CREDIT MANAGEMENTOVERVIEW AND PRINCIPLES OF LENDING

What is Credit Credit is defined as confidence in

borrowers ability & intentions to repay the loan extended to him by the creditor. Credit has become an integral part

of modern industrialization economies. It has been

considered as oil of the commerce. It contributes to the industrial growth and economic development. What is Credit Management Credit Management usually deals with the credit vetting of the customers,

allocation of available funds to different sectors/segments

of the economy, diversifying the applicable risk in extending credit, internal funds movements & reconciliation, as also maintaining relations with the customers

Goals of Credit Management in Banks

Optimize the mix of Banks assets Minimize bad debt loss Analyze customer credit risk Maintain financial flexibility Be responsive to individual customer Respect overall corporate financial constraints Credit Managers must become strategic partners in business operations 8. Credit Managers should learn how to manage people of different culture 9. A Credit system is a foundation stone of modern economy 1. 2. 3. 4. 5. 6. 7.

 Credit Management has two facets :

Credit Appraisal

Credit Monitoring

 Credit Appraisal deals with the evaluation of credit needs of the

borrower, his worthiness, his ability, his risk, policy regarding extension of credit to the borrowers, terms and conditions of the credit, sanctioning process of the Bank and involves a decision whether to extend the credit or not to the customer- pre sanction stage. Once a decision to extend the credit is taken, the borrower is asked to complete all the formalities of the terms and conditions, signing of the documents etc.(Pre disbursal stage). After which the

credit is disbursed to the borrower.

 Credit Monitoring This is a post disbursal period and is very

important for the banker since the health of the unit is determined during this phase. Banks are required to keep constant watch on

the unit vis--vis the loan account after disbursal of the loan, to
ensure that the amount disbursed to the unit is safe, is being utilised for the purpose extended (ensuring end use of funds), generates income and does not turn out to be sick. There are three types of follow up that constitutes credit monitoring

a) Financial follow up
b) Physical follow up c) Legal follow up

 Warning Signals
The loan account by itself would indicate explicitly the quality of the loan. There are bound to be warning signals before an account goes bad viz.,

(i)

Reductions in credits (deposit entries) in the loan account if it is

a working capital account.

(ii) Issuing cheques to the creditors by the borrower in excess of the limit/Drawing Power (DP) available in the account, thereby frequent returning of these cheques.

(iii) Delays and defaults in repaying the interest/ installments.

(iv) Non-submission/Delay in submission of the stock statements and/or financial data to the Bank. There is a need to identify these signals emanating from a loan a/c.

If the Bank does not take prompt follow up action, it could result in
further defaults, thereby leading to a further degeneration in the quality of the loan and create problem loans.

Basic Requirement of Lending

Capital (register) Credit Monitoring Documentation Legal Remedy Risk Management Credit Information

 Documentation The Banker grants financial facility to its customer under a valid contract, the terms and conditions of the financial assistance are

enumerated. Further, the terms of repayment as well as the

consequences in the event of breach of conditions are enumerated. As a part of initial exercise, during the post sanction phase, the bank obtains certain documents from the borrower/competent authority of the borrowing Company duly signed so as to bind the borrower legally and enforce charge. The importance of the documents lies in the fact that with proper documentation in force, there will not be any problem in enforcing a

claim by the bank in case of a default by the borrower.

LEGAL REMEDY
In case of persistent default by the customer, where all other measures taken by the banker including reviving of the unit are not successful, the recourse open to the bank is i. Enforce the repayment or enforce the security available through

the Court of Law. A common complaint of the banks and financial

institutions had been that they were facing enormous bottlenecks in the recovery of loans through the Civil Courts. In view of this the Government took initiative and established Debt Recovery Tribunals (DRTs). However, even after establishment of DRTs, enforcing security is still a time consuming process.

(ii)

To enter into a compromise proposal with the defaulting

borrower.

(iii)

On recommendations of Narsimahan Committee for the purpose of examining Banking Sector reforms, the GOI promulgated Securitization and Reconstruction of Financial Assets and

Enforcement of Security Interest Ordinance 2002 (SARFAESI)

which was later on replaced by an Act . The provisions of this act will enable Banks and Financial Institutions to exercise power in

taking over the possession of the securities, sell them and reduce
their non-performing assets.

SARAFESI ACT, 2002

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARAFESI) It empowers banks /FIs to recover their non-performing assets,

without the intervention of Court.

 The Act provided three alternative methods of recovery of nonperforming assets:

Securitization

Asset Reconstruction
Enforcement of Security without the intervention of Court

The provisions of this act are applicable to NPA loans with outstandings above Rs. 1 lac. NPA loan accounts where the amount is less than 20% of the principal and interest are not eligible to be

dealt with under this Act.

Non performing assets should be backed by securities charged to the Bank by way of hypothecation or mortgage or assignment.

Security interest by way of pledge, lien, hire purchase, lease are not
liable for attachment under this act.

 The act empowers the banks

To issue demand notice to the defaulting borrower and guarantor, calling upon them to discharge their dues in full within 60 days from the date of notice. To give notice to any person who has acquired any of the secured

assets from the borrower to surrender the same to the Bank.

To ask any debtor of the borrower to pay any sum due or becoming due to the borrower.

CAUTION: ANY SECURITY INTEREST CREATED OVER AGRICULTURAL LAND CAN NOT BE PROCEEDED WITH.

 If on receipt of demand notice, the borrower makes any

representation or raises any objection, Authorised officer shall consider such representation or objection carefully and if he comes to the conclusion that such representation or objection is not acceptable or tenable, he shall communicate the reasons for non-

acceptance within one week of receipt of such representation or

objection. A borrower/guarantor aggrieved by the action of the Bank can file an appeal with DRT and then

 With DRAT, but not with any Civil court. The borrower/guarantor is
required to deposit 50% of the dues before filing the appeal. If the borrower fails to comply with the notice, the Bank may take recourse to one or more of these measures:
Take possession of the security

Sale or lease the right over the security

Manage the same or appoint any person to manage the same.

 Illustration:
Excel Bank Ltd. has sanctioned following credit limits to Andheri Enterprises Ltd.: Cash- Credit Rs. 20 cr Bills Discounting Rs. 5 cr Term Loan Rs. 0 cr L/C Rs. 5 cr The stock statement submitted by M/s.Andheri Enterprises as on 30/06/2010 is as follows : Raw Material : 8 cr WIP Rs.3 cr FG: Rs. 8 cr Receivables: Rs.8 cr (including receivables of Rs. 2 cr which are more than 6 months & excluding those included under Bills Discounting Limit).

 The present outstanding as on 15/10/2010 in Cash-Credit account are Rs.22 cr (including overdrawing) and the account has remained continuously irregular since 14/09/2010 First Term Loan installment of Rs. 2cr and quarterly interest amounting to Rs.0.60 cr has also remained unpaid till date. Further, Bills discounted limit is fully utilised, however, bills amounting to Rs.1.60 cr due for retirement till date also remained unpaid. The margins applicable to RM, WIP, FG, Receivables are 30%, 40%, 30%& 40%. 8 Cheques amounting to Rs.3.40 crs have been recently returned for want of required DP in the account.

Question:
Calculate the amount of irregularity in the account as on date. What action should the bank take under the circumstances.

Risk Management : Banks Traditional role is to mobilize the funds from the household sector/surplus from the Corporates and deploy it with the household and Corporate Sector for consumption/productive purpose. Its role is that of intermediary. As such Banks are exposed to various risks. The price at which the Banks mobilize and transfer funds depend on two parameters the time for which the funds are made available and credit worthiness of the person to whom the funds are made available. Considering long term loans are priced higher than short term loans and a high risk borrower pays a higher price (interest), banks will have to factor liquidity risk and/or credit

credit risk to earn spreads. There is also a definite linkage between

the various risks faced by the banks. For example, if the bank charges a client floating rate of interest, in case of increasing rate

scenario, the banks interest rate risk will be lower. Consequently,

the payment obligations of the borrower increases. Other things remaining constant, the default risk increases if the client is not able to bear the burden of the rising rates. There are many instances where the interest rate eventually leads to credit risk. Top priority of the banks is to improve their asset quality by minimizing and managing their credit risk. A robust credit risk management framework with a proper risk management model

coupled with the sound/speedy legal framework improves the quality

of the assets.

Another technique being employed by the Banks to reduce interest and

liquidity risk is Asset-Liability Management (ALM). ALM has both macro and micro level implications.

At macro level it leads to the formulation of critical business policies,

efficient allocation of capital and designing of products with appropriate pricing strategies. At micro level, the objective is two fold it aims profitability through price-matching and ensuring liquidity by maturity matching. Price

matching maintains spreads by ensuring deployments of liabilities is

at a rate higher than the cost. Similarly, grouping the assets/liabilities based on their maturity profile ensures liquidity. The gap is then assessed to identify the future financing requirements.

Credit Information: Banks and lending institutions have a traditional resistance, to share credit information because of confidential nature of banker-customer relationship. To serve this purpose and to make credit and other data available specialised institutions known as Credit information bureaus have been set up. They serve as repository of current & historical data of the existing and potential customers.

CREDIT INFORMATION BUREAU OF INDIA LTD.(CIBIL)

CIBIL was promoted by SBI, HDFC, Dun & Bradstreet Information services (P) Ltd. to provide credit information of clients to its members. Presently, its shareholding pattern has been diversified to include number of banks and finance companies. CIBIL collects commercial and consumer credit-data and collates
such data to create and distributes credit reports to its members. CIBIL primarily gets information from its members and at subsequent stage will supplement it with public domain information in order to create a truly comprehensive snapshot of an entitys financial track record.

Credit Information Report(CIR)

Credit information report is a factual record of borrowers credit payment history. Its purpose is to help credit grantors make informed lending decisions-quickly and objectively. CIBIL caters to both consumer and commercial sectors. Consumer Credit Bureau covers credit availed by individuals while the Commercial Credit Bureau covers credit availed by non-individuals e.g. partnership firms, proprietary concerns, Private and Public Ltd. companies etc.

Type Of Information Available On Borrower

1.Basic information Name, Address, ID No., Passport ID, Voters ID, Date of birth, Registration No., Date of incorporation, Legal Constitutions, Board of

Directors etc.
1.Record of all the credit facilities availed by the borrower 2.Past Payment history 3.Amount overdue (if any) 4.Suit filed status

5.No. of enquiries made on that borrower by member

INFORMATION NOT INCLUDED IN CIR

- Income/Revenue details - Details of deposits with the banks - Details of the borrowers assets - Value of assets mortgaged - Details of investments

CIBIL itself does not classify any accounts as defaults account. It merely reflects the information of Asset Classification as per members record.

LENDING DECISION: CIBIL CIR only provides available credit information and
does not provide any opinion, indication or comment pertaining whether credit should or should not be granted.

The Credit grantors who have received an application for credit will make the credit decision. CIBIL does not own any responsibility merely on the basis of Credit information provided to the creditor.

RIGHT TO INFORMATION ACT 2005 IS NOT APPLICABLE TO CIBIL CIBIL is not a public authority.

CREDIT FACILITIES EXTENDED BY THE BANKS:

1. RETAIL : Risk Assessment on Scoring Model
Personal Loans: Amount sanctioned: Multiple of Monthly Income/Annual Income, Repayment 5-7 years, Documentation- Loan Application, Loan

Agreement, Demand Promissory Note (DP Note) Check-off facility (if

available), PDCs for EMIs or mandate to debit the account through ECS for monthly repayments.

Consumer loans: To buy consumer goods, Margin Nil to 25%, Repayment

5-7 years, documents as in personal loan additionaly Hypothecation agreement

 Vehicle Loans: Cars/Scooters Margin 5% to 25%, Period 5-7 years, Documents as above, Charge to be registered with RTO, Comprehensive Insurance to include Bank clause

Home Loans: Home Loans against mortgage of property, Equitable

Mortgage is preferred, Credit extended may be 60% to 85% of the cost of house/cost of construction, Period may range from 10 to 30 years depending upon income and age of the borrower. Title Documents relating to property are called for verification of ownership.

Photocopies of these documents are sent to Banks Legal Advisor to seek his opinion regarding ownership of the customer and also to know if the valid equitable mortgage can be created against the

property. Sometimes, if necessary technical report from approved

valuer to know the market value of the property is also called for. Documentation: Home Loan application, Loan agreement, personal guarantee agreements from the acceptable guarantors, Personal guarantee of the spouse/legal heir, Deposit of titles of the property for equitable mortgage, independent letter to be sent by the customer to the bank detailing the details of the property and his independent acceptability to equitable mortgage the property,

Recital to be prepared by the Banker, PDCs or ECS mandate for

EMIs.

Construction of house : Inspection, progressive payments on the basis of architects certificate, if title deed is not available, obtain any other acceptable security for the intervening period. Education Loan: Admission must be granted by a Recognised Institution, good academic track record of the student, Family

financial position, scoring model

MARGIN :
Upto Rs 4 lakhs Nil
Above Rs. 4 lacs : Studies in India 5% Studies Abroad15%Scholarship/ assistantship to be included in margin. Margin may be brought-in on year-to-year basis as and when disbursements are made on a pro-rata basis.

Loan repayment to start as soon as the student gets

employment or within 6 months of the completion of the

course.

 SECURITY :
Upto Rs 4 lacsCo-obligation of parents. No securityAbove Rs.4 lacs and upto Rs7.5 lakhsCo-obligation of parents together with collateral security in the form of suitable third party guarantee. The bank may, at its discretion, in exceptional cases, waive third party guarantee if satisfied with the net-worth / means of parent/s who would be executing the document as joint borrower.Above Rs.7.5 lakhsCo-obligation of

parents together with tangible collateral security of suitable

value, along with the assignment of future income of the student for payment of instalments Loan application, Loan agreement to be signed by the student and parents, personal guarantee agreements (if applicable)

LOAN AGAINST SHARES OF THE LISTED

COMPANIES: Sanctioned both as demand loan or Limit/DP in Current Account. Facility should be extended only in case of listed companies. Amount sanctioned should not be more than 50% of the average market

price of the share. Documents: Application form, DP

Note, Transfer deed duly signed by the shareholder. If

EMI-PDCS/ECS, Bullet Payment.

LOAN AGAINST BANKS OWN FDRS/NSCs etc.

Sanctioned both as demand loan or Limit/DP in Current

Account. Margin 25% Lien of Bank is noted (in case of

NSCs/ KVPs with the issuing Post Office) Documents: FDR/NSCS/KVPs duly discharged by the customer, Application for loan, DP Note.

REVERSE MORTGAGE
It is a contract between the Home owner and the financier/bank, which enables the Home owner to receive a stream of income (monthly/quarterly), from the future realizable value of home. It enables senior citizens/Old age (60 years & above) to get independent income and live honourably Normally banks will provide the stream of income to couple, till the last of two live but may put maximum tenure to 15 years The recovery of loan amount is effected through sale of house after the death of last of couple Even if maximum tenure of income stream is fixed for 15 years, couple can continue to live in the house till last of two is alive

 Legal heirs after death of couple can also pay the loan amount along
with interest and can acquire the house In case if sale of house takes place, any surplus amount after

clearing loan balance is passed on to the legal heirs

In case if the sale amount falls short of the loan amount, loss is borne by the bank Valuation of the property is got done and equity value on which annuity is paid to the couple may range from 60% to 90% of the

property valuation
Property valuation is revisited periodically and if couple requires annuity value can be increased

 Amount of annuity paid to the couple is based on factors like current

valuation, projected appreciation, age of applicant, current interest rates

Higher the age, valuation, more is amount available

Benefit to the Bank:

Bank will be able to get expected return on the principal invested
No risk of account becoming NPA Provisioning and capital adequacy norms still not defined by RBI More profitable to offer mortgage to older people because of less life expectancy

Risk factors for Bank

Life expectancy/mortality risk: May have to pay annuity for longer period, if borrower or spouse live longer. Risk is mitigated by fixing

tenure to 15 years
Interest rate risk: When interest rates move up: Can be mitigated by entering into floating rate contract Real Estate market risk: Depreciation in valuation: Real Estate values seldom depreciate in long run

Benefits to Borrower:
Supplement retirement income Remain economical independent With real estate values increasing, better equity left over for heirs

 No upper age prescribed. In fact more the age, more easy to get loan It is a non recourse loan. Bank can recover the amount only when

last of couple dies

Disadvantage
Non convential retirement tool May disturb emotional attachment Pricing is complex; based on future value, life expectancy, interest

rate risk

 If borrower have two or more spouses, reverse mortgage agreement will include only one and bank will be entitled to sell property accordingly

Closure and servicing cost is high upfront cost, servicing cost

(Insurance etc), closure cost (Margins due to life expectancy& others) Recommendations go only for 15 years or fixed annuity period

2.

COMMERCIAL CREDIT FACILITIES:

Credit Facilities are extended to proprietary firms, partnership firms, SMES/SSIs, Private Ltd. and Public Limited Companies based on

their CRA. The credit facility extended may be either Funded

Facility or Non Funded Facility.

Funded Facilities Non Funded Facilities

FUNDED FACILTIES
Working Capital:
a) b) c) d) Cash-Credit Limit (CC Limit) Temporary Overdraft Limit Bill Discounting CP Linked Working Capital loan

NON FUNDED FACILITIES

Letter of Credits (L/Cs)

Bank Guarantees

Loan for Purchase of Fixed Assets:

a) b) Term Loan Corporate Loan

EXPORT FINANCE
Pre-shipment Finance:
a) Export Packing Credit (EPC) denominated in Rupees b) Packing Credit in Foreign Currency (PCFC) denominated in Euro, Dollar, Pound, Yen

IMPORT CREDIT
Letter of Credit (L/c)
for import of machinery/material etc.

Post Shipment Finance:

a) Foreign Bill discounting Limit

with or without L/C.

LETTER OF CREDIT
It is a financial instrument issued by the bank on application of its customer (importer/purchaser) in favour of exporter/seller, guaranteeing reimbursement of drafts (Bills of exchange) drawn Parties involved:
Applicant-Importer/Purchaser Negotiating Bank Confirming Bank Opening Bank/Issuing Bank Reimbursing Bank Advising Bank Beneficiary

by the exporter/seller for the

supplies upto certain amount and within a specified period as per

terms enumerated in the L/c.

Types of L/cs
Revocable L/c & Irrevocable L/c, Confirmed L/c & Unconfirmed L/c Revolving L/c Transferable L/c Back to back L/c Deferred Payment L/c: Allows Bank to make payment in predetermined installments Anticipatory L/c: Red clause letter L/c, Green Letter clause L/c

Guarantees
Sec.126 of the Contract Act. A contract of guarantee is a contract to

perform the promise or discharge the liability of the third person in

case of his default. The person who gives the guarantee is called surety; the person on whose behalf /default the guarantee is given is called principal debtor and the person to whom the guarantee is given is called creditor/beneficiary. The liability of a guarantor/ surety comes into existence upon the failure of a debtor. If the surety extinguishes the liability of a debtor, then the surety will acquire all the rights of the creditor, known as right of subrogation.

Types of Guarantees
Financial Guarantees
Bid/Tender Guarantee Deferred Payment Guarantee (DPG)

Performance Guarantee
Advance Payment Guarantee (APG) Performance Guarantee (PG) Retention Money Guarantee (RMG )

DPG is a Financial Guarantee and can be said to be a substitute of

Term Loan. Difference between the two is that in case of Term Loan, the lender bank lays down funds to the extent loan extended for the purchase of FA. In case of DPG the bank does not lays down the funds for acquiring FA by the borrower but has to make sure that

the borrower has sufficient cash flows at the time of retirement of

bills drawn by the seller and got discounted by his bank on the strength of the purchaser/importers bank. It is therefore necessary

that the various aspects of appraisal of the project viz. economics of

the project, its technical feasibility and economic viability etc. are assessed in detail, as done in case of Term Loan.