SVKMS NMIMS
Mukesh Patel School of Technology
Management
Interim Report
On
Credit Risk Management of an Indian
Corporate by an Indian Bank
By
Santhosh Sasnoor
I032
71110110011
Faculty Mentor
Prof. Ravindra Phadke
Industry Mentor
Mr. Adil Cooper
Contents
Introduction........................................................................................................... 2
Central Bank of India.......................................................................................... 2
Credit Department.............................................................................................. 2
Project Description................................................................................................. 3
Fund Based......................................................................................................... 3
Term Loan........................................................................................................ 3
Cash Credit...................................................................................................... 3
Over Draft........................................................................................................ 3
Packing credit.................................................................................................. 3
Non-Fund Based................................................................................................. 4
Letter Of Credit................................................................................................ 4
Bank Guarantee.............................................................................................. 4
Balance Sheet, CMA analysis..............................................................................4
Internal Risk rating............................................................................................. 5
Industry Risk.................................................................................................... 5
Business Risk................................................................................................... 6
Management Risk............................................................................................ 6
Financial Risk................................................................................................... 6
Executive Brief................................................................................................... 8
Outcomes/Learnings......................................................................................... 14
Tasks completed and Future tasks....................................................................14
Introduction
Central Bank of India
Central Bank of India was the first Indian commercial bank which was wholly
owned and managed by Indians. During the past 102 years of history the Bank
has weathered many storms and faced many challenges. The Bank could
successfully transform every threat into business opportunity and excelled over
its peers in the Banking industry.
Corporate Vision:
To emerge as a strong, vibrant and pro-active Bank/Financial Super Market and to
positively contribute to the emerging needs of the economy through consistent
harmonization of human, financial and technological resources and effective risk
control systems.
Corporate Mission:
To transform the customer banking experience into a fruitful and enjoyable
one.
To leverage technology for efficient and effective delivery of all banking
services.
To have bouquet of product and services tailor-made to meet customers
aspirations.
The pan-India spread of branches across all the state of the country will
be utilized to further the socio economic objective of the Government
of India with emphasis on Financial Inclusion.
Credit Department
The credit department of Central Bank of India handles the credit and risk
management of the clients. This process is an ongoing process. Various steps
involved in this process are:
1. Receipt of an application from the customer.
2. Receipt of documents (PAN No. Balance Sheet, CMA Data, KYC Papers,
Registration No. MOA, AOA, Properties Documents such as Architects
Report, etc.)
3. Pre-Sanction visit by bank officers.
4. Check for RBI Defaulters list, CIBIL Data (external rating), ECGC caution
list, etc.
5. Valuation reports of the properties to be obtained from certified Charter
Accountant.
6. Activity and Industry Analysis i.e. SWOT Analysis, STEEPLE Analysis
7. Verification of Financial and Company data via MCA (Ministry of Company
Affairs).
8. Preparation of Financial Data.
9. Risk assessment using Internal Rating System, Ratio Analysis and
Sensitivity Analysis.
10.Proposal Preparation using all data to establish a drawdown and
repayment schedule.
11.Assessment of proposal
12.Sanction/Approval of proposal by Asst. General Manager of the branch.
13.Documentation, Agreements and Securities.
14.Disbursement of Loan.
15.Post sanction activities such as receiving stock statements, review of
accounts, renew of accounts, Inspection, etc. (On regular Basis)
Project Description
Assessing credit risk management of an Indian Corporate by an Indian Bank is a
vast and an ongoing process. An Indian Corporate can avail different credit
facilities. These are classified into two major types.
Fund Based
It is any credit facility which involves direct outflow of the banks funds to the
borrower. Different types of FB facilities are Term Loan, Cash Credit, Overdraft
and Packing Credit.
Term Loan
It is a credit facility that allows the borrower to draw a lump sum of capital
(although occasionally drawings may be made in several tranches) during a short
period after execution of the loan agreement. Such a loan is usually taken out for
a specified purpose, such as setting up a business/ factory or funding an
acquisition.
The term loan is usually a committed facility, which means that the bank is
obliged to advance monies at the borrowers request, and is not usually on
demand. The repayment of the loan is structured in accordance with an agreed
repayment schedule, the most common methods being by way of amortization,
which means that the loan is repaid in equal amounts at regular intervals over
the term of the loan. Once repaid, an amount cannot then be re-borrowed.
Term loans are further classified in three categories depending upon the period
of repayment as under:
Short term repayable in less than 3 years.
Medium term loans repayable in a period ranging from 3 years to 7 years.
Long term loans repayable in a period over 7 years.
Cash Credit
It refers to credit facility in which borrower can borrow any time with in the
agreed limit for certain period for their working capital need and allows for
flexible drawdown of funds as and when required. It secured by way of
Hypothecation of stock (primary security) and Debtors and all other current
assets of the business generated during the course of business. Cash credit can
also be secured by way of mortgage of immovable properties (collateral security)
It is different from a conventional loan, in that the debtor does not have to
receive the entire amount of the loan at one time. It's also different from a line of
credit, as the amount of resources extended are pre-approved and the
repayment schedule is the same whether the debtor is actively using the cash or
not.
Over Draft
An overdraft allows a current account holder to withdraw in excess of their credit
balance up to a sanctioned limit. It is a type of revolving loan where deposits
(credits) are available for re-borrowing, and interest is charged only on the daily
overdraft (debit) balance. It secured by way of Mortgage of immovable properties
and pledge of F.D., Bonds, shares securities, Gold & silver and any physical asset
and Hypothecation of Stock and Debtors and all other current Assets of the
business generated during the course of business.
Packing credit
It is a credit facility which sanctioned to an exporter in the Pre-Shipment stage.
Such credit facilitates the exporter to purchase raw materials at competitive
rates and manufacture or produce goods according to the requirement of the
buyer and organize to have it packed for onward export. It secured by way of
Hypothecation of Stock of goods and Debtors and all other current Assets of the
business generated during the course of business.
Non-Fund Based
Credit facilities that do not involve any actual deployment of funds by bank but
help the obligation to obtain certain facilities from third parties, are as termed as
non-fund based facilities. These facilities include issuance of letter of credit,
issuance of guarantees, which can be performance guarantee/financial
guarantee.
Letter Of Credit
When a buyer or importer wants to purchase goods from an unknown seller or
exporter. He can take assistance of bank in such buying or importing
transactions. It is a letter from a bank guaranteeing that a buyer's payment to a
seller will be received on time and for the correct amount. In the event that the
buyer is unable to make payment on the purchase, the bank will be required to
cover the full or remaining amount of the purchase.
Letters of credit have become a very important aspect of international trade due
to the nature of international dealings including factors such as distance,
differing laws in each country and difficulty in knowing each party personally. The
bank acts on behalf of the buyer (holder of letter of credit) by ensuring that the
supplier will not be paid until the bank receives a confirmation that the goods
have been shipped.
Bank Guarantee
It is a guarantee issued by a banker that, in case of an occurrence or nonoccurrence of a particular event, it guarantees to fulfil the loss of money as
stipulated in the contract. It may of various types like Financial Guarantees,
Performance Guarantees and Deferred Payment Guarantee.
In other words, if the debtor fails to settle a debt, the bank will cover it. It
enables the customer (debtor) to acquire goods, buy equipment, or draw down
loans, and thereby expand business activity.
The various tasks performed in each project undertaken are.
Balance Sheet, CMA analysis
The balance sheet and financial statements of the clients are acquired and are
analysed. This task needs to make a CMA report on the financial of the company
according to the Annual reports provided. The output of this task is an Excel
sheet called CMA sheet with all the financial data required to assess the credit
risk for an Indian Corporate is generated.
Credit Monitoring Arrangement (CMA) data is a very important area to
understand a companys financial standing. It is a critical analysis of current &
projected financial statements of a loan applicant by the banker.
It contains 7 statements as follows:
i.
ii.
iii.
iv.
v.
vi.
Particular of Existing & proposed limits: It contains the present
fund & non-fund based credit limits of the borrower and their usage
limits and history. The proposed or applied limit of the borrower is also
mentioned along with the outstanding amount.
Operating statement: It indicates the business plan of the borrower
which gives the current sales, direct & indirect expenses, Net Profit
along with the projections of sales, expenses and different positions for
next 2-4 years based on the banks request. This statement is a
scientific analysis of current & projected financial and profit generating
capacity of the borrower.
Analysis of Balance sheet: This statement gives the detailed
analysis of current & noncurrent assets, fixed assets, cash & bank
position, current & noncurrent liabilities of the borrower. It also
indicates the net worth position of the borrower for the projected years.
Balance sheet analysis gives a complete financial position of the
borrower and cash generating capacity during the projected years.
Comparative statement of Current Asset & liabilities: It gives the
comparative analysis of current assets & current liabilities movement
of the borrower. It helps in deciding the actual working capital cycle for
the projected period and the capacity of the borrower to meet their
working capital requirements.
Calculation of MPBF: It calculates the borrowers working capital GAP
and permissible finance in two lending methods, first method of
lending will allow the MPBF 75% of the net working capital GAP which is
Current assets less current liabilities, Second method of lending will
allow the MPBF 75% the current assets less current liabilities. So only
the MPBF limit is the cash credit component of the borrower which
generally known Drawing power (DP Limit). So this is very important
statement which decide the borrower`s borrowing limit from the bank.
Fund flow statement: Fund flow statement analysis for the current &
projected period is one of the statements in CMA data. This statement
analyses borrower fund position with reference to the working capital
analysis given in MPBF calculations & projected balance sheets. Basic
objective of this statement capture the funds movement of the
borrower for the given period.
vii.
Ratio analysis: This is the last statement which gives the key ratios to
the banker based on the CMA data prepared and submitted to the bank
for finance. Basic key ratios are Gross profit ratio, net profit ratio,
current ratio, DP limit, MPBF, Net worth, ratio of net worth with
Liabilities, quick ratio, stock turnover, asset turnover, fixed asset
turnover, current asset turnover, working capital turnover, Debt-Equity
ratio, etc.
Internal Risk rating
There is always a certain amount of risk involved in any facility availed by the
banks. The creditability of a customer is calculated taking into account all
aspects of the project giving appropriate weightage to the four components. The
weightage is decided according to the industry in which the business is operating
into. The final customer rating assigns him into a risk category which helps in
pricing of that loan.
Industry Risk
i.
ii.
It is evaluated based on demand-supply gap, govt. policies, Input related
risk and the extent of competition. The parameters include:
Industry Characteristics:
o Industry Prospects
o Impact of Government Regulations
o Key Input Risks
o Extent of competition
Industry Financials:
o Operating Margin (%)
o Return on Capital Employed (%)
Business Risk
It is evaluated on the basis of efficiency in production/trade, realization and
conducts of business vis--vis the policies. The parameters include:
i.
Operating Efficiency:
o Capacity Utilization
o Product design and development
o Availability of skilled labour
o Employee cost
ii.
Market Position:
o Brand Equity
o Customization of products
o Consistency of quality
o Product Range
Management Risk
It is evaluated based on the managerial ability and track record of the
management, professional and technical skill. The parameters include:
i.
Management
o Industry Experience
o Managerial Competence
o Business and Financial Policy
o Working Capital Management
o Corporate Governance
ii.
Track Record:
o Ability to meet sales projection
o Ability to meet profit projection
Financial Risk
This probably is the most important part of credit appraisal of a business loans as
it expresses the entire project in monetary terms. Financial appraisal tries to
assess the reasonability of the estimates of costs and expenses and also the
projected revenues. These may include the overall cost of project and the means
of financing.
Basically, it takes the financial statements of previous two audited periods and
the current period in order to forecast the future financial position for at least till
the loan matures. From that, the cash flows of each year are used to calculate
ratios like Debt Service Coverage Ratio, Current Ratio, Debt-equity ratio, and
Internal Rate of return (IRR).
These ratios are then compared with bank standards to determine feasibility of
project. The parameters include:
i.
Current Ratio: It is a liquidity ratio that measures a company's ability
to pay short-term obligations.
The formula is: Current Ratio =
Total Current Assets
Total Current Liabilities
The ratio is used to determine company's ability to pay back its short-term
liabilities (debt and payables) with its short-term assets (cash, inventory,
receivables). The higher the current ratio, the more capable the company is of
paying its obligations. According to Banks policy, Current ratio should be
minimum 1.33: 1.
ii.
Debt-Equity Ratio: It gives a measure of a company's financial
leverage calculated by dividing its total liabilities by stockholders'
equity. It indicates what proportion of equity and debt the company is
using to finance its assets. According to Banks policy, D-E ratio should
be maximum 3: 1.
The formula is:
DER =
Long Term Liabilities
Tangible Net Worth
A high debt/equity ratio generally means that a company has been aggressive in
financing its growth with debt which can result in volatile earnings as a result of
the additional interest expense and ultimately lead to bankruptcy.
iii.
TOL/TNW: This ratio reflects the relationship between capital
contributed by creditors relative to what is contributed by owners. From
a lender's perspective a lower TOL/TNW is better as it demonstrates a
larger owner commitment and rules out the company from bankruptcy.
According to Banks policy, TOL/TNW ratio should be maximum 4: 1.
The formula is: TOL/TNW =
iv.
Totla Outside Liabilities
Tangible Net Worth
Asset Coverage ratio: It determines a company's ability to cover
debt obligations with its assets after all liabilities have been satisfied.
According to Banks policy, ACR ratio should be minimum 1.5: 1.
The formula is: ACR =
v.
Total chargeable assets +value of collateral security
Total Indebtness
Fixed Asset coverage ratio: It determines a firm's ability to uphold
its debt payments with all of its fixed assets. It helps banks to analyse
if the loans given against fixed assets are safe or not. According to
Banks policy, FACR ratio should be minimum 1.5: 1.
Total
The formula is: FACR =
vi.
Total term loan
Debt-service coverage ratio: It is the
loan assessment. It determines the cash
interest, principal and lease payments.
easier it is to obtain a loan. According
should be minimum 1.5: 1.
The formula is: DSCR =
vii.
assets
most important ratio for term
available for debt servicing to
The higher this ratio is, the
to Banks policy, DSCR ratio
Net Income+ Deprecetion +Other noncash expenses
Principle Repayment + Interest Payment
Interest coverage ratio: It is a measure of a company's ability to
meet its interest payments. The lower the interest coverage ratio, the
higher the company's debt burden and greater is the possibility of
bankruptcy or default. A lower ICR means less earnings are available to
meet interest payments and that the business is more vulnerable to
increases in interest rates.
The formula is: ICR =
EBIT
Interest Expense
The financial risk is given maximum weightage for approving any loan proposal
and it is the only component which is absent from any kind of subjectivity. The
limitations within this rating system reside in the qualitative factors which may
be interpreted differently for different types of borrowers.
The bank uses Risk Assessment Model (RAM) of CRISIL Risk and Infrastructure
solutions. As per Basel guidelines the rating system has to be two dimensional
i.e. combined rating should be a product of borrower rating and facility rating:
1. Borrower rating gives the Probability of Default (PD) which is denoted as OR
and the ratings will be from OR1 to OR10.
2. Facility rating gives Loss Given Default (LGD) which is denoted as FR and the
ratings will be from FR1 to FR8.
The individual parameter scores are multiplied by their weights in order to arrive
at individual risk ratings. Those scores are further multiplied by their weightage
and the aggregate scores are converted into 10 alphabetic grades which
are indicative of the default risk associated with the borrower. The resultant
rating i.e. PD*LGD will be the combined rating. This will be denoted by CBI-I to
CBI-X where CBI-X would be the lowest.
Overall Weighted Risk
score
8.5 - 10
7.5 - 8.5
6.5 - 7.5
5.75 - 6.5
5.5 - 5.75
4.25 - 5.5
3.5 - 4.25
2.5 - 3.5
1.5 - 2.5
0 - 1.5
Risk Grade
Grade Description
CBI-I
CBI-II
CBI-III
CBI-IV
CBI-V
CBI-VI
CBI-VII
CBI-VIII
CBI-IX
CBI-X
Highest Safety
Very High Safety
High Safety
Adequate Safety
Moderate Safety
Sub-Moderate Safety
Inadequate Safety
High Risk-Prone
Vulnerable to Default
Default/Extremely
Speculative
Executive Brief
This is the proposal created by the bank for each corporate. This contains not
just the financial data but also the other details regarding the credit facility and
various parts of it like, securities, limits entailed, details of the directors, risk
involved, etc. This task gives an Executive Brief document of the corporate as an
output. This document is used for making the decision of disbursing the
requested credit facility to the corporate.
Some of the important aspects of an executive brief are,
1. Purpose of the proposal:
The purpose of the proposal is to be specified in this portion. For example
if there is a modification in the terms of the facility, to renew the facility, to
review the facility, etc.
For example: If a borrower is enjoying a term loan facility with the bank
and there are some changes in the terms of the facility like the ROI of the
facility has been increased and the limits of the facility have been
decreased. Then the proposal according to the purpose is to be made.
That is as there is no availment of any other facilities the proposal is to be
made accordingly.
2. Limits Recommended:
This table contains the details of the credit facility(s) availed to the
borrower by the bank. The details like the amount of credit availed,
various facilities availed and the limits of each facility, the rate of interest
at which the credit is availed, the margin that is the amount the borrower
has to invest, the proportion of the banks share in the facility that is in
case of a consortium.
3. Risk rating:
The risk involved is calculated by various rating agencies like CARE, CIBIL,
etc. This is the external rating. Rating agencies rate corporates and
release reports, these are the sources of the external rating. The validity
period of an external rating is 1 year.
The risk calculated internally by the bank is also specified in this table. The
risk as explained before is divided in to four parts. Risk regarding all the
parts is specified.
4. Pricing and other charges:
In availing a credit facility the bank has to do various tasks like
documentation, inspection, processing, etc. The charges for these
activities are described in this table.
5.
c
PRICING /COMMISSION/UPFRONT FEE/PROCESSING /OTHER CHARGES
Approval
for As per Rating /Policy
pricing
Rate of Interest
PC/PCFC
EBP/EBD/ EBRD
Upfront Fee
Processing
charges
Inspection
Charges
Commission etc
LC/ LG/ SBLC
Documentation
Charges
Recommended
by Br/RO/ZO
Proposed
by CO
The bank charges an interest rate on a credit facility which has two
components:
10
i. Base rate, which depends (fluctuates) upon monetary policy of RBI.
ii. Additional rate of interest, which depends upon the risk rating of the
borrower. In other words, the bank is charging an additional interest to
compensate for the risk involved in case of default by the borrower.
Here As per Rating Policy is based on the internal rating done on the
corporate. As per policy according to the rating the rate of interest limit is
proposed. This may not be the final ROI. For example the rating of the
corporate stands at CBI-IV then the additional rate is 2.5%.
5. Deviations from Policy:
This table contains the ratios that are deviating from the policy. That is as
explained above the current ratio of the corporate as per policy should be
greater than 1.33. This may not be the case in all cases. So if there is any
deviation from the policies they are specified in this table.
6. Sharing Pattern:
In case of a consortium, that is if a facility availed to a borrower is shared
by various other banks it is called a consortium. The share of each bank in
the total facility is specified in both Fund based and non-fund based
facilities.
7. Securities:
The security given by a borrower is classified into two broad kinds.
Primary: It is the security on which the loan is availed. In simpler
terms if a borrower is taking a loan of Rs.100 crores on his plant and
machinery. Then the tangible assets of the borrower are the primary
security.
Collateral: Apart from Primary security the borrower is expected to
give other assets like real estate, gold, etc. these are the collateral
security to the bank. These two run side by side.
8. Details about the Borrower:
Various details about the borrower are also specified in the document like
Board of Directors of the corporate, shareholding pattern, Industry details,
brief history, strengths and weaknesses of the company, etc.
9. Group Details:
If the corporate is a subsidiary of a group then the details of the group are
collected. Details like group exposure, group financials, etc.
11
10.
Financial Indicators:
The financial parameters of the corporate for past few years are specified
here.
10. Financial Indicators
Paid-Up Capital
Reserves & Surplus
Intangible Assets
Tangible Net Worth
Adjusted TNW
Long Term Liabilities
Unsecured loans from
Promoters
/
family
included under (5)
Capital
(4)+(6)
Net Block
(Rs. in crores)
FY
FY
FY
FY
FY
Audite
d
Audite
d
Audite
d
Estimate
s
Projection
s
Employed
10 Investments
11 Non-Current Assets
12 Current Assets
13 Current Liabilities
14 NWC
15 Net Sales
Domestic
Export
% Growth
16 Long Term Sources
17 Long Term Uses
18 Surplus/Deficit
19 Short Term Sources
12
20 Short Term Uses
21 Surplus/Deficit
22 FACR
23 Return on Equity %
24 Return on Assets %
The data for past few years is calculated using the CMA data generated in
the previous stage. The estimates and projections of the next year and the
following years is also collected from various sources like the corporate itself and
specified. Comments on the various important indicators are made and specified.
The reasons of any changes are specified in the comments.
11.
Ratios:
The data on the various ratios are specified in this table. These are
calculated while CMA data is created.
10.2 RATIOS:
Particulars
1
2
3
4
5
6
7
8
9
1
0
1
1
1
2
1
3
(Rs. In crores)
FY
FY
FY
FY
FY
Audited
Audited
Audited Estima
tes
Projectio
ns
Current Ratio
Debt/Equity Ratio
TOL/TNW Ratio
TOL/TNW Ratio with
unsecured loan as
quasi
capital
&
included in Net Worth
Gross Profit
EBIDTA
Net Profit Before Tax
Net Profit After Tax
% of growth
Depreciation
Cash Accruals
Gross Profit margin %
Net Profit margin %
Debt/EBIDTA %
13
12.
Calculation of MPBF:
As per the recommendations of Tandon Committee, the corporate are
discouraged from accumulating too much of stocks of current assets
and are recommended to move towards very lean inventories and
receivable levels. As per this method the borrower should finance 25%
of all current assets from owned funds and long term liabilities and the
balance will be financed by the bank. In this way the MPBF is calculated.
11.
b
1
2
3
4
5
6
7
8
9
9
Calculation of MPBF on sales estimates of . for the year ending
(Amt. in Crores)
Last Years Estimates for Following Year
Audited
the
current Projections.
FY2014
year ending FY2016
FY 2015
Net Sales
Total Current Assets
Total Current Liabilities (Other
than Bank borrowings)
Working Capital Gap( 2-3)
Min. required margin (25% of
CA
excluding
export
receivables)
Actual/Projected NWC
Maximum Permissible Bank
Finance (4-6)
Total
working
capital/
borrowing limits (4-7)
7 or 8 whichever is lower
Excess Borrowings (8-7)
13.
Letter of Credit:
If the borrower is availed any LC facility. The limits of LC, assessment of LC
are to be specified in this portion. The justification to the actions is also to
be specified.
14.
Bank Guarantee:
If the borrower is availed any Bank Guarantee facility. The assessment of
the BG, limits of BG and the justification of the actions are to be specified
in this portion.
14
Outcomes/Learnings
1. Analysing the Annual reports according to the facility requested.
2. Creating a CMA report using the audited Annual reports.
3. Calculating the risk involved that is internal risk rating using a software
Risk Assessment Model of Central Bank of India.
4. Creating Executive brief that is the proposal for the Requested corporate.
Tasks completed and Future tasks
In the four weeks work at Central Bank of India I have learnt the process of
assessing a credit facility for an Indian Corporate. This process has been
repeated for various companies enjoying the facility of Working Capital Loan with
Letter of Credit, Bank Guarantee till now. In the future the same is to be
continued for various other companies using other credit facilities like Term Loan.
15
