers domestic and international customers a unique combination of local insights and global perspectives, delivering independent information, opinions and solutions that help them make better informed business and investment decisions, improve the efficiency of markets and market participants, and help shape infrastructure policy and projects. Its integrated range of capabilities

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includes credit ratings; research on India's economy, industries and companies; investment research outsourcing; fund services; risk management and infrastructure advisory services

3.9 METHOD OF ASSIGNING CREDIT LIMIT AND

DRAWING POWER OVERDRAFT FACILITY FOR INDIVIDUALS Overdraft facility is provided to individual customers. In this case, the credibility of the borrower is assessed by tracking his past record. The transaction in his account for a minimum of past six months is checked to judge his credibility and predict his intentions to pay back the amount in near future. If his past record indicates that he did not default under normal circumstances, then overdraft facility is allowed. Such a facility up to Rs.2 lacs is provided to him based on the discretion of the branch manager. Overdraft limit over and above Rs.2,00,000 is provided only after the approval from the Regional Office is received. The limit is sanctioned against the total deposits of the individuals keeping 10% as the margin money.

CASH CREDIT FACILITY FOR BUSINESS CONCERN While assigning the cash credit limit to business units the bank first does an exhaustive analysis of the particulars furnished by the customer. The documents required include: Balance sheet of the concern for the past three years , Recent stock statement where stock includes raw materials in store, loose tools, work in progress and finished goods held in warehouse. It should be noted that only paid up stocks are to be considered and not the stock purchased on credit basis. Record of debtors: a statement showing the book debts up to 90 days is taken into account.

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Sales turnover: the sales turnover of the past three years should be clearly shown. In case where the sales turnover exceeds an amount of Rs 40 lacs, a certification from Chartered Accountant (CA) is to be obtained. PAN card details of the client are mandatory. Asset and liability statement of both the borrower and the guarantor for the preceding three years is to be verified. Two years of projected sales and balance sheets need to be procured from the borrower to comply with all the regulations laid down by the governing authorities. The details and documents related to stocks, debtors and sales are to be furnished regularly by the client on a quarterly basis to review his credit limit from time to time. The basic formula includes for calculation of the drawing power is as follows: 75% of stock + 50% of debtors (stocks and debtors calculated as per the details showed in the documents procured from the customer)

3.10 SECURITIES USED AGAINST LENDING The securities are broadly classified as primary security and collateral security. Collateral securities are the provisional securities accepted by banks that cover the loan amount and can be legally liquefied in case of default in repayment. The securities that are included under collateral are mentioned below: Policies:

Endowment policy matures after the death of the policy holder or the

predefined time duration, such as Life Insurance Policy of LIC is acceptable as security. One of the cheapest ways to borrow small amounts of money is to raise a loan against an endowment policy. The loans are not common with endowments taken out to back mortgages, but they are offered against savings policies. The banks usually sanction loan amount up to 80%-90% of the surrender value of the policy. National Saving Certificates (NSC) and Kendriya Vikas Patra (KVP): NSCs and KVPs may be pledged in the bank‟s name along with transfer application to request for

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sanction of loans, thus forming another type of bank security. The bank marks lien on the certificates surrendered by the borrower and informs the same to the issuing authority. Fixed Deposit Receipts (FDR): The medium term savings of the individuals may act as a liquid security for all types of loans and advances. The banks willingly sanction advances against the FDRs of their regular customers keeping 10% as margin. House property: It is not uncommon for real estate or intellectual property to be included as part of the calculation of the loans. Under house loan request, the house property of the borrower is usually taken as security that acts as an insurance against the loan amount sanctioned. One can avail up to 80% of cost of property as assessed by authorized official after all legal compliance. Other assets: Collateral is focused on accounts receivable, inventory and equipment. Assigning an appropriate possession as security is a common way of making secured term loans. The possessions may be any machinery, equipment, or business property that is accepted as collateral. The asset remains with the borrower unless there is default, in which case the same goes to the bank. Generally, credit against machinery and equipment is restricted primarily to new or highly serviceable and resalable used items.

MODES OF CHARGING SECURITIES Charging a security refers to creating a legal RIGHT to payment out of the assets given as security. It assigns judicial power to the banker to take recourse to the assets given as security in case of non remittal of the amount on part of the borrower. Five different modes of creating charge are stated as follows: i)

Lien: Banker‟s lien is the right to retain goods given as securities belonging to the debtor in order to get the debts discharged. This may either be general lien or specific in nature. However, to exercise this banker is required to prove his diligence that it had no notice of defect in the title.

ii)

Hypothecation: This is a charge upon any movable property of the debtor without transfer of its ownership to the creditor. So the goods remain in the possession of the owner but the borrower is under an obligation to submit regular returns to the bank

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indicating any increase or decrease in the value of said goods to help bank determine his drawing limit. iii)

Pledge: Pledge is just the opposite of hypothecation but the purpose remains same. Under this the goods that are charged remain in actual possession of the bank and no withdrawals or additions to the stock are permissible without bank‟s permission.

iv)

Mortgage: It is the transfer of interest in specific movable property for the purpose of securing the payment of money advanced or to be advanced by way of loan, an existing or future debt, or the performance of an engagement which may give rise to a pecuniary liability.

3.11 CALCULATION OF EMI EMI (Equated Monthly Installment) in simple terms means a fixed payment made by a borrower to a lender at a specified date in each calendar month. Equated monthly installments are used to pay off both interest and principal each month, so that over a specified number of years, the loan is paid off in full. The formula for calculation of EMI given the loan, term and interest rate is: EMI = (p*r) (1+r)^n (1+r)^n - 1 p = principal (amount of loan) r = rate of interest per installment period i.e., if interest is 12% p.a. r = 1 n = no. of installments in the tenure

^ denotes whole to the power.

3.12 DOCUMENTATION Advances are not reimbursed by the bank until documents are duly filled and properly executed in compliance with the guidelines of the bank. Documentation in a loan account is of prime consideration since these documents act as physical evidence in case the bank decides to initiate any legal proceedings for recovery of its dues.

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In all kinds of loans, bank ensures that it has all the pertinent documents from the borrowers to protect their interests. Banks have predesigned printed forms that are duly filled and kept in their record for future references. IMPORTANCE Document, being a written statement of facts, states certain rights and liabilities of parties entering into contract (in this case bank and the prospective borrower). It binds the parties to advance under law. The documents need to be properly executed and adequately stamped for it to be fit to pass order for a decree. GENERAL PRECAUIONS IN EXECUTING NECESSARY DOCUMENTS Documents may be typed or printed. Handwritten documents should be completed in same handwriting to avoid unnecessary misleading inferences. All documents should be signed in full signature and in the same font without overwriting or signature in initials. The date and place of the execution must be mentioned. And the ambiguity in writing the same should be avoided. The language should be simple enough for the borrower to understand and comprehend. EXECUTION OF DOCUMENTS The documents need to be executed in presence of the manager. In case it is to be executed by any illiterate person, the contents need to be explained ensuring that the executants are not under undue influence or coercion. In case of joint borrowers, the borrowers must jointly sign the documents where as in case of partners, any one (authorized) on behalf of all may sign. The execution in case of a company requires common seal to be affixed along with the signature of the authorized person as decided by the Board of Directors. As to the HUF, it is usually signed by the Karta on behalf of all the family members. STAMPING OF DOCUMENTS: According to Indian Stamp Act 1899, the documents that are properly stamped before or at the time of execution, can only act as the basis of a suit. Stamps are classified under two categories-

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judicial and non judicial. Judicial stamps are used in courts for filing suits and appeals while the non judicial stamps are used by the banks. Adhesive stamps and embossed stamps form part of the non judicial stamps and are used as applicable. Stamping of documents (wherever required) provides an identity and legal existence to the document to act as a proof of evidence in case of any dispute. RENEWAL OF DOCUMENTS It is mandatory to renew documents within three years. While reviewing the documents it should be ensured that all the necessary amendments as per the terms of advances are incorporated in the renewed document. SECURITY RECORD AND SAFE CUSTODY OF DOCUMENTS Document should be adequately examined by the officer-in-charge of advances. All the relevant particulars related to the original and the renewed document should be recorded in the Documents Execution Register.

3.13 CREDIT MONITORING Credit monitoring in a bank is to ensure that the funds are utilized for the sanction purposes and at the same time complying with all sanction terms and conditions. The purpose of this exercise is to avoid the time lag and cost over runs, to detect early warning signals and symptoms of incipient sickness in the units financed by banks and to initiate timely action for recovery or rehabilitation. Under credit monitoring arrangement bank ensures the following: a) Borrower should maintain reasonable estimates of current assets, current liabilities and working capital. b) Should maintain classification of current assets and current liabilities as per bank guidelines. c) Should maintain a minimum current ratio of 1.33 except for export industry and for new units. d) Should submit annual audited accounts in time for annual review bay banks.

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e) Ad hoc limits are sanctioned for periods not exceeding three months f) As far as possible, post sale limits are sanctioned in the form of bill finance.

CREDIT APPRAISAL TECHNEQUIES Under this process, the decision maker finds the answer to two important questions, one being whether the entrepreneur requires funds, what are his credentials? If the answer to the question is positive then the second question being the extent of his requirement and the ways in which it can be met. Assessment of credit requirement is often difficult because of lack of data. So RBI suggested that the banks may not insist on submission of audited financial statements up to credit requirements of Rs 25 lakhs, but beyond this limit, a structured analysis of the financial statements is a must. Due to increasing non performing assets, credit appraisal techniques are increasingly focused on the assessments of repayment capacity of the borrower that depends on his revenue generating ability.

RENEWAL OF DOCUMENTS At the time of renewal, the bank should obtain a fresh set of documents duly supported by supplemental deeds if required. A formal letter from the borrower agreeing to continue the credit facility by bank in future, is obtained. Acknowledgment of the debt and security incorporating particulars of the original security document duly signed by the borrower are obtained and attached to form a part of the renewed documents.

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CASE ANALYSIS XYX INFOTECH: A CASE ON CREDIT APPRAISAL BORROWER/COMPANY PROFILE The borrower is banking exclusively with IOB since September 2006. He is successfully running an NIIT computer training centre at Midnapore for which he is having a cash credit account in IOB with a limit of Rs 1 lakh. Credit rating of the borrower is „A‟ as in December 2008 and the worth of the proprietor is Rs 33.77 lakh. He has also taken a term loan of Rs 12.00 lakh from the bank out of which Rs 9.89 is still outstanding. There are no irregularities in the cash credit and term loan account till date. Comments on Operation (Full Last Year & Current Year up-to-date) A) F 209 period from to

Max

Min

Turnover

Income earned

01.97

00.36

14.57

0.15

03.46

01.18

22.21

0.14

_____________

______

_______

___________

(Rs. in Lacs) 1) Fund Based` 01.4.07-31.3.08

2)‟ Non Fund Based

3) Obtention of Stocks and Book debts Regular statements

and

Quarterly

Auditors

certificate on book debts and their latest dates

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B) Details of Ad-hoc/Excess granted The excess granted under Br discretion and were with period and its adjustment within regularized within the commitment period. the expiry time etc. (Whether

permission of sanctioning

authority obtained)

PRESENT REQUEST/ PROPOSAL The borrower is into business since 1992, and his existing branch of NIIT is working successfully. NIIT has offered him for opening a new unit at Kharagpur and he has paid more than Rs 10 lakhs as advance for starting the same. The present proposal of the borrower is as follows:

PRESENT REQUEST/PROPOSAL LIMIT Nature of Facility

(Rs. in Lacs)

Existing

Proposed

Increase

Limit-12.00

19.69

07.80

01.00

05.00

04.00

Bills /Others

___________

__________

____________

Non Fund Based

__________

__________

____________

Term Loan

DP- 09.89 Cash Credit against Stocks/Book Debts (not exceeding 90 days)

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COLLATERALS/ GUARANTORS RS. In Lacs.

Collateral Nature

Face Value

Present Value

Owned/held by

Deposit

01.50

01.73

_____________

NSCs/KVPs

____

____

____________

LIC Policy

05.00

____

_____________

Others

09.85

09.85

_____________

Total

16.35

11.58

Details of Land and

Land Area/Extend in

Building/Flat

Acre/Sq. ft.

Constructed Area Covered Area (for building)

Forced Sale Value

Owned by (Relationship between partner / directors)

Details of Collateral Security (Land & Building) (Should contain details of ownership, nature of property, location, extent of land and building, preliminary valuation report/Desk- top valuation / whether Agricultural/Housing plot/Commercial etc.

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Forced Sale Value Rs 9.85

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FINANCIAL ANALYSIS PARTICULARS

(1)

(2)

(3)

(4)

31.03.07

31.03.08

31.03.09

31.03.10

Tangible Net Worth (TNW)

07.01

07.57

11.87

16.77

Debt Equity Ratio

02.83

02.70

01.39

01.78

Current Ratio

01.55

01.59

01.42

01.56

Net Working Capital

00.56

01.63

02.69

04.83

TOL/TNW

02.83

02.70

01.39

01.78

Sales (Net Sales) (Less Excise)

0.26

21.00

30.00

40.00

Gross Fixed Assets

10.79

09.06

07.33

06.23

NPAT

00.03

02.34

04.50

07.40

Net Cash Generation (net of Dividend/drawings

------

04.07

06.23

08.50

N P A T / Sales

11.54

11.14

15.00

18.50

P B I T / Sales

11.54

11.14

22.40

27.63

Stocks

00.00

02.40

02.40

03.00

Sundry Debtors

-------

------

03.70

05.00

Sundry Creditors for Goods

-------

------

------

-------

Unsecured Loan (To be pegged) (From Directors/Partners/Friends/

-------

-------

-------

-------

Relatives /Associates)

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NET WORKING CAPITAL ASSESSMENT Sales Current year (2008 - 2009) Estimated Sales current year 2008-09

Comments on estimates: Net worth of the borrower is Rs 33.77 lakhs. Guarantor in this case is the proprietor‟s wife. Details of the collateral security are as

Projected Sales (next year) 2009-10

follows:

Accepted Sales turnover- (2009 - 2010 ) Comments in brief:

:

a) Estimated/Projected sales turnover:

40

b) 25% of projected/estimated sales turnover:

10 ,,

c)Minimum Margin at 5% of Projected/estimated sales 2

turnover: c) Available margin (as per Latest Balance Sheet): d) PBF ((b) –(c ) or (b) – (d) whichever is less): P B F (As per Nayak/Vaz Committee/Turnover Method)

3 7

07.00 Lacs, Proposed and sanctioned Rs.05.00 Lacs

Comments on Margin /adequacy

NWC for 2007-08 is 1.63 and for 08-09 is 2.69, we consider 3.00 for arriving MPBF

Structure of limits proposed Facility

Limit

Margin

1) Cash Credit

05.00

25%

2) Term Loan

07.80

25%

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Present stocks and Book debts value are

Comment on the adequacy of Drawing Power Availability

sufficient to cover

based on the latest Balance Sheet

D.P

TERM LOAN ASSESSMENT New NIIT centre to be opened at Kharagpur with rental flat, along with

Capital Asset to be Purchased / Created

all furniture, fixtures, machineries, and stationeries Margin Proposed:

05.80

(As per norms- Minimum of 50% for land 40% for Building 25% for Machinery / equipment) Available from internal generation/fresh/

15.40

Infusion of addl. Capital/USL (to be pegged) Need for capital asset / machinery / Building

07.80

construction ( Justification to be commented) Availability of adequate space / power / Man power (All other requisite infrastructure facilities) Calculation of D S C R PARTICULARS

PAT

48

Yes

(values in Rs. lakhs) 1

2

3

4

5

6

31.03.08

31.03.09

31.03.10

31.03.11

31.03.12

31.03.13

2.34

4.50

7.40

9.01

9.78

10.24

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Depreciation

3.07

1.73

1.10

0.80

0.64

0.54

Interest on term loan –

1.63

1.60

1.56

1.51

0

0

Proposed

1.05

1.00

0.95

0.91

0.86

0.80

A) Funds Available

8.09

8.83

11.01

12.23

11.28

11.58

3.62

3.62

3.62

3.62

______

______

2.14

2.14

2.14

2.14

2.14

2.14

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

5.76

5.76

5.76

5.76

2.14

2.14

Existing

Repayment Term Loan Installment – Existing Proposed Interest on Term Loan Existing

Proposed B) Total Obligation

D S C R (A/B) (Range 1.50 to 2.00 is acceptable as bank Norms) 1.40

1.53

1.91

2.12

5.27

5.41

Comments (Whether the machinery/equipments to be purchased is new or second hand ( Higher margin to be stipulated), Obtention of authenticated invoices/quotations/comparative price list on similar brands and satisfactory credit reports on the suppliers to be ensured) The debt service coverage ratio (DSCR), is the ratio of cash available for debt servicing to interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity's (person or corporation) ability to produce enough cash to cover its debt (including lease) payments. The higher this ratio is, the easier it is to obtain

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a loan. The phrase is also used in commercial banking and may be expressed as a minimum ratio that is acceptable to a lender; it may be a loan condition or covenant. Breaching a DSCR covenant can, in some circumstances, be an act of default. The DSCR up to 2011 is considerable as it rounds about the level 2.00. From 2012, since the existing term loan will be closed their total obligations will be reduced suddenly and accordingly the DSCR level will also be enhanced. However bank will be revising the DSCR with every year estimates and projections to compare with the actual achievements

METHOD OF CREDIT RATING NOTES (Specimen given in the case analysis) Average should be arrived at by dividing the net marks obtained (after deducting the negative marks) by total number of applicable positive features.

Above 7.5

A+

Above 6.5

A

Above 4.5

B

Below 4.5

C

SCORE

PARAMETERS 1.

Sales If the growth is increasing over the last 3 years @ 20 % and over @ 10 to 19 % @ 5 to 9 %

5

@ less than 5 % or decline in sales in any year during last 3 years 2.

Net Profit to Above 5 %

5

5 4 3 0 5

to satisfy our DSCR.

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3.

Sales 3 to 4 %

4

1 to 2 %

2

below 1 %

1

Sales to Bank 6 times

5

Borrowing

4.

3 to 5 times

3

3

1 to 2 times

1

below 1

0

Sales to TNW 5 times

5

3 to 4 times

4

1 to 2 times

2

2

below 1 5.

Level of

0 Above 80 %

5

utilization

70 to 79 %

3

of limits

50 to 69 %

1

below 50 % 6.

0

Documentation Perfect compliance

7.

5

5

Imperfect but beyond borrower‟s control

4

Not responsive

0

Compliance of Terms and Conditions Prompt compliance Delayed or unsatisfactory compliance

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5

5 3 ICFAI Business School

Not responsive 8.

Payment of Bills

0 NA

Prompt payment with :

9.

overdue less than 5 %

5

overdue less than 10 %

4

overdue less than 20 %

3

overdue less than 25 %

2

overdue more than 25 %

0

DPG /Term Loan Installments and Periodical interest Timely repayment

5

Delayed repayment (1 installment/1 quarter Interest outstanding)

3

Not repaid (2 or more installments/quarterly Interest outstanding)

10.

3

0

Renewal of Limits Timely renewal Delayed renewal upto 3 months

5 3

Non-renewal beyond 3 months 11.

Current Ratio 1.33 and above

52

3 0

20

20

1.25 and above

12

1.15 and above

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1.00 and above

4

RATING: The conduct of the accounts so far is satisfactory. However he is facing some problems in remitting funds to his account from Midnapore frequently. But ultimately he is sincere towards the repayment of the loan installments as well as CC A/c operations.

TRADE CREDIT ACCOUNTS

12. Total Liability: (A) TNW (For Companies other than HP and Leasing) Upton 2.0

25

Upton 2.5

23

Upton 3.0

20

Upton 3.5

16

Upton 4.0

12

Upton 4.5

8

Upton 5.0

4

Above 5.0

53

25

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(B)

For HP and Leasing Companies If public

deposits are : NA 7 to 10 times of NOF

25

6 to 6.9 times of NOF

23

(Ratio of Public Deposits to NOF)

54

5 to 5.9 times of NOF

20

4 to 4.9 times of NOF

16

3 to 3.9 times of NOF

12

2 to 2.9 times of NOF

8

1 to 1.9

4

Less than 1

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13. Sundry Debtors Level Actual in line with level assessed

5

5

(including 20 % deviation) Deviation : 20 to 50 %

3

Deviation : Above 50 %

0

NEGATIVE FEATURES 1.

Delayed submission of QIS, CMA and financial statement : Delay up to 3 months

2.

2

2

Delay between 3 and 6 months

3

Delay beyond 6 months

5

Delay in submission of Stock

statements :

Beyond 15 days from due date

3

3

up to 30 days Beyond 30 days from due date 3.

5

Documentation Irregularities : Not rectified within 30 days from date

5

of detection or borrower not responsive 4.

Non fund/ancillary business routed

5

through other banks/non consortium members (in case of Consortium advance) without the concurrence of consortium.

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5.

Merchant Banking Business not

5

offered to IOB 6.

Sales-actual at variance with projections Estimate

7.

Variance between 10 and 15 %

3

Variance exceeding 15 %

5

Default in payment of LC obligations including A & E : Paid with a delay of 1 to 7 days

2

Paid with a delay of 7 to 15 days

3

Paid with a delay of beyond 15 days

5

8.

Current ratio below 1

5

9.

Business Mix (for HP and Leasing Cos only) : Concentration of business within the group

10.

30 to 50 %

3

above 50 %

5

Default in payment of installments/

5

Interest on funded loans beyond 30 days 11.

Return of Bills -

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10 to 25 %

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more than 25 % 12.

5

For HP and Leasing Companies only :

Over dues in HP installments/Lease rentals 10 to 25 %

3

more than 25 %

5

NOTES: 1. For scoring under point No. 7 under „Positive

Features‟ viz., compliance with other

terms and conditions,

account the following :

branch should take in to

Terms and Conditions in sanction letter such as maintenance of margin, obtention of letter of pegging, no lien letter, power of attorney, non-declaration of dividend etc. 2. In case of guarantees invoked, if payment of invoked amount is not settled within 15 days, the rating of the borrower should be downgraded to “C”. 3. If LCBR dues are not met even after 15 days from the due date, the rating of the borrower should be downgraded to “C”.

TOTAL POSITIVE POINTS------------ 86 TOTAL NEGETIVE POINTS-----------05 NET POINTS = 81 AVG = 81/12 = 6.75 RATING-------------A

MULTIPLE DISCRIMINANT ANALYSIS The studies above provide for looking at a number of separate clues (ratios to sickness or failure). It would be more useful to combine the different ratios into single measure of the

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probability of sickness or failure (bankruptcy). The technique of Multiple Discriminant Analysis (MDA) helps us to do so. The use of MDA helps to consolidate the effect of all ratios. It is derived from the following discriminant function: Z= 0.012X1 + 0.014X2 + 0.033X3 + 0.006X4 + 0.010X5

where

Z = discriminant function score of the firm X1= net working capital/total assets (%) X2= retained earnings/total assets (%) X3= EBIT/total assets (%) X4= market value of total equity/book value of debt (%) X5= sales/total assets (times) According to the established guideline Z score which can be used to classify firms as either financially sound- a score above 2.675- or headed towards bankruptcy- a score below 2.675. the lower the score, the greater is the likelihood of bankruptcy and vice versa.

Z SCORE 3

2.73 2.5

2.12

2 1.5

1.08

1

0.5 0

2008

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2010

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The Z score of XYZ INFOTECH has seen a considerable rise in 2009(2.12) compared to 2008 (1.08), which will further rise to 2.73 in the year 2010 if we consider the projected balance sheet of the firm. This gives the clear indication that the company is in the sound position as compared to the previous year and it will very soon cross the acceptable mark of 2.675 in the coming year which proves numerically that the firm is financially sound.

BANK FINANCE Limits recommended for sanction

BPLR+

RS. LACS.

Nature of Facility

Limit

Margin

Interest

Security(PRIME)

1) Cash credit

5.00

Stocks-25%

BPLR+0.50 %

Hypothecation of stocks and book debts

BPLR+0.50 %

Hypothecation of machineries, furniture‟s, fixtures.etc

B.Debts-50% 2) Term loan

7.00

25%

RECOMMENDATIONS The captioned party has been enjoying the mentioned limits from September 2006. The proprietor is an experienced person engaged in business for the last 4-5 years. He started unit at Midnapore in 2006 and handled successfully. Some of the big names in Pvt. Sectors (like-IBM) are approaching the institute for campus interview. NIIT, a brand in itself, had offered him to open another branch at Kharagpur, and has already issued the license. Their Kharagpur unit‟s future seems quite blooming, since it is an industrial place strongly supported by IT sector background and basis. The government has also come up with many new policies and schemes which are favorable for opening new Private Sector biggies at Kharagpur. So the customer‟s this unit will be unquestionably getting huge opportunities for their services, i.e. imparting of training for employment.

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EXPORT CREDIT Pre-shipment finance is also known as packaging credit it refers to any loan or advance granted or any other credit provided by a bank to an exporter for financing the purchase processing manufacturing or packaging of goods prior to shipment on the basis of letter of credit opened in his favor or in favor of some other person.

Post-Shipment finance means any loans or advance granted or any other credit provided by an institution by an institution to an exporter of goods services from India from the date of extending the credit after shipments of goods rendering of services to the date realization of exporter proceeds Pre Shipment Finance is issued by a financial institution when the seller wants the payment of the goods before shipment. The principal objective behind pre-shipment finance or pre export finance is to enable exporter to: Procure raw materials. Carry out manufacturing process. Provide a secure warehouse for goods and raw materials. Process and pack the goods. Ship the goods to the buyers. Meet other financial cost of the business. The concepts related to export credit and their treatment are more lucidly explained with the help of a case study (Liberty Marine Syndicate Ltd.) that was witnessed during the SIP period. This would bring a decipherable picture of the manner in which the export credit is granted to any party.

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CASE STUDY THE LIBERTY MARINE SYNDICATE LTD. BACKGROUND Liberty Marine Syndicate Ltd was established on 22.02.1972. The company was established to do and undertake contracts for transport and transporting, shipping and clearing and that of ship chandelling, stevedoring, chipping and painting, multimodal transport operation and international freight forwarding and all kinds of work and servicing in connection there to. The company is also engaged as contractors in connection with contracts of loading, unloading and handling of cargo of any or all description and of preparation of special cribbing and wedging and packing for wagons and wagon loading. One of the main areas of activity is charting between India to fast and red sea/Africa lne specializing in cargos such as iron ore/minerals: agricultural products/fertilizers: bagged cargo: steel product cement/ clinker/ logs and projects/ heavy lifts. We act as house brokers for SPS group, glencore, swiss Singapore, IMFA and ISPAT to name a few. The two directors of the company namely Mr.Rakesh Aggrwal and Mr. Vimal Aggrwal having the net worth of Rs 32 lacs and Rs 35 lacs respectively are having 16 years of experience in this business. They are banking with IOB since August 2007.

PROJECT PROPOSAL AND REQUIREMENTS As the borrower is into the business of exports and imports so the borrower needs packing credit, letter of credit and letter of guarantee for the successful operation of its business. The specific requirement of the borrower is as follows: Type of facility required

Amount

Letter of credit

Rs 4 crore

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Letter of guarantee

Rs 2 crore

Packing/Cash Credit

Rs 4 crore

TOTAL

Rs 10 crore

The primary security given by the borrower was land and building with the market value of Rs 2 crore backed by another security of Rs 2 crore. So the total security given by the borrower was Rs 4 crore approx.

FINANCIAL ANALYSIS AND RECOMMENDATIONS PAST PERFORMANCE (In Rs lacs) YEAR ENDING

2004(AUDITED)

2005(AUDITED)

2006(AUDITED)

2007(AUDITED)

Sales & Servicing Profitability Net worth

1185.35 6.17 24.99

2319.60 10.76 45.24

2431.04 25.13 110.37

2602.04 36.58 281.95

It is apparent from the above table that the sales volume of the company is increasing gradually with the subsequent increase in the profitability and net worth of the company year by year.

SWOT ANALYSIS Strengths: 1) The company is one of the leading chartering brokers in the country. 2) They are established stevedores and handling agents in the eastern part of the country. 3) They have already started export of iron ore to China which is in high demand and has vast scope.

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4) The company is a professionally managed one with good infrastructure support. Opportunity The company has huge opportunity to expand its export business, as there is huge demand from China. Weakness and threats Over dependence on china for export is fraught with risk. Competition from other iron ore exporting countries is a threat.

KEY FINANCIAL INDICATORS In Rs Lacs PARTICULARS Paid up capital Net worth Long term secured loan Long term unsecured loan Net fixed asset Intangible asset Deferred tax Receivable Other current asset Current liability Bank borrowing Net working capital Net sales Operating profit after interest PBDIT Depreciation Interest Other income Tax PAT Cash accruals Increase in net sales % gross profit to net sales PAT to net sales (%) Return on capital employed% Interest cover(times)

63

31.03.05 7.34 45.24 --------22.01 ----0.89 426.14 110.66 513.46 ----22.45 2319.60 29.41 35.22 5.35 .46 .68 10.76 18.65 24 95.69% 5.60 0.8 ----75.56

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31.03.06 7.34 110.37 --------67.12 --------307.50 168.40 427.98 ----47.92 2431.21 40.71 49.47 8.31 .45 5.61 15.58 25.13 33.44 4.81% 7.28 1.03 ----97.47

31.03.07 42.34 281.95 --------82 --------441.93 260.44 497.72 ----204.65 2602.04 55.14 68.51 10.11 3.26 5.29 18.56 36.58 46.69 7.02% 7.50 1.41 ----19.35

31.03.08 42.34 384.25 --------72 --------650 732 1068.08 ----316.92 3500 155 205 10 40 5 52.7 102.3 112.30 34.51% 1.42 2.92 ----5 ICFAI Business School

Fixed asset to secured term lib ----Nil Rate of dividend

----nil

----Nil

----Nil

The company is well managed professional group with branches all over the country. From the above financial statement it is clear that they are growing from strength to strength. Also the company is undertaking number of new contacts every year. Therefore there is wide variation between the sales and profitability of the company from year to year.

CALCULATION OF NET WORKING CAPITAL In Rs Lacs PARTICULARS CURRENT ASSETS Cash and balance Investment other than long term Receivable Inventory Advance to supplier Advance payment tax Other current asset TOTAL CURRENT ASSETS

31.03.05

31.03.06

31.03.07

31.03.08

50.12 60.54 426.15 ----------------536.81

75.77 ----307.50 --------38.02 54.61 475.90

145.36 40 441.93 --------56.58 58.50 702.37

75 40 650 400 165 52 ----1382

CURRENT LIABILITIES Short term borrowing from bank Short term borrowing from other Sundry creditors Provision for taxation Other statuary liability TOTAL CURR LIABILITIES

15.54 ----466.38 ----30.63 512.55

----26.30 354.64 38.63 8.41 427.98

400 37.87 388.90 60.69 10.26 497.72

400 ----551.69 113.39 ----1065.08

NET WORKING CAPITAL

24.25

47.92

204.65

316.92

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DEBTOR AND CREDITOR DAYS 160 140

73.4

120

57.53

54.55

100

53.24

80

Creditor Days 67.1

60

67.8

62

Debtor Days

46.1

40 20 0 2005

2006

2007

2008

Working capital is basically the difference between current assets and current liabilities. Positive working capital means that the company is able to pay off its short-term liabilities. Negative working capital means that the company currently is unable to meet its short term liabilities with its current assets. As the company‟s current assets are exceeding its current liabilities every year (i.e. NWC is positive), this means that the company is in no trouble of paying back its creditors in the short term. An increasing working capital along with an increase in net sales is good sign for any company in both short and long term. Working capital also gives investors (bank in this case) an idea of the company‟s underlying operational efficiency. Money that is tied up in the inventory or that customers still owe to the company cannot be used to pay off any of the company‟s obligation. So even if the company is not operating in the most efficient manner, it can still show up as a rapid increase in working capital. Slow collection signals an underlying problem in company‟s operations. Debtor days ratio actually indicates the number of days of sales that are on the balance sheet of the company as debtors. The ratio is expressed in number of days. A higher debtor days ratio (as

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in this case) signifies several problems in the collection of funds faced by the company or the financial position of debtors. Creditor day ratio indicates the number of days of purchases that are on the balance sheet of the company as creditors. The ratio is expressed in number of days. A lower creditor days ratio signifies that the company is liberal in paying its creditors and follow a policy of paying them at a faster rate. The company has shown an increasing trend in the debtor days over the past few years. It has increased about 22% over the period of past 4 years. This indicates that the company is not able to collect its dues in a short span of time. Comparatively it can be seen that the creditor days of the company has seen a decreasing trend every year and has come below debtor days in tears 2007 and 2008. This is the negative sign for the company as this means that the company has to pay to the creditors from the surplus cash every time it makes purchases. Stocking up of the inventory in 2008 and high debtor days are the two main reasons for the acute rise in the net working capital of the company in 2008. Though the NWC shows that the company is financially sound but it also shows the poor debtor management in this case. But still as per the bank, the NWC projections are at comfortable level as the company has enough current assets to pay back its current liabilities.

OTHER FINANCIAL INDICATORS PARTICULARS Net sales NPAT Cash generation Current ratio TNW TOL/TNW Quick ratio Debt equity ratio

66

31.03.2006 24.31 0.25 0.33 1.11 1.10 3.92 1.11 0.24

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31.03.2007 26.02 0.36 0.47 1.41 2.82 1.78 1.41 1.55

31.03.2008 35 1.02 1.12 1.30 3.84 2.78 0.93 1.04

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SHORT TERM SOLVENCY RATIOS 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2

0

2006

2007

2008

Current ratio

1.11

1.41

1.3

Quick ratio

1.11

1.41

0.93

Short term solvency or liquidity ratios measure the ability of the firm to meet its current obligations. There is a short fall in current ratio in 2008 then the acceptable level, though as per the bank, the current ratio is above the benchmark level in 2007. The quality of current assets has also decreased in the year 2008 due to the stock up of the inventory worth Rs 400 lacs and increase in debtor days from 62 to 67.8. The quick ratio for the years 2006 and 2007 are well above the benchmark level of 1 and highly acceptable by the bank. The quick ratio in 2008 has decreased largely due to the stocking up of the inventory but still the level is acceptable as the company has been following a good policy in regard to inventory in the previous years as it has not allowed the stock to pile up and is also deemed to follow the same policy in the future years.

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DEBT EQUITY RATIO 1.8 1.6

1.55

1.4 1.2 1.04

1 0.8 0.6 0.4 0.2

0.24

0

2006

2007

2008

The company has maintained a very acceptable level of debt equity ratio in 2008. Thought the D/E ratio saw a sharp rise in 2007 due to rapid increase in short term borrowings of the company but the company has brought back the ratio at an acceptable level of 1.04 in 2008 as there was a considerable increase in the net worth of the company. SALES: During the past three years, the company has shown steady growth of sales and further going by the past trend, they appear comfortable of achieving the projections comfortably. NET PROFIT: The company is registering continuous increase in profit with the increase in net sales. They have also maintained the trend of growth of profit which is acceptable. TNW: Tangible net worth has been increasing every year due to plowing back of profit. Upon achieving the projected level of business the TNW will reach the level as projected. TOL/TNW: It‟s the ratio of total outsider liability by tangible net worth. In year 2007 the ratio is 1.78 which is around the acceptable level of the bank. But the ratio has increased to 2.78 in year 2008 which has crossed the acceptable benchmark. It means that the total outside liability is 2.78 times the tangible net worth of the firm. Though the company showed 2.30 as the projected ration in 2009, it has to bring down this ratio to the acceptable level.

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SECURITY COVERAGE The company initially offered mortgage of land building, valued at Rs 200 lacs approximately backed by another security worth Rs 200 lacs. Valuation is done by the approved assessor appointed by the bank. Further the borrower has promised that they would not avail the facility/value of letter of credit and letter of guarantee. The only facility they would exercise is packing credit that is proposed to amount to Rs 400 lacs and equals the security offered by the borrower.

RECOMMENDATIONS (AS PER BANK) Keeping in view the satisfactory conditions of the business and taking into account the future prospects of getting additional business through them and the reference about the background of the promoters by the SPS group (one of the major account holders in the bank), bank recommended for the favorable consideration of limits proposed. The same request was sent to Regional office for consideration for which the Regional office replied in positive.

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NON PERFORMING ASSETS An asset becomes non-performing when it ceases to generate income for the bank. According to RBI an asset may be termed as NPA if it falls under any of the following category: Interest or /and installment of principal remains overdue for a period of more than 90 days in case of a term loan The account remains out of order in respect of an overdraft or cash credit. The bill remains overdue for a period of more than 90 days in case of bills purchased and discounted. The installment or/and principal remains overdue for two crop season for short duration crops and one crop season for long duration crops.

ASSET CLASSIFICATION ,

Banks are expected to classify nonperforming assets further into three categories based on the period for which it has remained nonperforming. Thus they are classified into: Substandard Assets: A substandard asset would be one, which has remained NPA for a period less than or equal to 12 months. Such an asset will have well defined credit weakness that jeopardizes the liquidation of the debt and are characterized by the distinct possibility that the bank will sustain some loss if deficiencies are not covered. Doubtful Assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months. It has all the weakness inherent in the asset that were classified as standard with added characteristics that the weakness make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable. Loss Assets: This is an asset that has been identified by the internal auditors or RBI. This is uncollectible. When account comes under this head it can be written off.

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COMPUTATION OF NPA LEVELS Banks should deduct the following items from the Gross Advances and Gross NPA to arrive at Net Advances and Net NPA respectively: ECGC claims received (if any). Balance in interest suspense account Part payment received in suspense account Total provisions held

UPGRADATION OF LOANS ACCOUNTS CLASSIFIED AS NPAs ,

If arrears of interest and principle are paid by the borrower in case of loan accounts classified as NPAs, the accounts should no longer be treated as non performing and may be classified as standard accounts. Advances against NSCs eligible for surrender, KVPs and life policies need not be treated as NPAs provided adequate margin is available in the accounts. Advances against gold ornaments, government securities and all other securities are not covered by this exemption. Writing off of NPA: In case the loan account remains NPA and the borrower does not make any attempt for its up gradation, the bank may opt for writing off the account with due consent from regional office. Amounts set aside for making provisions for NPA‟s are not eligible for tax deductions. Therefore the banks should make either full provisions as per the guidelines of RBI or write off such advances and claim such tax benefits as are applicable. Recoveries made in such accounts should be offered for tax purposes as per the rules. Banks may write off advances at Head Office level, even though the relative advances are still outstanding in the branch books. However, it is necessary that provision is made as per the classification accorded to the respective accounts. So, if an asset is a loss advance, 100% provision will have to be made thereof.

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SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST ACT The act extends to whole of India with effect from July 21, 2002. The act deals with three aspects: Enforcement of security interest by secured creditor (banks/financial institution) Transfer of non-performing assets to Asset Reconstruction Company, which will then dispose those assets and realize the proceeds. To provide a legal framework for securitization of assets. This empowers bank to recover the amount due without the intervention of the court. The provisions of the act are applicable only for NPA loans with an outstanding amount above Rs. 100,000. NPA accounts where the amount due is less than 20% of the principal and interest, are not eligible to be dealt under this Act. If the pre conditions for taking action to enforce security interest are satisfied then the secured creditor can send a written notice to the borrower to discharge in full his liabilities within 60 days from date of notice failing which the creditor shall be entitled to exercise all his powers. However, if the borrower fails to pay the amount within specified period the creditor can take any of the following measures to recover his dues: Take possession of the secured asset including the right to transfer by way of lease or sale for realizing the asset. Takeover the management of the secured asset including all the rights to realize the asset. Appoint any person as manager to manage the assets, the possession of which has been taken over by the creditor.

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NPA OF BRANCH (in Rs. lacs)

100 90 80

70 60 50 40 30

20 10 0 NET NPA

2005

2006

2007

2008

2009

41.04

54.4

59.11

38.37

88.39

BRANCH ADVANCES (in Rs. lacs)

18000 16000 14000 12000 10000 8000 6000 4000 2000 0 ADVANCERS

73

2005

2006

2007

2008

2009

728.85

15922.33

3173.22

6283.79

4504.41

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CASE STUDY EDUCATIONAL LOAN Borrower’s Information The case under study is related to Education Loan of Mr. Neal Rajput who was pursuing Bachelor of Business Administration (BBA) from Shantiniketan in 2003. Both, the borrower and his father had a joint account and were banking with IOB since the year 1998. The prospect had already completed the first year of his studies and required financial assistance for completion of second and third year of the course. The father of the prospect, Mr. Dharani Rajput also the guarantor in this case had total assets sufficient enough to cover the loan amount.

Details/ Requisites of the proposal ,

The total pecuniary support needed to continue the course was Rs.52,000. However, the bank after a thorough financial analysis of the proposal concluded that it could finance just a part of it which amounted to Rs. 38,000. The same amount was sanctioned after the completion of all the legal formalities pertaining to the loan and documentation of the same. The father signed as a guarantor. The particulars of total net worth of his assets are as follows: The house property owned by guarantor was valued at Rs.600,000. The face value of shares held by him amounted to Rs. 8500 where as the market value of the same as on the date of valuation was Rs. 34,900 approximately. The endowment policy, Life insurance Policy (worth Rs.6 lacs) proposed to mature in the year 2029. As per the guidelines laid down by RBI, bank cannot keep any security for any education loans sanctioned to an extent of Rs 400,000 while in cases where the advance exceeds this amount, guarantee of a third party and collateral are mandatory.

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Bank Finance and Repayment Schedule ,

After a thorough analysis of the proposal, the bank decided to extend assistance up to Rs. 38,000 at an interest rate of 11.5%. Thirty six equated monthly installments of Rs. 1253 were to be made. Endowment policy of the guarantor was in custody of the bank as an assurance, creating an obligation on the borrower to make prompt payment as per the agreement. Further the agreement stated that the repayment of the amount mentioned above, would start either immediately after the joining of the job by the student in any organization or after a period of six months of completion of the course, whichever is earlier. In the mean time the guarantor was supposed to make the interest payment monthly.

Default and Reasons ,

Irregular interest payment during the course of study led to accumulation of the amount. Even after the immediate placement of the student subsequent to completion of his course, the borrower did not start the repayment of the sanctioned amount. Despite of innumerable notices sent by the bank no prompt payment was received, either from the borrower or the guarantor. Later on personal visit by the officials, Mr. Dharani Rajput informed bank about the root cause of such a default. His son, Mr. Neal Rajput had eloped with his girl friend and married her without the consent of his parents. The parents did not have any info about his whereabouts. The guarantor was suffering from a cardio disease and had gone through a major by pass surgery. Due to this he had also left his job and was under complete bed rest. So, even he was not capable of repaying the total sum of money due.

Follow up by the bank The bank incessantly tried communicating the borrower from the date the repayment was due. Despite of continuous official notices, the bank could not solicit any response from the other end. On personal visit to the guarantor, the bank got a clear view of the reason of default.

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Bank also made an attempt to contact the borrower in person. It communicated the organization where he was initially inducted. The authorities came to know that he had already left the organization two months ago. The account was finally slipped to NPA. The mother of the borrower assured that they would be in a position to repay the outstanding amount from December, once she started some household business (knitting and weaving). Since the outstanding amount is nominal and the guarantor‟s financial position is unsound, so the bank on humanitarian grounds did not take any legal action against the guarantor.

Future Course of Action After repeated reminders by the bank to the guarantor, the account was classified as NPA as per the recommendation of the Regional Office (RO). According to the guidelines of the RBI, bank will not charge further interest on the payment due. The account may be treated in the following way: Account may remain as NPA and written off in due course of time depending on the discretion of the RO. Other alternative left with the bank is to wait for the endowment policy of the guarantor that is proposed to mature in 2029 and then adjust the account accordingly thereby remitting the balance left to his account. Bank may even try contacting the borrower through his own sources and if found, try to recoup the amount through legal procedure.

CONCLUSION AND RECOMMENDATION AS PER THE ANALYSIS Though the borrower was customer of the bank, the interest payments were not regular. The bank should have sent a written notice instead of verbal reminders. Further, the reimbursement of the loan should have been stopped on account of breach of such an agreement on the part of the borrower.

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On the other hand, bank may have collaborated with the college authority to know about the performance of the student in his college. Immediately after receiving the information about his placement form the college, bank should have communicated to his employer and suggested the borrower to opt for auto debit. This facility provided by the bank enables the automatic transfer of the loan installment from his salary account to the loan account on a monthly basis. As far as the current situation is concerned, bank has taken a more humanistic approach.

MISCELLANEOUS CASH CREDIT PRATIBHA CONSTRUCTIONS Borrower’s Information ,

Mr Debojeet Roy initially owned a utility store. He was banking with IOB since the inception of new alipore branch. The customer ventured into construction business in 2003. He became a proprietor of a new business enterprise named Pratibha Constructions. Mr. Debojeet Roy, being the owner of one third of a property valued at Rs. 203.73 lakhs came up with the proposal of constructing a commercial cum residential apartment.

DETAILS OF THE PROPOSAL The proprietor required financial assistance of Rs 32 lacs to develop the property owned by him. After due consideration bank sanctioned a cash credit of Rs 1500,000 at an interest rate of 15% for the building and construction purpose in September, 2003. The land that was proposed to be developed was mortgaged as security with the bank. Details of the property were furnished by the owner. The loan request was sanctioned, keeping 80% as margin and the proprietor started with his construction work.

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Later in April 2004, client requested for a further sanction of two term loans, one of Rs. 250,000 and the other of Rs 500,000. The two term loans were required for lift construction and for flooring, sanitary and sewage pipes respectively. He also requested for enhancement of cash credit limit from Rs. 1500,000 to Rs 3000,000 for carrying on the remaining construction work. The client promised to pay back the term loan by September, 2004 and the cash credit limit availed by December, 2004. The payment was supposed to be made out of the sale proceeds of the flats that were being constructed.

PROPOSED PROJECT/ PROJECT PROFILE: Mr. Debojeet Roy Number of Residential Flats

10

Number of Business Shops

8

Number of Garage

4

Total Investment

Rs. 61,50,000

Already Invested

Rs. 29,40,000

Loan Required

Rs. 32,10,000

BANK FINANCE AND REPAYMENT SCHEDULE After an in depth analysis bank decided to grant him a cash credit limit of Rs 15 lacs in October 2003. Land and property of the borrower was charged as security. The property was valued at Rs 203.73 lacs where 80% was kept as margin. In April 2004, as per the request of the client bank sanctioned the following: Enhancement of credit limit from Rs. 1500,000 to Rs. 2500,000 Approval of a term loan of Rs. 250,000 for construction of lift (costing Rs. 390,000) Another term loan of Rs 500,000 for flooring, sewage, sanitary etc ( costing Rs 15 lacs). All loans and limits were sanctioned at an interest rate of BPLR + 3.5%. The repayment schedule of the term loans as follows: Twelve EMIs of Rs 20834 against the term loan of Rs 2.5 lacs

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Twelve EMIs of Rs 41667 against the term loan of Rs 5 lacs. Miscellaneous cash credit limits to be adjusted in full latest within 12 months. The entire property of the client was mortgaged with the bank as security.

DEFAULT Where the term loans should have been repaid in full, the bank in May 2005 observed that the account had turned irregular. The total amount outstanding as on May 2005 was as follows: Rs 2313533 against cash credit account including the interest. Rs 132665 against term loan of Rs 2.5 lacs. Rs 219137 against term loan of Rs 5 lacs.

FOLLOW UP BY BANK As soon as the account was classified as irregular, bank sent a notice to the borrower stating that the period of repayment has lapsed and the conditions stipulated by regional office had not been met. No response was received from the borrower either for further extension of credit limit or request for renewal of the same. Request from borrower for extension of repayment period was received in July 2005 along with the reason of non compliance with the terms. He agreed to repay the entire amount with interest by December 2005. The same was forwarded by the branch to regional office with the recommendation to exceed the time frame to march 2006 by which he shall be able to clear the entire amount and renew the limit. The request was considered and sanctioned by the Regional office. Despite of extension of repayment period, the borrower was still not able to regularize his account till March 2006. Since May 2006, the account was always on the verge of slipping into NPA but each time borrower either credited a part of the amount due or renewed the account by submission of relevant financial documents. The following steps were taken by the client to save his account from being NPA:

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A payment of Rs 6 lacs was made in September 2006 Renewal of account in March 2007 A sum of Rs 4 lacs paid in November 2007 A part payment of Rs 3 lacs in Mach 2008 The last amount credited to the loan account in October 2008 was Rs 7 lacs. After October 2008, the borrower neither made any payment to adjust his account nor renewed it. The bank tried to contact the borrower through notices and in person but failed to solicit any response. So in March 2009 the account was finally categorized as substandard asset.

COURSE OF ACTION The bank issued the securitization and reconstruction of financial assets and enforcement of security interest (SARFAESI) notice. As per the guidelines of SARFAESI, the borrower is given 60 days to clear the amount due else the bank would have all the legal rights to liquidate the security to realize the unpaid amount. The borrower contacted the bank after receiving the notice and promised to repay the amount in full before the lapse of the period, through the sale proceeds of the flats that were unsold.

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SOME PROBLEMS OBSERVED DURING PRE & POST SANCTION OF ADVANCES Certain issues relating to prior and post advances are identified. These issues may be addressed to ease the sanction procedure of loans and facilitate the consumers to comply with the legal formalities. The problems are discussed as under: Problems associated with pre sanction of loans: The overall procedure is a lengthy one thereby taking long duration in final sanction. This not only a time consuming process but also lacks single window service. This involves too much of paper work, making the process tedious. A number of verifications are required that discourages the borrower to avail the credit facility offered by the bank. The terns of agreement might sound ambiguous to the borrower leading to further misconception regarding the conditions stated in the loan agreement. There is a fixed limit on the amount of loans that can be sanctioned by the branch. For limits exceeding such an amount, the approval of Regional Office needs to be taken. This again consumes a lot of time. There are a number of instances where there remain certain discrepancies regarding the terms and conditions of loans between bank branch and regional office. Problems associated with post sanction of loans: Despite of regular monitoring of the accounts, certain accounts result in NPA. Recovery of NPA is a major cause of concern.

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CONCLUSION AND RECOMMENDATION The conclusion based on the cases that were witnessed in due course of time brings forth certain recommendations. The suggested recommendations may include the following: A thorough analysis of any proposal is required in the preliminary stage so that chances of such a loan account being NPA in future is forecasted well in advance and minimized. Similarly, as soon as the accounts slip into Special Mentioned Accounts (SMAs), strict and regular follow ups are essential to save them from turning into loss accounts. Moreover, incorporation of a Z-score Model to assess the bankruptcy chances of the prospective borrower in near future would prove to be of great help.

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ATTATCHMENT BALANCE SHEET INDIAN OVERSEAS BANK

BALANCE SHEET

------IN Rs. CRORES------

Mar '04

Mar '05

Mar '06

Mar '07

Mar '08

12 mths

12 mths

12 mths

12 mths

12 mths

544.80 544.80 0.00 0.00 1,385.57 150.72 2,081.09

544.80 544.80 0.00 0.00 1,888.57 141.82 2,575.19

544.80 544.80 0.00 0.00 2,510.17 122.47 3,177.44

544.80 544.80 0.00 0.00 3,327.59 117.97 3,990.36

544.80 544.80 0.00 0.00 4,197.90 113.97 4,856.67

Deposits Borrowings Total Debt

41,482.58 729.47 42,212.05

44,241.24 590.68 44,831.92

50,529.32 736.63 51,265.95

68,740.41 2,896.23 71,636.64

84,325.58 6,353.65 90,679.23

Other Liabilities & Provisions Total Liabilities

3,028.88 47,322.02 Mar '04

3,407.94 50,815.05 Mar '05

4,914.43 59,357.82 Mar '06

6,629.82 82,256.82 Mar '07

6,323.84 101,859.74 Mar '08

12 mths

12 mths

12 mths

12 mths

12 mths

4,332.22 912.87 20,294.86 20,171.64

4,175.44 778.52 25,205.19 19,014.72

3,077.96 629.28 34,756.20 18,952.28

4,686.11 4,293.19 47,060.29 23,974.47

9,124.23 1,217.09 60,423.84 28,474.71

739.60 339.28 400.32

819.56 375.05 444.51

865.33 419.40 445.93

1,000.13 509.20 490.93

1,102.80 569.11 533.69

3.71 1,206.40 47,322.02

7.84 1,188.84 50,815.06

11.80 1,484.35 59,357.80

19.73 1,732.11 82,256.83

24.88 2,061.29 101,859.73

7,282.71 5,759.66 35.43

4,849.95 5,268.43 44.67

9,658.91 6,321.79 56.08

15,846.11 8,427.48 71.08

24,173.83 10,215.01 87.05

Capital and Liabilities: Total Share Capital Equity Share Capital Share Application Money Preference Share Capital Reserves Revaluation Reserves Net Worth

Assets Cash & Balances with RBI Balance with Banks, Money at Call Advances Investments Gross Block Accumulated Depreciation Net Block Capital Work In Progress Other Assets Total Assets Contingent Liabilities Bills for collection Book Value (Rs)

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REFERENCES  Pandey I. M., 2007. Ninth Edition. Financial Management. Noida: Vikas Publishing House  Indian Overseas Bank, 2008. Introduction Program for Probationary officers  Zacharias K.D. and Ramamurthy G.M., 2008. Legal and Regulatory Aspects of Banking. New Delhi: Rajiv Beri for Macmillan India Ltd.  Indian Institute of Banking and Finance, 2008. Second Edition. Principles and Practices of Banking. New Delhi: Rajiv Beri for Macmillan India ltd.  Iyenegar Vijayaragavan, 2007, First Edition. Introduction to Banking New Delhi: Excel Books

Valuable insights provided by:

Company Guide- Mr. Rakesh Kumar Niraj Assistant Manager, Loans and Advances Department Indian Overseas Bank

Faculty Guide- Prof. Dipanker Dey

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GLOSSARY Bill Finance: Financial assistance provided by the bank against the bills that includes bills purchased and bills discounted. BPLR: Benchmark Prime Lending Rate Cibil: Credit Information Bureau India Limited CRISIL: DPG: Deferred Payment Guarantee, Payment of Bank guarantee on installments. DPN: where no specification for a fixed period for the repayment of loan is given, the bankers take a DPN. In DPN, the borrower makes a promise to the banker to repay the loan amount on demands with agreed rate of interest. This is duly stamped, thus acting as evidence in a court of law. KMC: Kolkata Municipal Corporation MPBF: Maximum Permissible Bank Finance NEFT: National Electronic Fund Transfer Overdue: any amount due to the bank under any credit facility is „overdue‟, if it is not paid on the due date fixed by the bank. Out of order: if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power, the accounts are treated as out of order. Similarly if the amount due is less than the sanctioned amount but there are no credits continuously for more than 90 days and the amount is not enough to cover the interest debited during the same period, the account is treated as out of order. PAT: Profit After Tax PBF: Permissible Bank Finance

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RTGS: Real Time Gross Settlement SECURED CREDITOR: Any bank or financial institution and includes TNW: Tangible Net Worth

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