09 - Chapter 4 PDF

CHAPTER 4
Effectiveness on Credit Appraisal

and Internal Rating Systems
4.1 Background
4.2 Methodology
4.3 Features of New Internal Risk Rating Models of Ten
Banks
4.4 Effectiveness of Parameters/Variables as Default
Predictors - Analysis And Findings
4.4 Effectiveness of Risk Rating Models - Analysis and
Findings
4.6 Testing of Hypothesis
4.7 Overall Performance of the Models and Comment on
Hypothesis
4.8 Conclusion
Chapter 4
Effectiveness Of Credit Appraisal And Internal Rating

Systems
4.1 Background
Banks’ credit appraisal and internal ratings of corporate clients are intended to
quantify the expected likelihood of future borrower defaults, A survey of literature
reveals that credit appraisal is a complex activity that involves analysis o f a maze of data
both qualitative and quantitative. Banks have been doing credit analysis ever since they
entered the business of credit dispensation. Till two decades ago, most of the financial
institutes were exclusively relying on the “expert” opinion of credit officers to assess the
credit risk on commercial loans. Universally, banks have been collecting information on
borrower character (reputation), capital (leverage), capacity (volatility of earnings), and
collateral, to decide whether or not to grant credit (Altman & Saunders, 1997). In his
book “Framework for Credit Risk Management” Brian Coyle suggests a simple
framework for lending to corporate customers, CAMPARI and ICE. The mnemonics
stand for issues relevant to the lending proposition: C- Character, A- Ability, M- Means,
P- Purpose, A- Amount, R- Repayment, I- Insurance and I-Interest, C- Commissions and
E- Extras respectively. J.F. Sinkey (1992) identifies five Cs of credit that should be
included in any subjective (qualitative) credit analysis: character (willingness to pay),
capacity (cash flow), capital (wealth), collateral (security), and conditions (economic
conditions).
However, since mid-90s, credit risk modeling has gained increasing impetus
among the banks. With the dawning of information-based technologies, usage of credit
scores to generate loan-level information about a borrower’s inclination to repay the loan
has become a norm. Global giants have commenced measuring the borrower’s credit-
worthiness against a representative database and use the resulting information to decide
whether to sanction a loan and if “yes”, on what terms (Murty, 2002). Credit risk,
however, is very difficult to model. Credit risk models are far more difficult to back-test
than market risk models (Jackson and Perraulin, 2000). Compared to developments in the
international scene on risk methodologies, risk rating systems developed by banks in
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India are yet to evolve and stabilize. Banks in India have developed risk-rating systems
based on their experience and with the help of external consultants. The problem faced by
Indian banks in developing an appropriate model is the lack of huge data set for back
testing the system developed. Despite all these oddities, banks have been consistently
attempting to further the effectiveness of credit scoring as an internal tool to measure risk
inherent to every credit proposal and the New Basel Accord has only strengthened the
need for such an up-gradation. Indian banks in response to Basel II are evolving new
credit appraisal systems. Some of the new appraisal systems are already in place. Though
the concerned banks have performed back-testing while designing and using it
subsequently,'no academic study has been conducted to measure the effectiveness of the
new credit appraisal systems and rating models.
It is, therefore, felt worthwhile to know the adequacy/ effectiveness of the credit
rating systems in practice in public sector banks as a tool of credit appraisal. For this
purpose the following research question and hypothesis has been taken in the study.
Research Question 1: What is the level of effectiveness of the credit appraisal
process?
Hypothesis I : Weaknesses in credit appraisal is a major cause of accounts
turning into bad loans.
The above research question and hypothesis are highly interrelated in the sense
that ineffectiveness in the risk rating models/ systems implies that there is weakness in
the credit appraisal process which consequently/ eventually turns borrowal accounts into
bad loans.
The text of this chapter has been organized as follows- Section 4.2 gives the
description of the research methodology adopted for the research question and
hypothesis, Section 4.3 describes the credit rating models used by the sample banks along
with the various features of the models, Section 4.4 measures the effectiveness of the
parameters/ variables as default predictors, Section 4.5 measures effectiveness of the
models , Section 4.6 tests the hypothesis, Section 4.7 discusses the overall performance
of the models and Section 4.8 concludes.
4.2 Methodology
In order to implement Basel II, sample banks are now applying credit rating
models with variants to suit specific situations. All the ten banks together has as many as
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thirty-five risk rating models out of which the study has selected nineteen models for
measuring the effectiveness of the models. Some of the models could not be assessed as
they are mainly for big borrowal accounts, which is outside the purview of the study. The
present study have taken loan cases with fund-based limits up to Rs.5 crores, Within the
specified limit there are nineteen models and all these models have been selected for
testing purpose. As mentioned before, two aspects have been examined viz. testing of
parameters (used in the models) as default indicators/ predictors and testing of the model.
Parameters are tested for each model and also for different categories of loans. Banks
generally categorize the loans based on type of facility say, (1) Working Capital (WC)
and (2).Term Loan (TL); on type of activity i.e., (1) Manufacturing (2)Trading (3)
Service/Infrastructure; on nature of accounts i.e., (1) Existing (units which already exists
in the bank loan portfolio), (2). Existing but New (units which are new to the bank but
are having operations) and (3) Greenfield /New (units which are entirely new with no
prior experience in the line of business). Accordingly, twenty-six categories/
combinations are possible out of which we have analysed the parameters for sixteen
number of categories. Ten categories are excluded from the analysis as the sub
classification has led to reduction in the number of cases to the extent that these could not
be subjected to statistical treatment.
These 16 categories/ situations are as follows:
1. Term Loan
2. Manufacturing units availing Term loan
3. Service and Term Loan
4. Greenfield/ New Manufacturing units availing Term Loan
5. Greenfield/New Trading and Service/ Infrastructure accounts availing Term Loan
6. Working capital
7. Manufacturing accounts availing working capital
S. Working Capital and Trading accounts
9. Existing Trading and service accounts availing WC
10. Existing Manufacturing accounts availing WC
11 .Manufacturing concerns
12. Trading concerns
13. Service concerns
14. Existing accounts
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15. Existing but New accounts
16. Greenfield accounts
Financial data of the 181 accounts selected for this study (details in chapter 3 for
reference) has been collected from the Balance Sheet and the Profit/Loss Statement of the
borrowers and Appraisal Memorandum/ Loan proposal maintained in the individual
credit/ loan files. For the non-financial parameters, appraisal note/ memorandum has been
studied. And for those non-financial parameters where appraisal comments are not
available in the appraisal notes or memorandum, the information on those parameters are
obtained from discussion with the concerned credit officers of the banks. The information
thus collected on these non-financial parameters are sorted into the scales as given in the
different models of the banks and also into the standard scale developed for the purpose
of analyzing the loan cases for different categories of loan. The sorting has been done by
the researcher and the same has been validated and corrected by the respective credit
officer of the bank . While validating and correcting, the credit officers are requested to
a
reflect the situation or position at the time of sanctioning the loan. The standard scale
developed for the purpose is presented in Appendix 3.5. Since different banks are using
different number of classes/ levels for each parameter, the standardized scale has been
developed taking the maximum number of classes amongst the models. It should be noted
that this standard scale is used only for testing the parameters under different categories
and not for testing the model itself.
The above process of data collection has been followed as many loan cases taken
here' had been evaluated by the bank at the time of sanction using their old internal rating
models and our information requirement is for the new rating models and for all the
ninety-four parameters used by all the models together.
The study has assigned scores to these 181 cases for each of the 19 models of the
banks and the scores thus obtained have been used in regression analysis, discriminant
analysis, logistic regression, transition matrix, AUC (Area-under-curve) and Brier score.
Scores are also estimated separately for financial and non-financial parameters.
As mentioned earlier in chapter 2, a few literatures are available on measurement
of effectiveness of internal rating systems probably because internal ratings by
commercial banks are a more recent development. Their history in most cases does not
exceed 5 - 1 0 years (Krahnen & Weber, 2001). Krahnen & Weber have developed a
comprehensive framework for evaluating the quality of standard rating systems. They
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suggest fourteen principles that aught to be met by good rating practice. These generally
accepted rating principles are potentially relevant for evaluation and improvement of
existing rating system. As admitted by the authors, the development of these principles
may be considered as work-in-progress which require further improvement by regulators,
researchers and expert in the field. These principles may however be considered as
standards against which effectiveness of credit appraisal and rating models may be
assessed. Any rating system meeting these standards may be considered to be effective
and absence o f these features or standards may be considered as an indication of
weakness in the credit appraisal and internal rating systems.
These fourteen principles/ standards/ requirements are stated below.
1. Comprehensiveness: A bank’s rating system should be able to rate all past,
current and future clients.
2. Completeness : A bank should rate all current clients and keep on rating its past
clients.
3. Complexity : A bank should have as many different rating systems as necessary
and as few as possible.
4. POD definition: A bank should have a proper definition of its PODs (probability
o f defaults).
5. Monotonicity : This requirement defines the relation between ratings and
expected default frequencies. If two PODs are identical, the ratings also have to
be identical.
• 6. Fineness : This requirement is regarding the degree of fineness or the number of
categories or grades that a rating system should have.
7. Reliability : The rating system should be reliable.
8. Back-testing : This requirement states that the (ex-ante) probability o f default
should not be significantly different from the (ex-post) realized default
frequency.
9. Informational Efficiency : A rating should correctly incorporate all information
available to the bank.
10. System Development: A rating has to be improved over time.
11. Data Management: Past and current rating data should be easily available.
12. Incentive Compatibility : The rating process has to be embedded in the
organization of credit business such that the risk o f misrepresentation by credit
officers is minimized.
13. Internal Compliance : The distribution of rating outcomes is constantly
monitored by controllers, assisted by random inspections.
14. External Compliance : The adherence of a bank’s management to its agreed
rating standards is monitored by neutral outside controllers, either on a
continuous, or random basis.
While evaluating credit appraisal and rating models o f ten banks, some of these
principles are used where possible and few more aspects has been looked into. It should
be noted that all the surveyed banks are constantly evolving the models by incorporating
new features or modifying new features through their experience in applying the new
model. The test result will reflect the features of the model which are upgraded or
incorporated till December 2004.
The following criteria has been extracted from the principles mentioned in the
earlier paragraphs and the suggestions of other researchers for testing the hypothesis and
measuring the overall effectiveness of the models developed by each of the banks, These
criteria are
1. Effectiveness of the parameters used in the model as default predictors.
2. Effectiveness of the model in terms of explanatory power, discriminatory
power, ability to estimate default probabilities, AUC and Brier scores.
3. Rating Migration
4. Monotonicity
5. Complexity
6. Fineness
The first two criteria has been used as main criteria and the remaining are used as
supplement as rigorous analysis is not possible in the latter five cases due to the fact that
models are still in the process of evolution and the required information is not in place.
4.3 Features of New Internal Risk Rating Models of Ten

Banks
There are three features o f the risk rating models. These are:
1) Parameters / Variables;
2) Scales and Weightage assigned to each Parameter/ Variable
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3) Scores and Gradation
The sections below discusses the components, parameters and model
characteristics o f the ten banks included in the study.
4.3.1 Parameters/ Variables

The risk dimensions used by the banks for credit appraisal can broadly be
categorized as two viz., financial risk and non-fmancial risk. Non-financial risk includes
Business/ Industry Risk and, Management Risk. Facility rating is another area included
in some o f the banks’ rating system for risk assessment. The parameters under facility
rating mainly cover loans and covenants attached to an obligation. Critical parameters are
assessed under these broad categories o f risk (financial and non-financial). These risk
components are allotted weights based on their relative importance. •
We briefly discuss these risk dimensions in the following paragraphs.
A. Financial Risk
There are at least four important financial dimensions which should be analyzed
to, ascertain the financial health of a borrower. These are: Liquidity, Solvency, Turnover
and Profitability. Review of the sample banks’ new rating models for credit appraisal
reveal the occurrence of thirty-one financial parameters with frequencies ranging from
two to ten amongst different banks. Table 4.1a lists these financial parameters along with
their frequency o f occurrence in the sample banks. In addition to the thirty-one
parameters ten more parameters have been taken from the academic literature for testing
their discriminating power. However, parameters shown as * could not be tested.
A brief description o f these parameters is given in Box 1.
Box 1: Financial Parameters

1. CR (Current ratio) = CA / CL ; CA= Current Assets, CL= Current Liabilities.
2. TOL/TNW( Debt-Equity Ratio) where TOL = Total outside Liabilities, TNW =Tangible Net
Worth (Net Worth less Intangible Assets)
3. LT Debt / TNW ( Debt-Equity Ratio) where LT Debt = Long Term Debt
4. BorrFund / TNW (Debt-Equity Ratio) where Borr. Fund = All interest bearing loans
5. NP/Sales (Net Profit Margin)(%) = (PAT/ Net Sales) x 100 where PAT=Profit After Tax
6. GP/Sales (Gross Profit Margin)(%) where GP= Gross Profit and Sales = Net Sales
7. ROCE1 (Return on Capital Employed)3 (PAT+ Interest/TNW+long term borrowings + short
term borrowings) x 100
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Table 4.1a : Financial Parameters used in Rating Models of Indian Banks and Previous Studies
N o R a t io P u b li c S e c t o r B a n k s P r e v io u s s t u d ie s
1 CR UCO, UBL CAN, ALLAH, CBI UNION, ANDH, PNB, SBI, GRK, RM, F-K, B, D,
VIJ(10) TA L,F,H , A-H-N.
2 TOL/TNW UCO, UBI,CANALLAH, UNION, ANDH, PNB, SBI (8) GRK
3 LT Debt/TNW UCO, ALLAH, UNION, ANDHRA PNB,SBI (6) CRY, E-M, BK, S &P
4 Borr. Fund/TNW VIJ, CBI (2) M, RM, Back, Bhatt
5 NP/Sales (%) CAN, ALLAH, UNION, SBI, VU (5) GRK H, Bhatt.
6 GP/Sales (%) UBI (1) Bhatt
7 ROCE1 UCO, UNION, PNB (3) GRK
8 ROCE2 ALLAH (1)
9 ROCE3 SBI (1)
10 PBDU/Interest ALLAH, ANDH, SBI (3) CGM, S & P
11 PBIT/Interest UBI (1) CGM, A-H-N, S & P
12 PBHVTot. Op. asset UBI(l) F-K
13 Bk. BoiT/wcgap UBI(l)
14 N. Sales/NFA UBI(l) A-H-N, Bhatt
15 N FA /IL (0) IDBI
16 PBT/TNW UBI, ALLH, VIJ (3) CGM
17 Inv / Avg. Mthly. Sales PNB (1) E, F, BK
18 Bk. Borr /N Sales CAN, PNB (2) F-K D, E,
19 PBIT/ N Sales (0) A-H-N, S& P, T,H
20 PBD1T/N Sales PNB, VIJ (2) H
21 Inv +ReceivJ N Sales UCO, UBL CAN, PNB, SBI (5)
22 Op.lncome / ST Borr. H
23 Coll Period(days) ANDH(l) FK
24 Increase m N sales UBI, CAN (2)
25 Promoters’ contribution UBL CAN, ALLAH (3)
26 PBT/N Sales P& P
27 Increase in Net Profit CAN, VIJ (2)
28 Margin on Security (0) IDBI
29 DSCR UCO, UBL CAN, ALAH, UNION, PNB, SBL VIJ (8) Bhatt.
30 Intt Payment/ N Sales (0) H
31 N Cash ff OpiLTDebt PNB (1) CGM, B,D, Bhatt
32 PBT/N Assets (0) RM
33 Net Assets Turnover (0) RM
34 Debtors Turnover (0) RM, TA
35 Inventory Turnover UBL CAN, ANDH (3) RM, Bhatt
36 N P / N Op. Cash Flow UCO(l)
Priority Obligation* UBI(l)
(Sales - Variable cost)/
PBIT* UBI(l)
Sales/breakevcn sales* UCO(l)
PBDIT/operating
income* CAN (1)
Trends in
Performance* SBI(l)
IJCO- United Commercial Bank UBI- United Bank of India
CAN- CanaraBank ALLAH-Allahabad Bank
UNION-Union Bank ANDH Andhra Bank
PNB- Punjab National Bank SBI-State Bank of India
VIJ- Vijaya Bank CBI- Central Bank of India
IDBI- IDBI Bank GRK- GRK Murthy (2000)
F-K - Frydman & Kao RM - K Ram Mohan
CGM- Crouchy, Galai & Mark A-H-N - Altman, Haldeman & Narayanan (1977)
B -Beaver (1966) D -Deakin(1972)
E -Edminster(1972) SrP -S & P Cororate Ratings Critena (1998)
T - Theodossiu, (1989) TA - Tamari (1963) Bhatt -Bhattacharya(1995)
H - Hayden (2003) F -Fernandes,,2005 BK - Back, et al (1997)
P & P -P eel& Peel (1987)
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Box 1 : Financial parameters (...contd.)
8. ROCE2 = (PBDIT /TNW+ long term + short term borrowings) x lOOwhere PBDIT= Profit
before depreciation, interest & tax
9. ROCE3 = (PBDIT) xlOO / (TNW + Long Term Borrowings)
10. PBDIT/Intt. = Profit Before Depreciation, Interest & Tax / Interest
11. PBIT/Intt, = Profit Before Interest & Tax/ Interest
12. PBIT/Tota! Op. Asset where Total Operating Asset = Total Assets - Intangible Assets
13. Bk Borr./WC gap where Bk. Borr.=Short Term Bank Borrowings and WC gap=CA-CL
14. N Sales/ NFA where NFA= Net Fixed Assets (Fixed Assets - depreciation)
15. NFA / TL where TL = Term Loan
16. PBT/TNW where PBT = Profit Before Tax
17. Inv. / Avg. Mthly. Sales (in months) = (Inventory x 12) / Net Sales
18. Bk. Borr./N Sales where Bk. Borr, =Short Term Bank Borrowings
19. PBIT/N Sales where PBIT = Profit Before Interest & Tax
20. PBDIT/N Sales where PBDIT = Profit Before Depreciation, Interest & Tax
21. Inv. + Receiv. / Net Sales( in months) = (Inventory +Receivab!es) x 12/Net Sales
22. Op. Income / S T Borr. = Operating Income / Short Term Borrowings
23. ColI. Period (in days) where Coll. Period = Collection Period =Debtors x 360/Net Sales
24. Increase in N Sales(%) = {(Current Year Net Sales - Previous Year Net Sales) / Previ. Year
Net Sales} x 100
25. Promoter’s contribution = Tangible Net Worth / Total Assets less Intangible Assets
26. PBT/ Net Sales = (Profit Before Tax/ Net Sales) x 100
27. Increase in Net Profit(%) = {(Current year Net Profit-Previous year Net Profit) / Prev. year
Net Profit} x 100
28. Margin on Security (MOS) = {(Net Fixed Asset - Term Loan) / Net Fixed Asset} x 100
29. DSCR (Debt Service Coverage Ratio) = (Profit after Tax +Depreciation+Interest on Term
Loan and interest to partners)/(Interest+ Repayment o f Term Loan)
30. Intt. Payment / Net Sales =Interest / Net Sales
31. N Cash fr. Op./ L TDebt (Net Cash from Operations/ LT Debt)
= (Net Profit+Depreciation- non-operating income + non-operating expense)/ Long
Term Debt
32. PBT/ Net Assets where Net Assets = Net Fixed Assets + Net Current Assets where Net
Current Assets = CA - CL(exc!uding bk. Borr.)
33. Net Assets Turnover = Net Sales / Net Assets (as defined in parameter 32)
34. Debtors Turnover = Net Sales / Debtors
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Box 1 : Financial param eters (...contd.)
35. Inventory Turnover = Net Sales / Inventory
36. NP/ Cash flow (net profit/ net operating cash flow) = Net Profit / Net Profit +Depreciation -
non-operating income* non- operating expense)
• Priority Obligation Ratio* = Net Operating Cash Flow/ Priority Outflows
» Operating Leverage* = (Net sales - variable cost)/ PBIT
• Sales/ Break even sales*
• Operating PBDIT/ Operating income*
• Trends in Performance*
B. N on-fm ancial R isk a n d its M e asu re m e n t

M ost o f the banks have classified the non-fm ancial param eters under two broad
heads- m anagement and industry/ business parameters. Som e o f the banks, however, have
clubbed the param eters relating to conduct o f account separately under the head Conduct
o f Accounts. A few o f the banks have considered facility related parameters in their
rating m odels while others have not included it in their rating models. However, for all
banks these item s/ param eters constitute the loan covenant and the minimum
requirem ents for availing the loan facility. A list o f the non-fm ancial param eters is given
in Table 4.1b along with name o f banks where they occur as param eters in the rating
models. It m ay be noted that terms non-fmancial param eters, subjective parameters and
qualitative param eters are used interchangeably in this study. In addition to the
param eters incorporated by the rating models o f the ten banks, three more parameters
have been taken from the academic literature for testing their discrim inating power.
These additional param eters are tested with the intention o f possible incorporation in the
suggested m odels. A ltogether 58 param eters are considered in the study under non-
fmancial risk factors. Param eter num bering 37 to 73 pertains to m anagement risk; 74 to
78 pertains to facility risk factors; 79 to 94 pertains to business/ industry risk factors
(Table 4.1b). These param eters are discussed in the following paragraphs.
(i) M an ag em en t R isk P a ram e te rs
The quality o f m anagement and m anagement structure are very important
indicators o f a com pany’s credit risk. Evaluation o f m anagem ent is important not only
from the point o f view o f its impact on a com pany’s perform ance, but also from the point
o f view o f its integrity. This is because the intentions o f the m anagem ent determine the
willingness o f the com pany to repay its debts. Basically under this risk category banks
Table 4.2 b : Non-Finaneial Parameters used in Rating Models of Indian Banks and existing
literature
N o. R atio B anks an d P rev io u s S tu d ies
37 Experience UBI, CAN, ALLAH, UNION, PNB, SB1, VIJ, CGM
38 Integrity UCO, ANDHRA, PNB, SBI, GRK
39 Competence SB1, VIJ
40 Market Reputation UCO, CAN, ALLAH, UNION, ANDH, RM
41 Track Record UCO, ANDHRA, PNB, SBI, CGM, GRK
42 Expertise UCO, CAN, ALLAH, UNION, PNB, SBI, GRK
43 Succession Planning UCO, CAN, UNION, ANDHRA, SBI, CGM
44 Labour M anagement UBI, CAN, UNION, PNB, SBI
45 Resourcefulness UCO, UBI, CAN, ALLAH, UNION, PNB
46 Management Initiative UBI, UNION, SBI, CGM, GRK
47 Composition o f Board UBI, ALLAH, UNION, PNB, GRK
48 Relationship with Bank UBI, ALLAH, UNION, ANDHRA, SBI, CBI, GRK
49 Audit Qualification UCO, UBI, ANDHRAPNB, SBI
50 Ability to meet sales prj. UCO, UBI, CAN, ALLAH. UNION, ANDHRA. PNB, SBI
51 Ability to m eet profit prj. UCO, CAN, ALLAH, UNION, ANDHRA, PNB, SBI
52 Financial Control CAN, SBI
S3 Statutory Com pliance UNION, ANDHRA, SBI
54 Litigation Cases UCO, UBI, UNION, CGM , RM
55 Performance o f Gp. Cos UNION, ANDHRA
56 Shareholdg. o f promoters UBI
57 Compl. o f Sanction terms UCO, UBI, CAN, ALLAH, UNION, VIJ, CB , RM
58 Serv. o f Instal. & Intt. UBI, CAN, ALLAH, UNION, ANDHRA, VIJ, CBI
59 Submission o f fin. Slat. UBI, CAN, UNION, ANDHRA, PNB, SBI, RM
60 Renewal o f Limits CAN, ANDHRA, CBI
61 Submission o f stock stat. UCO, UBI, CAN, UNION, ANDHRA, PNB, SBI, CBI
62 Project Implementation UBI
63 Mgt. o f invent. & receiv. UCO, PNB, CBI
64 Turnover in Account CAN, UNION, VIJ
65 Utilisation o f Limit UBI, RM
66 Overdrawings in Account CAN, UNION, VIJ
67 Diversion o f Fund UCO, PNB
68 Operations in Account UCO, UBI, CAN, ALLAH, UNION, ANDHRA, PNB, SBI
69 Reliability o f fin. Stat. PNB, CGM, RM
70 Cheques Returned CAN, UNION, VIJ
71 Overall account conduct UBI,PNB, SBI, CGM , RM
72 Mgt. o f Creditors UBI
73 Loans and Advances PNB
74 Tenor o f Loan ALLAH, UNION, PNB, SBI, CGM
75 Margin on Term Loan UNION
76 Security Coverage ALLAH, UNION, ANDHRA, VIJ
77 Liquidity o f Security SBI
78 Availability o f guarantee UNION, ANDHRA, SBI, CGM
79 Com petition UBI, CAN, ALLAH, UNION, ANDHRA, PNB, SBI, CGM
80 Technology UBI, CAN, ALLAH, UNION, ANDHRA, PNB, SBI
81 Capacity Utilisation UNION, PNB, SBI
82 Raw Material UBI, CAN, ALLAH, UNION, PNB
83 Infrastructure ALLAH, PNB, VIJ
84 Location CAN, ALLAH, UNION
85 Product Quality UBI, CAN, ALLAH, ANDHRA, PNB, SBI
86 Spread o f market UCO, UBI, CAN, ALLAH, UNION, PNB, SBI
87 Distribution Network UCO, UBI, CAN, ALLAH. UNION, PNB, SBI
88 Export Potential UBI, CAN,
89 Import Policy PNB
90 Track Record o f supplier IDBI
91 Regulatory Aspects UBI, CAN, ALLAH, ANDHRA, PNB, SBI, VIJ, CGM, GRK
92 Compl. o f environ. Reg. UBI, CAN, ALLAH, ANDHRA, PNB, SBI, VIJ
93 Industry prospects UCO, CAN, ALLAH. ANDHRA, SBI, VIJ
94 Industry Cycles UCO, UBI, ALLAH, UNION, ANDHRA, PNB, SBI, GRK
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are looking into integrity, competence and experience, corporate governance and conduct
o f account. As many as 37 param eters/ variables are used by the banks to reflect the
characteristics o f the management. A brief discussion o f the parameters are given in Box
2.__________________________________________________________________________
Box 2: Management Param eters
Experience -Measures the experience of the borrower/ promoter/ management expressed in
categories- More than or equal tolO years; 5 years and more but less than 10 years; Less than 5
years; New in the line but experienced elsewhere and; No experience.
Integrity - Evaluates the borrower’s willingness and sincerity to repay. The categories fo r
scoring are Beyond doubt; Reliable; satisfactory; Marginally acceptable; Poor.
Competence - Measures the ability of the borrower to manage the business. This aspect is scored
on the basis o f three categories viz., Very high as evidenced by the timely execution o f projects;
Management competence exist but lack o f proper planning has led to delays a n d ; Complete lack
o f managerial competence.
M arket Reputation -Borrower’s reputation in the market. It has been scored as excellent; good;
average and; poor.
T rack Record - Evaluates the borrower’s past performance on loan repayment. The categories
fo r scoring are Very good; Good; Average and; Poor.
Expertise - Borrower’s qualification/ professional knowledge. The categories fo r scoring this
parameter are - one or more promoters are technically qualified; promoters have availed the
service o f a technocrat/professional; depends upon experienced personnel without engaging
professionals and; no support fo r technical knowledge.
Succession Planning - The standing of the party in the business reflects the business acumen of
management. The categories fo r scoring are: Family business and no cause fo r concern; young
promoters with fam ily background; old promoters and succession expected and; old promoters
with no successors/first generation entrepreneurs.
L abour M anagem ent - Assessed in terms of any loss of working hours in the past. The
parameter has relevance for manufacturing firms rather than trading firms. The categories fo r
scoring are: No labour unrest in the last 3-5 years; Occasional unrest in 3-5 years and; frequent
in the last 3-5 years.
Resourcefulness - This parameter indicates the financial strength of the borrower or its ability to
infuse fund in the business when required. The scoring categories are: Excellent; Good; Average
and; Poor.
M anagem ent Initiative - Measures the borrower’s / management’s attitude towards business
and capability o f being a leader.
The categories fo r scoring are: Proactive in taking initiative to be leader; Capable but necessary
thrust lacking and; Both will and capacity to take initiative is missing.
76
Box 2: Management Param eters (....contd.)
Composition of Board / M anagement - In case of a corporate customer, the composition of the
board has to be examined to see whether it is a diversified board. In case of an entrepreneurial
Board the borrower should have a diversified managerial structure below it. The categories fo r
scoring are: dominantly professionals and experts; dominantly promoters with professional
skills; promoters supported by experienced people and; promoters and relatives only with no
professional skills,
Relationship with Bank - The nature of relationship of the borrower with the bank can be used
to assess the management. The categories used fo r measuring this are: More than 10 years and
conduct satisfactory; More than 5 years and conduct satisfactory; Satisfactory relation during
last 5 years; New account.
Audit Qualification - The qualifying remarks o f the auditors in the audit reports of the
borrowers also speaks o f their capability of managing operational variables. The scoring on this
parameter is based on the categories viz., No qualification from auditors; Qualification having
no financial implications; Qualification having financial implications; Unaudited balance sheet
certified by borrowers and; Others.
Ability to Meet Sales Projection and Ability to Meet Profit Projection - Management’s
capability is reflected in their ability to meet projections in terms of sales and profit. The comment
on this parameter is based on the borrowers past performance and are categorized as : More
than equal to 95%; More than equal to 85% but less than 95%; More than equal to 70% but less
than 85%; More than equal to 60% but less than 70% and; Less than 60%.
Financial Control -Reflects management’s capability. The categories used are: Management
has rigid control over finances and deviation from plan negligible; Satisfactory planning but
deviations observed; No well defined plan but satisfactory control over finances and; Frequent
changes in financial plan and lack o f effective control.
Statutory Compliance - This is used to see how far the borrower has complied with payments of
statutory nature like provident fund of employees, income tax, wealth tax etc. The scoring
categories are: Payment regular; Delay on certain occasions but paid and; Payments are
pending.
Litigation cases - Evaluates a borrower in terms o f any court cases pending or involvement in
unethical social and business practices. The scores are based on three categories: none, a few and
many.
Performance of Group Companies - The performance of allied concerns of the borrowers also
reflects the borrower’s capability. The categories used fo r scoring are excellent, good, average
and poor.
77
Box 2: Management Param eters (....C ontd.)
Shareholding of Promoters - This parameter reflects the borrower’s commitment and

involvement in the business and is measured in terms o f Major, Satisfactory and Minor.
Compliance of Sanction Terms - Whether a borrower has complied with the terms on which the
loan has been sanctioned reflects his commitment and integrity which are important determinants
of his willingness to repay the loan. The categories fo r scoring are - all terms complied with on
time; all terms complied-but with delay; conditions relating to security creation complied, others
not; conditions other than security creation complied and; conditions not complied.
Servicing of Instalm ent and Interest - This parameter is an indicator of the borrower’s past
behaviour towards meeting financial commitments. A poor past record is an indicator of poor
ability or unwillingness on the part of the borrowers to repay the debt. Six banks have used this
parameter for assessing loan proposals. The categories used are- timely repayment on due date;
delayed payment upto 15 days; delayed payment upto one month; delayed payment upto 2 months
and; payments delayed beyond 2 months,
Submission of audited financial results- The timeliness of submission of the financial
statements indicates the borrower’s intention. The normal practice among firms for getting their
financial statements audited is within six months from the balance sheet date. So the scoring
categories used are - within six months from balance sheet date and beyond six months from
balance sheet date. Six banks have used this parameter.
Renewal of Limits - This parameter is used by banks for assessing borrowers availing working
capital limits. The categories fo r scoring are - renewal not overdue; renewal overdue up to 30
days; renewal overdue up to 60 days; renewal overdue up to 90 days and; renewal overdue
beyond 90 days.
Submission of Stock Statement/ Quarterly Monitoring Statements - This parameter measures
the timeliness of the borrower in submitting stock statements, monthly select operational data and
other feedback data. The categories used fo r assessing the borrower on this parameter are- timely
submission (on due date); delay up to 15 days; delay up to 30 days; delay up to 45 days and;
delay o f more than 45 days.
Project Implementation -This parameter finds relevance in assessing borrowers who have
availed finance for projects. The past implementation record o f the borrower indicates his
operational efficiency. The categories are- no time/cost overrun; overrun below 5%; overrun
>=5%o and < 10%; overrun >= 10% and < 20% and; overrun >20%.
M anagement of Inventory & receivables- This parameter assesses the efficiency of inventory
and receivables management. The categories used fo r scoring are - norms generally adhered
. (deviations up to 15%); minor deviations from norms (15%-30%) and; major deviations (>30%).
78
Box 2: Management Parameters (....Contd.)
Turnover in the Account - This parameter indicates the behaviour of the account by observing
the amount of sale proceeds being routed through the account. A high turnover is a healthy sign.
The scoring categories are- more than 90% o f sales; >=70% but<90%; >=60% but <70% a n d ;
<60%.
Utilization of limit - The parameter is relevant for working capital limits. The categories used
are- >=90%; > =75% but <90%; >=60% but <75%; >=50% but <60% and; <50%.
Overdrawing in the Account- Frequent overdrawing in a cash credit facility is not a good sign
for the account. The categories are-no over drawings; on few occasions but regularized on time;
on few occasions but slight delay in regularization; frequent over drawings but regularized timely
and; frequent over drawings and delay in regularization.
Diversion of Fund -Diversion of fund should give a clear signal o f the doubtful intention of the
borrower and indicates account conduct. The categories are - no fu n d diversion; transfer to sister
concern observed but only fo r trading activity; frequent transfers requiring clarifications and;
frequent transfers not related to trading activity.
Operations in Account - The extent of irregularity in an account has been evaluated by this
parameter and is used by four banks in the sample. The categories used are- Account running
regular; remained irregular fo r 15 days; irregular fo r 16-30 days; irregular fo r 31-45 days and;
irregularity o f more than 40 days.
Reliability o f Financial Statements - The banks must always be satisfied as to the quality and
reliability o f the financial statements. This includes consideration o f size and capabilities of the
accounting firm. The categories used are -more than 95%; >90% and <=95%; >85% and
<=90%; >80% and <=85% and; <=80%.
Cheque Returned- This is another account conduct parameter. The categories used are-no
cheque retuned; occasional returns; returns observed leading to temporary imbalances and;
frequent returns observed.
Overall Account Conduct - The manner in which a borrower has conducted his accounts in the
past generally gives an indication how the account is likely to behave in future as well. All the
factors mentioned earlier like compliance of sanction terms, submission o f financial data, routing
of sales, irregularity in account, etc. are considered while using this parameter for evaluation. The
categories used are excellent, very good, good, average and unsatisfactory.
M anagement of Creditors - Too much of credit purchase may lead to loss in terms of cash
discounts. Borrower’s management of purchases is an indicator of their ability.
Loans and Advances - This is the Loans & Advances item under Current Assets of the balance
sheet. The categories used are satisfactory, average and too high.
79
Five parameters have been included under Facility Rating as given in the box below .
Tenor of loan' indicating the period of the loan- longer the period more risky is the proposal;
Margin on Term loan indicating the promoter’s contribution- higher the margin lesser the
riskiness of the proposal;
Security Coverage- higher the coverage lesser the risk;
Liquidity of security- more liquid the security less is the risk;
Availability of guarantee- especially important for banks providing loans to small and medium
enterprises that cannot offer sufficient collaterals.
Industry/ Business Parameters

The business performance o f a company has a direct relationship with the credit risk of
the company as the business performance determines the generation of cash for debt repayment.
16 parameters have been taken in the study under the business/ industry dimension.
A brief description of all the Industry/ Business parameters is given in Box 3
Box 3: Industry / Business Parameters

Competition - The borrowers’ relative position in the industry vis-a-vis its competitors is an
indicator of the business efficiency. The categories used fo r scoring are: monopoly, near
monopoly, moderate, tough and very tough.
Technology - The efficiency of production activities is the base on which the value addition
largely depends. While evaluating a proposal from a manufacturing concern the state of
technology used vis-a-vis technology used by competitors needs to be considered. The categories
used fo r scoring are - state o f the art technology; latest/ superior technology but is at its initial
stage; average technology comparable to peers; old technology but time tested and may last fo r
some years and; outdated/untested/ subject to fa st obsolescence.
Capacity Utilization - The level at which a manufacturing concern is operating indicates its
operational efficiency. Capacity utilization is evaluated using the categories- operating above
BEP and optimum utilization; above BEP and utilization is higher than peers; above BEP and at
par with industry; above BEP but utilization is lower than peers and; operating below BEP.
Raw Material - Availability of raw material is a critical factor affecting the operating
performance o f a manufacturing concern. If availability is uncertain or if there is high price
volatility, then there is substantial risk in the operations of the concern. The categories used fo r
scoring are - buyers ’ market; adequate availability at competitive price; demand almost equal to
supply and generally available; inputs available but at a higher cost and; scarcity/ low
availability.
Box 3 : Industry / Business Param eters (...Contd.)
Infrastructure - The smooth functioning of a manufacturing concern is highly dependent on the
infrastructural facilities available like power, labour and transport. This aspect has been evaluated
subjectively by using the categories viz,, good, average and poor.
Location- A firm which has easy access to markets or to the raw material supplier enjoys a
competitive advantage. Locational advantage is also a critical factor which needs to be considered
in project evaluation. Three categories have been usedfor scoring purpose viz., most favourable,
favourable and not at all favourable.
Product Quality - The quality of product directly influences sales which in turn determines the
repayment capacity of the borrower. This parameter has been assessed by using five categories -
quality best in industry; quality better than peers but not best; average quality at par with peers;
lower than average quality and; inferior to peers.
Spread of M arket - A widespread market in terms o f customer base and the geographical
diversity is a factor influencing the marketing strength o f a business concern. This has been
assessed using the categories viz., widespread market; diversified but further scope o f
penetration; operating in few ' areas, maintaining market share; attempting to spread and;
concentrating only in one market.
Distribution Network - Marketing strength is also determined by selling and distribution
network o f the business concern. The categories used fo r scoring are- best selling network;
network better than peers; average network comparable with peers; network not commensurate
with the size o f the company and; poor.
Export Potential -This has been measured on the basis of the existence o f potential or its non
existence.
Im port Policy- The government policy towards imports is another factor that needs to be looked
into while evaluating proposals where inputs need to be imported. The categories used are-
advantageous, neutral and not advantageous.
Track-record of know-how supplier - Manufacturing concerns may outsource the supply of
know-how requirements. It is necessary to assess the quality of the supplier. The categories used
are excellent, good and poor.
Regulatory Aspects -The legal/ institutional setting including laws and regulations o f the
government by and large affects business concerns and needs to be considered in loan evaluation.
The categories used fo r scoring are unaffected by regulatory risk; risk adequately taken care of;
delicately balanced / can adversely affect i f adequate steps not taken and; unable to cope with
situation.
81
Box 3 : Industry / Business Parameters (...C ontd.)
Compliance o f Environmental regulations - Environment issues are major concerns for all, A
business concern for its long run survival cannot overlook environmental considerations. This
parameter has been assessed on three categories viz., full compliance, partial compliance and
lopsided compliance/ utter disregard o f environmental regulation.
Industry Prospects - The overall industry prospect has been evaluated subjectively based on
four categories viz, excellent growth prospects, satisfactory growth prospects, marginal growth
prospects and no potential for growth.
Industry Cycles - Almost all industry suffers from some amount o f cyclical fluctuations. It is
important for a banker to know on which side o f the cycle a borrowing unit is operating to enable
him to adjust to the credit needs o f the borrowers and the riskiness o f his fund. The categories
usedfor scoring on this parameter are - not affected by cyclical fluctuation, favourable industry
cycle with long term prospects and susceptible to unfavourable change in the market.
4.3.2 Scales and Weights Assigned to the Factors / Categories of Factors

All the banks included in the study apply scoring methodology. The models
specify a number of distinct parameters/ factors with specific scale on which score/mark
is assigned to a particular parameter. Almost all the models follow similar aggregation
rule . Unlike general scoring model where score on individual parameters are multiplied
by weights, the scoring methodology used by the banks sums up the scores assigned to
the parameter to obtain the total aggregate score with exception in the case of models of
Allahabad bank where scores obtained in each category are multiplied by the weightage
which appears to be derived from the maximum score possible under each category of
risk factor. Moreover, SBI model for Trade accounts also use weights multiplier for each
parameter. For other models the maximum score on each parameter can be considered as
weightage assigned to the parameters.
Table 4.2 highlights the parameters with the maximum score normalized for total
of 100 marks. As can be seen from the table the difference across the banks arise from the
number of parameters, maximum marks assigned to each parameter and adjustment made
in the final score to take into account the specific requirements of various categories of
loans. Assignment of weights varies with the type of i) facility eg. working capital or
term loan, ii) activity viz., trading, manufacturing or service and iii) size of exposure.
82
O in
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Table 4.2: Normalised Maximum Score (out of 100) / Weights of Parameters
o
V"
A L L A H ||
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83
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Table 4.2 (...c o n td ): Normalised Maximum Score (out of 100) of Parameters/ Factors
I
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6
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84
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b to CM to CM CM CM CM CO 05 CO r ~
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Weights assigned tothe group of Financial and Non-Financial Parameters/ Factors

CM r>- O) co
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b CO CM CO to fO mt in to T~ CO to
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not scored but deducted from financial score for any -v e comment
to CM CM <M CM CM CM CM CM CO CM CO h-
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of Parameters| used inthe Rating Models
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85
In general, the models put more emphasis on the non-financial parameters than
the financial parameters both in terms of number o f parameter and the weightage
assigned to each category. The number of parameters vary from five to forty-eight with
less number of parameters in case of models for small limits. Financial weights varies
from 13.4 per cent to 100 per cent with an average of 38 per cent. Only in four models
out of twenty models, where financial parameters have received weightage greater than
50 per cent,
4.3.3 Scores and Gradation
Table 4.3 reveals that different scores and gradation are being used by the
different banks though there are lot of commonalities among them . UCO Bank and
Canara Bank uses the lowest number of grades(6 ) while Union Bank model has the
highest number (11). Accordingly, interval o f scores on which gradings are based also
vary widely across the banks. One of the interesting observation regarding gradation and
associated risk is the definition of the highest risk. Banks like UBI , UCO, UNION
consider risk to be very high if scores are below 50-60 % . On the other hand, SBI, PNB,
Allahabad Bank, Canara Bank, Vijaya Bank assigns highest risk when scores are 35% or
below. This tentatively indicates that the risk perception of the banks vary widely and it is
likely that one loan proposal receiving the lowest grade in one bank may get mediocre
grade in another bank. Further, banks like PNB has gone for finer gradation in respect of
certain grades in the middle range. PNB has three notches in four of the classes.
These gradations are helping banks to fix different interest rate directly or
indirectly and reviewing the portfolio risk from time to time. It should be noted that
though the banks are using a number of gradations in the lower end , banks are generally
reluctant to sanction loans if loan proposal score below the middle grades. These
proposals are considered to be in the default category. It has, however, been observed that
most of the banks’ models do not explicitly define the default categories. None of the
banks maintain default categories on an internal scale unlike U.S. banks as understood
from Treacy & Carey (1998).
4.4 Effectiveness of Parameters/ Variables as Default

Predictors -Analysis And Findings
Two types o f analysis have been done to examine -
86
Table 4.3 : Gradation (G) and Scores (S) under the Rating Models of Individual Banks
| Bank I LowRisk High Risk
A
0s*
O
>=50% to Below 50%
nO
UCO S >= 90% >=80% to < >=70% to • <
O'N©
90% 80% <60%
<
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CQ
CQ
A++
UBI S >= 90% >=86% to < >=80% to < >=70% to < 80% >=60% to Below 60% Substandard, Doubtful
90% 86% <70% 1___ and Loss asset
a
UBI CR 0 UBI CR 1 UBI CR2 UBI CR 3 UBI CR4 UBI CR 5 1 UBI CR 6,7 & 8
CAN S >= 66.7% >=56.7% to >=46.7% to ! >=36.6% to >=26.6 <26%
< 66.7% < 56.7% i <46.6% to <36.6% •
*
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>
>
>
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VIII
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ALLAH > 90% >80% to <= >70% to <= >60% to <= 70% >50% to > 40%
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SO
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CR 1 CR 2 CR3 CR4 CR 5 CR 6 CR7 Doubtful
O
CR 8 and Loss asset
CR 9,10 & 11
Oso
ANDH S | > 95% 91%-95% 81%-90% 71%-80% 61%-70%

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80% <= 70% <= 60% <= 50% <= 40%
<
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SBI S >=90%
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SBI/ SB2 / SB3 / SB4 / SB5 / SB6 / SB7 / SB8/
SBTL1 SBTL2 SBTL3 SBTL4 SBTL5 SBTL6 SBTL7 SBTL8
V
mmI
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> 85% >70% to <= > 60% to > 45% to >35% to
•o'N©
85% <= 70% <= 60% <=45%

o
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CBI S Above ! 85% - 90% 80% - 84% 70% - 79% 60% - 69% 56% - 59% 1 45% to’ < 45%
O'Vin©
90% ! 50%
£
<
O
03+
<
Q
in O
CQ
O
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These two grades are used in the RAM model which is not being used by the Regional office in Guwahati. Hence this model is excluded from the study.
a. explanatory and discriminatory power of parameters under different categories
of loans i.e., whether the parameters used are good indicators of default.
b. explanatory and discriminatory power of parameters used in different banks’
rating models.
4.4.1 Effectiveness of Parameters under Different Categories of Loans

A set of multiple regressions has been performed on these two sets of
variables/parameters (financial and non-fmancial) after the normalization of their values.
The purpose of this is to find the explanatory power of the two sets-consisting of ninety-
four parameters . Health of the borrower has been taken as the dependent variable with
the value 1 for non-default/ standard account and 0 for defaults. The independent
variables are the financial and non-financial/ subjective variables - ninety-four in all.
Further discriminant analysis has been applied to the above dependent and independent
variables for different categories of loans. We tried to use logistic regression (LR) too,
but LR did not provide optimal solution apparently because of high number of
independent variables in LR compared to the number of cases. Hence, the LR solution is
dropped from the analysis.
1. Term Loan
Except UB1, none of the banks have a separate model exclusively for term loan .
However, most of the banks have provision in their model to re-adjust the marks for term
loan facilities.
Out of 181 accounts, 86 accounts are term loan accounts. Ten parameters do not
have relevance to the term loan accounts and hence these parameters are dropped from
both regression and discriminant analysis. Analysis were done separately for financial
parameters, non-financial parameters and combination of both. The results of the
regression analyses are given in the Tables 4.4.1.1a to 4.4.1.1c.
Using step-wise regression the researcher found thirteen parameters to be
significant at 10% confidence level with explanatory power of 73.5% (Table 4.4.1.1a).
This implies a relatively few parameters can predict the health o f the borrowers. Out of
thirty-two financial parameters, only four parameters viz,, increase in net sales, net assets
turnover, collection period and Net FA/ TL have entered the step-wise regression. The
interesting finding is that three out of four financial factors, are adversely impacting the
health of the borrower. However, when the regression was done considering only
Category 1: Term Loan
Table 4.4.1.1a : Regression Output with both Financial & Non-Financial parameters
F= 19.02(.000); Durbin-Watson = 1.495. R=.88 1 R2= 775 ; Adj.Ri= .735

Stand.
Variable Co-eff. t Signif. Adj. R2
Constant 5.59 .000
Servicing of instalment & interest .348 4.86 .000 .350
Margin on security .281 3.82 .000 .451
Fin. control .284 3.61 .001 .528
Increase in Net sales -.180 -2.94 .004 .568
Net assets turnover -.209 -3.51 .001 .591
Margin on Term Loan • -.233 -3.49 .001 .618
Liquidity of security .244 3.93 .000 .648
Industry Cyclicality -.185 -3.07 .003 .682
Labour management .166 2.64 .010 .691
Collection period -.162 -2.55 .013 .702
Relationship with bank .140 2.11 .038 .716
Net FA/TL .148 2.11 .038 .728
Integrity .110 1.68 .096 .735
Table 4.4.1.1b : Regression output with Financial parameters only

F= 10.11 (.000); Durbin-Watson= .821 ; R= .575 ; R2=-.331 Adj.R2= .298
Variables Stand. Signi Adj.
Co-eff, t f. R2
Constant 5.33 .000

Net FA/TL .416 4.41 .000 .175
Debtors Turnover .235 . 2.47 .015 .216
Net Profit/Cash Flow .245 2.65 .010 .267
ROCE= PBDIT/TNW+LT & ST borrowings .196 2.14 .035 .298
Table 4.4.1.1c : Regression output with Non-financial parameters
F= 18.591 (.000); Durbin-Watson= 1.34 ;R= .733 ; R = .538 ; Adj.R2= .509

Stand.
Variable Co-eff. t Signif. Adj. R2 '
Constant 9.47 .000
Servicing of instalment & interest .2.2 1.80 .075 .350
Financial control .336 3.66 .000 .446
Overall a/e conduct .282 2.82 .006 .480
Import Policy -.146 -1.91 .059 .496
Tenor of Loan .143 1.74 .085 .509
89
financial parameters in the regression model, the regression model enter again four
financial parameters of which only one parameter was found to be common .
Interestingly, all the four parameters influence positively the health of the borrower. As
such, NFA/ TL has highest predictive power among all the parameters considered (Table
4.4.1.1b) followed by Debtors Turnover ratio and Net Profit/ cash flow. Among the
subjective parameters, two parameters Servicing of Installment and Interest and Financial
Control mechanism of borrower have displayed highly significant predictive power
(Table 4.4.1.1 a & 4.4.1.1 c). They alone can explain more than 40% of the variation in the
dependent variable. Further the comparison o f Table 4.4.1.1b & 4.4.1.1c reveals that
subjective parameters have more predictive power than the financial parameters though
both categories have high predictive power. This is more or less consistent with the
weightage assigned by UBI who has specific model for tern loan and by SBI who had
clear cut provision for term loans in their model.
The analysis of parameters through multiple discriminant analysis (MDA) reveal that
even less number of parameters are needed to discriminate between default and non-default
cases. MDA unearth only six parameters which can adequately discriminate default and non
default cases with accuracy rate of 88.4% (Table 4.4.1.Id and 4.4.l.le). Five out of six
parameters are common with the regression model. Only one parameter viz., Increase in Net
Profit is added. When MDA was run with only financial parameters, it has extracted same
financial parameters as was found in the regression model. When few more significant
financial parameters are added, MDA extracted more financial parameters than the subjective
parameters (Table 4.4.1.Id - last two columns). This tentatively indicates that MDA models
can be built even by considering financial parameters as done by most of the authors
including Altman. Addition of subjective parameters add little to the discriminating power.
This may be due to non-normality of the subjective parameters. The classification power of
the financial parameters depicted in Table 4.4.1.1g also support this argument where four
financial parameters alone could classify about 79% cases correctly. Further it can be seen
from the Tables 4.4.1.1 e, 4.4.1 f and 4.4.1.1 g that MDA models classifies default/ NPA cases
more correctly than non-default/ non-NPA cases where misclassification rate is significantly
higher.
2. Manufacturing units availing Term Loan
The eighty-six term loan accounts are further segregated into manufacturing
(forty-nine) and service accounts (thirty-seven) to make the sample more homogeneous.
90
Table 4.4.1.Id: Discriminant Output
Cofnbined Output Parameters Financial Output Combined+Fin. +Non-fin.
Variable Canon. Variable Canon. Variable Canon.
Discrim Discrim Discrim
Co-eff. Co-eff. Co-eff.
Industry Cyclicality -.322 PBDIT/tnw+LT .433 Net FA/TL .752
Servicing of nstalment -.708 & ST Borrow. Debtors .433
& interest Net FA/TL .763 Turnover
Financial Control .482 Debtors .488 Overall a/c .953
Net Assets Turnover -.306 Turnover Conduct
Increase in Net Profit ' -.345 Net Profit/Cash .534
Margin on security .724 Flow
Classification Table 4.4.1.le: Combined Output Classification Table 4.4.1.If: Comb.+Fin+Non-fin.
Com.+F+NF npa non Tot.

Combined nPa non Total NPA count 58 2 60
NPA count 56 4 60 % 96.7 3.3 100
% 93.3 6.7 100 Non count 9 17 26
Non count 6 20 26 % 34.6 65.4 100
% 23.1 76.9 100
Cross- 0 91.7 8.3 100 Cross - 0 95 5 100
o
o
validated 1 23.1 76.9 validated 1 30.8 69.2 100

Correct classifieation= 88.4% (%)
Cross -valid. Class = 87.2%
Correct classification= 87.2%
Classification Table 4.4.1.lg: Financial Output Cross -valid. Class = 87.2%
Fin. Output npa non Tot.

NPA count 54 6 60
% 90 10 100
Non count 12 14 26
% 46.2 53.8 100
Cross- 0 90 10 100
(%) 1 46.2 53.8 100
validated
91
Tables 4.4.1.2a to 4.4.1.2c display the results of the regression analysis of the
manufacturing units who have availed term loans. One interesting observation is that the
explanatory power of the regression model has improved after segregation of the term
loan accounts into two homogeneous groups viz., manufacturing and service. The R is
87% for. manufacturing accounts availing term loan (Table 4.4.1.2a) and 85.5% for
service concerns availing term loan (Table 4.4.1.3a) against 73.5% when both are
combined (Table 4,4.1.1a). Few new parameters are entered into the regression model
replacing the previous ones keeping the number more or less same. Here too, Servicing of
Instalment and Interest is found to be the most dominant non-financial parameter and
NFA/TL is the most dominant amongst the financial parameters. Further non-financial
parameters appears to have more explanatory power than financial parameters as seen in
category 1 (Term Loan accounts).
Contrary to the output of regression, the classification power of MDA in case of
manufacturing units has gone down substantially when non-financial and financial
parameters are considered together in the MDA model (Table 4.4.1.2e and 4.4.1,2g). But
on the other hand, discriminating power of the MDA model has been found to be quite
satisfactory when only financial parameters are considered in the MDA model (Table
4.4.1.2f). There could be two plausible reasons for this apparent contradictions- 1.
number of parameters has increased when combined compared to number of cases taken,
resulting in loss of effectiveness of MDA model; 2. most of the subjective/ non-financial
parameters are not normally distributed. Hence, their inclusion in the MDA model may
violate the normality assumption of the MDA model. This comment also require further
investigation as their inclusion in the previous case ( Term Loan- all accounts combined)
has not resulted in this type of behaviour.
3. Service and Term Loan
When regression was run considering only term loan for service concerns, the
results appears to be very similar to that of term loans in manufacturing concerns in
respect of explanatory power but with notable differences in respect of certain parameters
(Tables 4.4.1.3a to 4.4.1.3c). The most significant financial parameters i.e. NFA/TL and
the most significant non-financial parameter i.e. servicing o f instalment and interest did
not enter in the step-wise regression. And only three to four significant parameters are
found to be common. This tentatively indicates that service and manufacturing sectors
requires different set o f parameters for models to have more predictive value.
Category 2 : Manufacturing units availing Term Loan
Table 4.4.1.2a : Regression Output with both financial & non-financial parameters
F = 24.04C.000); D-W = 1.941 ; R = .953; R2= .908; Adjusted Rl = .870

Variables Standard. t Signif. Adj. R3'
Coeff.(3)
Constant 6.104 .000
Servicing of Instalment & Interest .461 5.35 .000 .545
Increase in Net Sales -.283 -4.70 .000 .602
Integrity .222 3.40 .002 .647
ROCE=PAT+Intt./ tnw+ LT & ST -.203 -3.38 .002 .686
Borrowings
Utilisation ofLimit -.223 -4.09 .000 .711
DSCR .217 3.87 .000 .741
Overall a/c Conduct .311 4.23 .000 .768
Labour Management .237 3.99 .000 .786
Availability of Guarantee .135 2.30 .027 .802
Project Implementation -.197 -3.01 .005 .828
Net Assets Turnover -.117 -1.97 .057 .842
Liquidity of Security .158 2.29 .028 .850
Reliability of Financial Statement .213 2.71 .010 .863
Technology -.118 -1.71 .096 .870
Table 4.4.1..2b: Regression Output with Financial Parameters
F = 9.23C.000); D-W = .863 ; R = .535; R'= .287 ; Adjusted R" = .256

Variables Standard. t Signif. Adj. R'
Coeff.(p)
Constant 3.647 .001
Net Fixed Assets/Term Loan .442 3.487 .001
GP/ Net Sales -.231 -1.823 .075 .256
Table 4.4.1.2c : Regression Output with Non-financial Parameters

F = 18.35(.000); D-W = 1.72 ; R = .871 ; R*= .758 ; Adjusted R2= .7 17
Variables Standard. t Signif. Adj R2
Coeff.(P)
Constant 7.78 .000
Integrity .283 3.30- .002 .625
Utilisation of Limit -.216 2.72 .009 .648
Statutory Compliance -.174 -2.07 .044 .673
Project Implementation -1.93 .060 .717
00
i*1
Table 4.4.1..2d : Discriminant Output o f Manufacturing & Term Loan accounts
Combined output + Fin. + Subj. para. Financial Parameters Combined Output
Variables Canonical Variables Canon. Variables Canon.
Discrim. Disc. Disc.
Coefficient Coeff. Coeff.
Project Implementation 1.52 GP/N. sales .687 Project Implementation 1.37
Statutory Compliance -1.33 NFA/TL -.472
Increase in .508 All non-fmaneial
N. Profit No Output
Margin on -.535
Security
Classification Table 4.4.1.2e:Com.+fin.+non-fin. Classification' fable 4.4.1.2f:1 ;in.

Com.+Fin+Subj. NPA Non Tot. Financials NPA Non Tot.
NPA count 5 32 37 NPA count 29 8 37
% 13.5 86.5 100 % 78.4 . 21.6 100
Non count 0 12 12 Non count 2 10 12
% 0 100 100 % 16.7 83.3 100
Correct classification= 34.7 % Cross- NPA 75.7 24.3 100
Cross -valid. Class = 22.4% validated
(%) Non 25.0 75.0 100
Correct classification= 79.6 %
Classification Table 4.4.1.2g: Combined Output Parameters
Combined Out. NPA Non Tot.

NPA count 7 30 37
% 18.9 81.1 100
Non. count 0 12 12
% 0 100 100
Cross-valid. Class = 24.5%
94
C a t e g o r y 3 : S e r v ic e a n d T e r m L o a n
T a b le 4 .4 .1 ,3 a : R e g r e s s io n O u tp u t w ith b o th fin a n c ia l & n o n -fin a n c ia l p a ra m e te rs
F = 2 2 .4 4 { .0 Q 0 ) ; D -W = 2 .2 0 ; R = 9 4 6 ; R 2 = .8 9 5 ; A d ju s te d R ‘ = .8 5 5
V a ria b le s S ta n d a rd . t S ig n if. A d j.
C o e f T .( 3 )
C o n s ta n t - 1 .7 4 .0 9 3
F in a n c ia l C o n tro l ‘ .3 9 0 3 .6 1 .0 0 1 .4 1 9
M a rg in o n S e c u rity .4 3 1 4 .8 8 .0 0 0 .5 4 1
L iq u id ity o f S e c u rity .3 3 8 4 .4 1 .0 0 0 .6 0 0
D iv e rs io n o f F u n d .1 4 7 2 .0 3 .0 5 2 .6 6 1
N e t A s s e ts T u m o v e r - .3 7 8 - 5 .3 1 .0 0 0 .7 0 8
S p re a d o f M a rk e t - .3 3 9 - 4 .5 2 .0 0 0 .7 7 4
R O C E = P B D IT /T N W + L T & S T .3 9 7 3 .8 0 .0 0 1 .8 0 4
B o rro w in g s
N e t C a s h fro m O p e ra tio n s /L T D e b t - .2 1 6 - 2 .7 7 .0 1 0 .8 3 0
S u c c e s s io n P la n n in g ,2 0 2 2 .3 8 .0 2 5 .8 4 1
P e rfo rm a n c e o f G ro u p C o m p a n ie s - .1 7 1 - 1 .9 1 .0 6 7 .8 5 5
T a b le 4 .4 .1 .3 b : R e g re s s io n O u tp u t w ith F in a n c ia l P a ra m e te rs
F = 8 .5 3 ( .0 0 0 ) ; D -W = 1 .0 5 ; R = .6 6 1 ; R " = .4 3 7 ; A d ju s te d R 2 = .3 8 6
V a ria b le s S ta n d a rd . t S ig n if. A d j. R1
C o e f f .( P )
C o n s ta n t .8 4 0 .4 0 7
M a rg in o n S e c u rity .6 1 0 4 .4 1 7 .0 0 0 .1 7 2
P B D 1 T / T N W + L T & S T B o rro w . .5 2 7 3 .6 9 3 .0 0 1 .3 4 0
N e t A s s e ts T u rn o v e r - .2 5 7 - 1 .8 7 8 .0 0 9 .3 8 6
T a b le 4 .4 .1 .3 c : R e g re s s io n O u tp u t w ith N o n - f in a n c ia l P a ra m e te rs
F = 1 4 .2 5 ( .0 0 0 ) ; D -W = 1 .9 3 ;F 1 = .8 8 ; R " = .7 7 5 ; A d ju s te d R ' = 7 2 0
V a ria b le s S ta n d a rd . t S ig n if. A d j. R *
C o e f T .( P )
C o n s ta n t 2 .4 2 .0 2 2
F in a n c ia l C o n tro l .3 8 6 2 .7 0 .011 .4 1 0
L iq u id ity o f S e c u rity .3 5 9 3 .5 5 .0 0 1 .5 2 0
M a n a g e m e n t o f In v e n to ry & R e c . - .2 5 4 - 2 .8 4 .0 0 8 .5 6 5
M a n a g e m e n t In itia tiv e .3 6 5 2 .7 4 .0 1 0 .6 1 2
D iv e rs io n o f F u n d .3 0 2 3 .0 9 .0 0 4 .6 3 5
P e rfo rm a n c e o f G ro u p C o m p a n ie s - .4 7 6 - 3 .3 7 .0 0 2 .6 7 6
L a b o u r M a n a g e m e n t .3 3 1 2 .3 9 .0 2 3 .7 2 0
C la s s if ic a tio n T a b le 4 .4 .1 .3 d : F in a n c ia l
F in a n c ia ls N P A N o n T o t.
N P A c o u n t 21 2 2 3
% 9 1 .3 8 .7 1 0 0
N o n c o u n t 3 11 14
% 2 1 .4 7 8 .6 1 0 0
Cross- N P A 8 7 13 1 0 0
v a lid a te d
N o n 2 8 .4 7 1 .4 1 0 0
(% )
C o rre c t c la s s ific a tio n ^ 8 6 .5 %
C ro s s - v a lid . C la s s = 8 1 .1 %
In respect of MDA, inclusion of non-financial parameters led to the MDA model
being ineffective. As such, none of the non-financial parameters appear to have
discriminating power (may be for the reasons cited earlier under category 2). On the other
hand, financial parameters appear to have satisfactory discriminating power and could
classify 86.5% cases correctly (Table 4.4.1.3d) with less classification error for default
cases.
4. Greenfield / New Manufacturing units availing TL
There are 32 cases in manufacturing sector which are start-up venture with no
prior actual information on financial as well as non-financial parameters ( these units are
classified by some banks as Greenfield). Since there are uncertainties in the information,
due to projection based, as well as in the success of the venture, the study has done
separate analysis considering only the greenfield accounts with the view to examine
whether different rating model is needed for this category of loan proposal. The
regression analysis has revealed an interesting outcome. Only the non-financial
parameters entered the regression model explaining 86.8% of the dependent variable
(Table 4.4.1.4a). The explanatory power of the financial parameters was found to be
negligible but when regression was done using only financial parameters, six parameters
can explain 59.8% of the dependent variables (Table 4.4.1.4b). The- apparent
contradictory result is due to the fact that most of the banks revise the financial
projections submitted by these borrowers based on non-financial parameters. And as
such, non-financial parameters reflects the variation in the financial parameters.
Discriminant analysis shows very high classification power o f the parameters
used in the model . Correct classification is found to be 96.6% with more level of
accuracy for default cases (Table 4.4,1.4c). Similar observation is seen when only
financial parameters are considered in the MDA (Table 4.4,1.4d). There is good reason
for banks assigning high weightage for subjective parameters.
5. Greenfield/ New Trading and Service/ Infrastructure accounts availing TL
For the Greenfield accounts in the service sector, both the financial and non-
financial parameters are found to be more or less equally effective unlike the Greenfield
accounts in the manufacturing sector (Tables 4.4.1.5a, 4.4.1.5b, 4.4.1.5c). Further there is
little commonality among the effective parameters in both these categories of loans.
Discriminant analysis shows very high discriminating power of the parameters
with 100% classification accuracy when both financial and non-financial parameters are
96
C ategory 4: Greenfleld/N ew M anufacturing units availing T erm Loan
Table 4 .4 .1 .4 a: Regression Output with both Financial & Non-financial
parameters
F = 23.69f.000); D-W = 2.039; R = .952; R2= .906; Adjustec R' = .861

Variables Standard. t Sign if. Adj. R1
Coeff.fp)
Constant >
10.989 .000
Resourcefulness .490 6.60 .000 .412
Collection Period .360 4.817 .000 .542
Export Potential .227 3.046 .006 .669
Ability to meet Sales Projection .441 5.568 .000 .728
Technology -.290 -3.228 .004 .775
Raw Material -.244 -3.315 .003 .801
Industry Prospects .237 2.845 .009 .828
Compliance of Environ. .195 2.785 .011 .853
Regulations
Expertise -.155 -1.908 .069 .868
Table 4.4.1.4b : Regression Output with Financial parameters
F = 8.67(.000); D-W =1.12 ; R = .f122; R '= .675; Adjusted R" = .598

Variables Standard. t Signif. Adj. R'
Coeff.(3)
Constant 3.352 .003
Inventory Turnover .424 3.217 .004 .256
LT Debt/ TNW -1.253 -3.896 .001 .327
GP/Sales -.255 -2.019 .054 .389
"*-4
PBDIT/TNW+LT & ST Borrow.

OO
-4,140 .000 .433

i
TOL/TNW .947 2.978 .006 .495

PBIT/Totai Operating Assets .417 2.758 .011 .598
Table 4.4.1.4c- Classification Table(Comb.+ Fin) Table 4.4.1.4d : Classification Fin. output
Comb.+Fin. Out. NPA Non Tot. All Financials NPA Non Tot.
% 100 0 100 ■ % 95.7 4.3 100
% 11.1 88.9 100 % 33,3 66.7 100
Cross- NPA 100 0 100 Cross- NPA 91.3 8.7 100
validated validated
Non 11.1 88.9 100 (%) Non 33.3 66.7 100
(%)
Correct classification= 96.9 % Correct c!assification= 87.5 %
Cross -valid. Class = 96.9 % Cross -valid. Class = 84.4 %
Category 5: New Trading & Service /Infra. Accounts availing Term Loan
Table 4.4.1.5a : Regression Output with both financial & non-financial

parameters
F = 14.3K.000); D-W = 1.85; R = .905; R2= .819; Adjusted R2 = .762

Coeff.(P)
Constant 5.81 .000
Liquidity of Security .541 4.87 .000 .448
Relationship with Bank .316 3.15 .005 .553
Inventory Turnover ,521 3.58 .002 .646
DSCR -.313 -2.19 .041 .695
Expertise .229 2.23 .038 .735
Margin on Security .185 1.79 .089 .762
F = 5.901 (.002); D-W = .845 ; R = .727; R - .529; Adjusted R1= .439

Variables Standard. t Signif. Adj. R2
Coeff.(3)
Constant 3.256 .004
Net Fixed Assets/ Term Loan .406 2.427 .024 .143
PBDIT/TNW+LT & ST Borrow. .960 3.311 .003 .285
PBT/TNW -.651 -2.244 .036 .351
Table 4.4.1.5c : Regression Output with non-financial parameters
F = 16.44f.000); D-W = 1.549 ; R = .767; R2= .588; Adjusted R2 = .553

• Coeff.(0)
Constant 6.502 .000
Liquidity of Security .683 5.105 .000
Table 4.4.1.5d: Classification Table (Combined) Table 4.4.1,5e: Classification Table (F)
Combined NPA Non Tot. All Financials NPA Non Tot.

% 100 0 100 % 100 0 100
% 0 100 100 % 25 75 100
Cross- NPA 94.4 5.6 100 Cross- NPA 94.4 5.6 100
validated validated
(%)_____ Non 0 100 100 (%) Non 37.5 62.5 100
Correct classification= 100 % Correct classification3 92.3 %
98
used (Table 4.4.1.5d). Like in the case of greenfied accounts in manufacturing sector,
financial parameters also depicted high discriminating power with correct classification
of 92.3% (Table 4.4.1.5e).
6. W orking Capital
Unlike term loans, working capital loan proposals are for short-term (one year)
and are renewed every year if the performance of the borrowers are satisfactory. Out of
181 accounts, 95 accounts are working capital accounts. Since 6 parameters do not have
relevance to this type o f loan category , these have been dropped from both regression
and discriminant analyses. Analysis were done separately for financial parameters, non-
finaneial parameters and combination of both. Regression analysis results are given in
Tables 4.4.1,6a to 4.4,1.6c.
Sixteen parameters are found to be significant in the regression analysis when the
combined sets of financial and non-financiai parameters was considered . These
parameters together could explain 73.7% of the variation in the dependent variable (Table
4.4.1.6a).
Out of the financial parameters, only four parameters viz., Net sales/net fixed
assets, LT debt/TNW, ROCE and PBIT/net sales have entered the step-wise regression.
The interesting finding is that 2 out of 4 financial factors are adversely impacting the
health o f the borrower (Table 4.4.1.6a). However, when the regression was done
considering only financial parameters in the regression model, the model entered only 2
financial parameters of which only 1 parameter was found to be common (Table
4.4.1.6b). Moreover, these two significant parameters could explain only 5.6% of the
variation in the dependent variable.
Amongst the non-financial parameters, •4 parameters have entered both the
regression models (Table 4.4.1.6a & 4.4.1.6c). Thus, we can say that a few subjective
parameters can explain around 63% of the variation in the dependent variable (Table
4.4.1.6c). Amongst them, a single parameter viz., Reliability o f financial statement could
explain around 30% of the variation (Table 4.4.1,6a).
The analysis of parameters through multiple discriminant analysis (MDA) reveal
that even less number o f parameters are needed to discriminate between default and non
default cases. MDA unearth only 4 parameters which can adequately discriminate default
and non-default cases with accuracy rate o f 83.3% (Table 4.4.1.6d and 4.4.1.6e). All the 4
parameters are common with the regression model. When MDA was run with only
99
Category 6: Working Capital
Table 4.4,1.6a: Regression output with both financial & non-fmancial parameters
F= 17.64 (.000); Durbin-Watson= 1.788 ; R=%884 ; R2=.781 ; Adj.R2= .737

Stand.
Variable Co-eff. t Signif. Adj. R2
Constant 10.83 .000
Reliability of financial statement .333 5.36 .000 .312
Audit qualification .256 J 3.99 .000 .424
Net sales/Net Fixed Assets .289 4.90 .000 .460
Liquidity of security -.336 -5.44 .000 .512
Mgt. of inventory & receivables ,310 5.53 .000 .543
Board composition -.216 -3.61 .001 .579
Product Quality .126 2.01 .048 .609
Competition -.176 -3.03 .003 .621
Submission of ABS .223 3.69 .000 .640
.011
LT debt/ TNW -.147 2.538 .013 .684
Export potential -147 -2.58 .693
R0CE=PB1T/ TNW + LT debt -.183 -2.95 .004 .703
PBIT/Net sales .179 2.77 .007 .713
Performance of group companies -.136 -2.38 .019 .725
Technology .123 2.145 .035 .737
Table 4.4.1.6b: Regression output with Financial parameters only
F= 3.79 (.000); Durbin-Watson = .21n ; R= .27; R2=.07; Ad .R2= .056

Variables Stand.
Co-eff. t Signif. Adj. R2
Constant 7.46 .000
PBT/TNW -.238 -2.36 .020 .035
PBlT/sales .176 1.74 .005 .056
Table 4.4.1.6c : Regression output with Non-fmancial parameters
F= 16.22 (.000); Durbin-Watson= 1.56 ;R=.82S ; Ri= .68 ; Ac j.R - .628
Stand.
' Variable CoefF. t Sign
Constant 10.88 .000
Financial control .206 2.64 .010
Reliability of financial statement .407 5.42 .000
Liquidity of security ' -.293 -4.45 .000
Submission of ABS .266 4.08 .000
Management of inventory & receivables .311 4.26 .000
Board composition -.257 -3.79 .000
Product Quality .242 3.53 .001
Experience .310 4.67 .000
Export potential -.117 -1.72 .088
Security coverage -.115 -1.76 .081
Ability to meet sales projections -.128 -1.67 .098
Table 4.4.1.6 d : Discriminant output
Combined Output Parameters Combined +Fin, Output Para.

Variable Canonical Variable Canonical
Discriminant Discriminant
Co-efficient Co-efficient
LT debt/ TNW 2.34 PBIT/sales -.658
Board composition -6.59 PBT/TNW .882
Product Quality 7.94
Submission of ABS 5.93
Classification Table 4.4.1.6e combined output parameters Classif. Table 4.4.1.6f: Comb.(F)
+Fin.output
Combined Default Non-default Total Com(F)+Fin, Default Non-default Total

NPA Count 9 13 22 0 count 10 12 22
% 45.5 54.5
% 40.9 59.1 100 1 count 13 61 74
Non Count 3 71 74 % -17.5 82.5
% Cross- 0 36.4 63.6 100
4.1 95.9 100 (%) 1 17.6 82.4 100
! Cross- 0 81.8 18.2 100 validated
validated 1 56.8 43.2 100 Correct classification= 74.0%
Correct classification= 83.3% Cross -valid. :iass = 71.9%
Cross -validation classification = 52.1%
101
financial parameters, it has extracted same financial parameter as was found in the
regression model (Table 4.4.1.6d- second column). These two parameters could correctly
classify 74% of the cases (Table 4.4.1,6f)-
7. Manufacturing units availing Working Capital
The 95 working capital accounts are further segregated into manufacturing
accounts (27 nos.) and trading concerns (52 nos.) to make the sample more
homogeneous. Out of 34 financial parameters used, only five parameters entered the
regression model. These five parameters could explain 61.7% of the variation in the
dependent variable (Table 4.4.1.7a). When regression was done on the non-financial
parameters, the predictive power of the significant parameters was found to better than
financial parameters (Table 4.4.1.7b). The non-financial parameters could explain 86.2%
of the variation and a single parameter viz., Reliability of financial statement alone could
explain more than 50% of this variation.
When MDA was run with only financial parameters, it has extracted the same five
financial parameter as was found in the regression model (Table 4.4.1.7a and 4.4.1.7c).
This MDA model could discriminate 96.3% of the cases correctly into default and non
default classes (Table 4.4.1.7e), However, when MDA was done considering only the
significant non-financial parameters, three parameters have been dropped from the
model. These three parameters could correctly classify 100% of the cases (Table
4.4.1.7f). Further, when both sets of significant parameters were used for MDA, the
model entered more non-financial parameters (same as MDA with only significant non-
fmancial parameters) than financial parameters (Table 4.4.1.7c- column 1) and the
showed very high discriminatory power (Table 4.4.1.7d). This indicates that non-
financial parameters have a better discriminatory power than financial parameters in this
category o f loans. The apparent reason could be that the banker is in a better position to
evaluate the borrower on non-financial parameters for this category of loans where the
relationship is ongoing.
8. Trading units availing Working Capital
When regression was run considering working capital loan for trading
concerns, the results appears to be similar to that of working capital for manufacturing
concerns in respect of explanatory power of the two sets of parameters in the sense that
the non-financial parameters have a better explanatory power than the financial
parameters in both categories (category 7 and 8) but with notable difference in the extent
102
Category 7: Manufacturing accounts availing working capital
Table 4.4.1.7a : Regression Output with Financial parameters

F = 9.37(.000); D-W = 1.395 ; R = 831; R2= .691 ; Adjusted R2= .617
Variables Standard. t Signif. Adj.R2
Coeff.(p)
Constant 10.72 .000
PBT/Net Assets 1.010 3.80 .001 .194
Collection Period -.490 -3.88 .001 .309
PBIT/Total Operating Assets -1.253 -4.05 .001 .392
NP/ Sales .593 3.20 .004 .555
Borrowed Fund/TNW -.282 -2.138 .044 .617
Table 4.4.1.7b : Regression Output with non-financial parameters
F = 28.10(.000); D-W = 1.92 ; R = 945; R2= 89^ ; Adjusted R2 = .862
Coeff.fP)
Constant 8.61 .000
Reliability of Financial Statement .377 3.90 .001 .498
Compliance of Sanction Terms .311 3.62 .002 .698
Location .267 3.29 .004 .823
Turnover in the a/c -.186 -2.10 .048 .862
Table 4.4.1.7e : Discriminant Output
Subj. Output + Fin. Out put Financial Parameters Combined +Fin+Subj

Coefficient Coeff. Coeff.
NP/ N. Sales .891 Borr.Fund / .571 No Output
Borr.Fund / TNTW -.650 TNW All Subjectives
Relationship with Bank 1.222 NP/N. Sales -1.14 No Output
Compliance of Sanction 1.027 PBTT/Tot. 2.58
Terms Op. Assets Subjective Output
Reliability of Financial .880 Collection .946 Reliability of Financial .787
Statement Period Statement
PBT/N Asset -1.923 Compliance of ; .794
Sanction Terms
Relationship with Bank .580
Classification Table 4.4.1.7d : Subj. + Fin. Classification Table 4.4.1.7e: Financial
Non-Fin + Fin. NPA Non Tot. Financials NPA Non Tot.

% 100 0 100 % 85.7 14.3 100
Non count 0 20 20 Non count 0 20 . 20
% 0 100 100 % 0 100 100
Cross- NPA 100 0 100 Cross- NPA 71.4 28.6 .100
validated validated
(%) Non 0 100 100 (%) Non 5.0 95.0 100
Correct classification 100 % Correct classification= 96.3 %
Cross -valid. Class = 100% Cross -valid. Class = 88.9%
Classification Table 4.4.1.7f: Subjective Output Parameters
Combined Out. NPA Non Tot.

NPA count 6 o ■ 6
% 100 0 100
Non count 0 20 20
% 0 100 100
Cross- NPA 83.3 16.7
validated
(%) Non 0 100
Correct classification= 100 %
104
of explanatory power. The explanatory power of both sets of parameters - financial and
non-fmancial has come down to 49.8% and 79.1% respectively when applied to trading
concerns availing working capital (Tables 4.4.1.8b and 4.4.1.8c). Amongst the non-
fmancial parameters a single parameter viz., audit qualification could explain most of the
variation (34.5%). Further, it is seen from the regression run that a new set of financial
parameters have entered the regression model (Tables 4.4.1.7a and Table 4.4.1.8b) giving
an indication that trading and manufacturing sectors requires different set of parameters
for models to have more predictive value.
In respect of MDA, only two out of the nine significant financial parameters have
entered the MDA model (Table 4.4.1.8d -columnl). This parameter is Promoters
Contribution and Net sales/net fixed assets. The financial parameters could discriminate
90.4% cases correctly into default and non-default classes (Table 4.4.1.8f). The same
discriminatory power was observed when MDA was done on the combined sets of
significant parameters (Table 4.4.1.8e).
Overall we find that the discriminatory power o f the MDA improves when the
classification/categorisation of the working capital borrowal accounts into homogeneous
groups viz., manufacturing and trading is done. This again gives an indication that
models could work better when developed for specific situations.
9. Existing Trading or service units availing WC
The working capital borrowal accounts are generally existing borrowers because
of the renewal nature of such loans. We have therefore, further segregated accounts into
existing ones separately for trading and manufacturing concerns. Existing service
concerns which are very few in number have been clubbed with trading concerns. The
number of cases in this category of loans is forty-three.
The regression output shows seventeen significant parameters out of which only
three are financial parameters. These seventeen parameters could explain 91.1% of the
total variation (Table 4.4.1.9a). Out of the 31 financial parameters considered in both the
regression runs (combined set and alone) only two to three different parameters entered
the models . The explanatory power o f the financial parameters was found quite low at
24.2% (Table 4.4.1.9b), However, the non-financial parameters were found to have much
better explanatory power (76.1%) compared to financial parameters (Table 4.4.1.9c).
The MDA output has shown that only two significant financial parameters viz.,
PBDIT/Sales and PBT/Net Assets have entered the model (Table 4,4.1.9d- second
105
Category 8; Trading accounts availing Working Capital
Table 4.4.1.8a: Regression Output with financial & non-fmaneial parameters

F = 25.20(.000); D-W = 1.395 ; R = .90; R2= .82^ ; Adjusted R2= .792
CoefF.(0)
Constant 13.74 .000
Audit Qualification .491 7.12 .000 .345
PBT/Net Assets -.653 -7.77 .000 .513
Mgt. of Inventory & Receivables .430 5.794 .000 .582
N. Sales/Net Fixed Assets .237 3.510 .001 .643
Increase in Net Profit .240 3.149 .003 .698
Net Cash from Operations/LT Debt .275 3.598 .001 .755
Litigation .148 2.25 .029 .774
Composition of Board -.155 -2.16 .036 .792

F = 11.10(.000); D-W = 1.321; R = 74; R2= .547 Adjuster R2= .498
Coeff.(p)
Constant 12.312 .000
Promoter’s contribution -.564 -5.004 .000 .320
ROCE=PAT+lntt/tnw + LT& ST -.997 -4.426 .000 .406
Borrowings
Borrowed Fund / TNW -.245 -2.116 .040 .443
PBDIT/ TNW+ LT & ST Borrow. .493 2.256 .029 .477
PBIT/ interest .178 1.71 .093 .498
Table 4.4.1.8c : Regression Output with non-financial parameters

F = 20.31 (.000); R = .912; R2=.832 ; Adjusted
R2 = .791
Variables
Constant
Audit Qualification
Overdrawings in Account
Submission of ABS, P/L
Compliance of Sanction Terms '
Renewal of Limits
Reliability of Financial Statement
Diversion of Fund
Management of Inventory & Re c. '
Distribution
Expertise -
Table 4.4.1.8 d : Discriminant Output
Combined Output + Fin. Output. Financial Parameters
Variables Canonical Variables Canon.
Discrim. Disc,
Coefficient CoefT.
Promoters contribution -1.02 NP/N. Sales 2.12
Net Sales/Net F. Assets .980 PBDIT/lnterest -.411
Audit Qualification 1.27 PBIT/Net Sales -1.14
Increase in Net .632
Sales
Classification Table 4.4.1.8e- Combined+ Fin. Classification Table 4.4.1.8f- Financial output
Comb. + Fin. NPA Non Tot. All Financials NPA Non Tot.
% 60 40 100 % 60 40 100
Non count I 41 42 Non count 1 41 42
% 2.4 97.6 100 % 2.4 97.6 100
Cross- NPA 0 100 100 Cross- NPA 50 50 100
validated validated
- (%) Non 2.4 97.6 100 (%) Non 2.4 97.6 100
Correct classification= 90.4 % Correct classification= 90.4 %
i Cross -valid. Class = 78.5% Cross -valid. Class = 78.9%
107
Category 9: Existing Trading & Service accounts availing WC
Table 4.4.1.9a : Regression Output with financial & non-financial parameters
F = 26.19(.00G); D-W = 1.94 ; R = .973; .947; Adjusted Ri = .911
Variables Standard. t Signif.
Coeff.(P)
Constant • 15.93 .000
Relationship with Bank .368 5.56 .000
PBIT/Total Operating Assets -.128 -2.33 .G28
Increase in Net Profit .200 3.06 .005
Management of Inventory & Rec. .407 7.28 .000
Regulatory Aspects -.271 -4,80 .000
Reliability of Financial Statement .259 4.17 .000
Compliance of Sanction Terms -.337 -5.05 .000
Overdrawings in the A/C .283 4.25 .000
Market Reputation .111 1.75 .091
Submission of ABS, P/L .367 5.62 .000
Audit Qualification .265 4.22 .000
Competition -.094 -1.67 .106
Diversion of Fund -.179 -2.50 .019
Succession Planning -.117 -2.12 .044
Increase in Net Sales .207 3.10 .005
Management Initiative -.193 -2.86 .008
Expertise .122 1.81 .081
Table 4.4.1.9b: Regression Output with Financial parameters

F = 7.7.8(.001); D-W = ; R = .527; R' = .278; Adjusted R2= .242
Coeff.(p)
Constant 2.724 .010
PBDIT/Sales -.349 -2.533 .015 .158
PBT/Net Assets -.324 -2.352 .024 .242
Table 4.4.1.9c: Regression Output with non-financial parameters

F = 17.76(.000); D-W = 1.67 ; R = 898; R'= .807; Adjusted Ri = .76
Variables Standard. t Signif. Adj . R2
Coeff.(p)
Constant 14.95 .000
Audit Qualification .340 4.02 .000
Compliance of Sanction Terms -.707 -7.14 .000
Submission of Stock Statement,etc. .471 4.05 .000
Overall a/c Conduct .271 2.83 .008
Regulatory Aspects -.152 -1.86 .071
Utilisation of Limit -.141 -1.78 .084
Submission of ABS, P/L .157 -1.71 .095
T able 4.4.1.9 d: Discriminant Output
Combined + Fin. Output+Subj. out. Financial Parameters Comb(S)+Subj. O ut
Coefficient Coefif. Coefif.
PBIT/Total Op. Assets -.359 PBDIT/Sales ,712 Relationship with Bk. .699
Market Reputation .502 PBT/Net .606 Audit Qualification .800
Relationship with Bank .795 Assets Comp, of Sane. Terms -1.61
Audit Qualification .625 Sub. of stock statement 1.21
Compliance of Sanction -1.534 Overall a/e Conduct .623
Terms Regulatory Aspects -.625
Sub. o f stock statement 1.317 M gt o f Inv. Sc Rec, .713
Mgt. o f Inv. & Ree. .646 Overdrawings in a/c .536
Overdrawings in the A/C .656 Diversion o f Fund -.843
Diversion o f Fund -.633
Regulatory Aspects .714
Classification Table 4.4.1.9e- Comblned+ Fin.+Subj. Classification Table 4.4.1.9f-Fin. output
Comb.+Fin.+S NPA Non Tot. Financials NPA Non Tot.

% 100 0 100 % 62.5 37.5 100
% 0 100 100 % 20 80 100
validated validated
(%) Non 2.9 97.1 100 (%) Non 20 80 100.
Correct classification* 100 % Correct classification* 76.7 %
Cross -valid. Class = 97.7 % Cross -valid. Class * 76.7 %
Classification Table 4.4.1.9g- Combined (Sub.)+ Subj. Output
Comb.(S) +Sub. NPA Non Tot.

NPA count 8 0 8
% 100 0 100
Non count 0 35 35
% 0 100 100
Cross- NPA 100 0 100
validated
(%) Non 2.9 97.1 100
Correct classification= 100 %
Cross -valid. Class = 97.7 %
109
column) and these could classify 76.7% (Table 4.4.1.9f) o f the cases correctly into
default and non-default classes. It is interesting to note that the discriminatory power of
these two financial parameters is much higher (76.7%) than its explanatory power
(24.2%). As in the case of regression, here too, the non-fmancial parameters have more
discriminatory power (Table 4.4.1.9g).
10. Existing Manufacturing units availing WC

There are 22 cases in this category. Out of thirty-three financial parameters
considered, only five were found to be significant in the regression run and these
explained 79.5% o f the variation in the dependent variable (Table 4.4.1.10b). In case of
non-fmancial parameters, 100% of the variation is seen to be explained by seventeen
parameters out o f fifty-five parameters considered (Table 4.4.1.10a).
The MDA results show that all the five significant financial parameters enter the
MDA model (Table 4.4.1,10c), The discriminatory power is seen to be very high for
these set of parameters with classification accuracy of 100% (Table 4.4.1.10d). We find
that the discriminatory power of the financial parameters is higher than their explanatory
power which is also noted in the previous case which considered existing trading
concerns with WC limit. However, the explanatory power o f financial parameters for
loan category 10 is far better than loan category 9 (table 4.4.1.10b and 4.4.1.9b).
11. Manufacturing concerns

Three regression models were run - considering both sets, only financial and only
non-financial The output is given in Tables 4.4.1.1 la to 4.4.1.1 lc. The results show that
non-financial parameters’ satisfactory explanatory power of 77.2% comes down to 38%
when only financial parameters are considered. The non-financial parameter Servicing of
Instalment and Interest alone explains 64.1% of the variation (Tables 4.4.1,11a and
4.4.1.11c).
The MDA results show that one financial parameter viz., DSCR and two non-
financial parameters viz., servicing of instalment & interest and Submission of stock
statement,etc. enter the discriminant model (Tables 4.4.1.1 Id). These parameters were
significant in the regression models. These three parameters could correctly classify
93.4% of the cases (Table 4.4.1.1 le). Addition of one more non-fmancial parameter has
left the discriminatory power unchanged (Table 4.4.1.1 If).
no
Category 10: Existing Manufacturing accounts availing WC
Table 4.4.1.10a : Regression Output with Non-financiai parameters
F * 62290.41 ; D-W = 2.75 ; R = 1; R' = 1; Adjusted R^ = 1

Variables Standard. t Signif.
Coeff.(P)
Statutory Compliance .607 294.69 .000
Reliability of Financial Statement .371 189.09 .000
Composition of Board -.187 -80.69 .000
Project Implementation -.414 -268.85 .000
Cheques Returned .396 179.53 .000
Diversion of Fund -.166 -64.57 .000
Product Quality -.146 -84.17 .000
Turnover in the A/c -.072 -47.78 .000
Infrastructure .126 68.55 .000
Availability of Guarantee .106 57.40 .000
Competition .027 17.16 .000
Compliance of Environ. Regulation -.035 -29.36 .000
Regulatoiy Aspects .039 26.01 .000
Competence .027 16.43 .000
Spread of Market -.017 -8.37 .004
Audit Qualification -.015 -6.23 .008

F = 16.54(.000); D-W = 1.908 ; R = .920; R2=.8/16; Adjusted R* = .795
Variables Standard. t Signif. Adj. R^
Coeff.(P)
Constant 9.542 .000
Collection Period -.590 -4.28 .001 .490
NP/ Sales .982 4.32 .001 .630
PBIT/Sales -.475 -1.99 .064 .717
Inventory Turnover -.332 -2.76 .015 .763
Bank Borrowing/ Sales -.298 -1.87 .081 .795
Table 4.4.1.10c: Discriminant Output Classification Table 4.4.1.10d- Fin. output
All Financial Parameters

Variables Canonical Financials NPA Non Tot.
Discrim. NPA count 4 0 4
Coefficient % 100 0 100
NP/ Sales -2.486 Non count 0 17 17
Bank Borrowing/ Sales .758 % 0 100 100
PBIT/Sales 1.300 Cross- NPA 100 0 100
Collection Period 1.139 validated
Inventory Turnover .920 (%) Non 0 100 100
Correct classification* 100 %
Cross-valid. Class = 100%
111
Category 11: M anufacturing Concerns
Table 4.4.1.11a: Regression output with financial and non-financial parameters

F= 49.59 (.000); Durbin-Watson= 1.63 ;R = .914 ; R2= .836 ; Adj. R2= .8 9
Standardised
Variable Coefficient t Sign Adj.R2
Constant 18.83 .000
Servicing of interest & installment .584 8.44 .000 .641
Submission of stock statement .257 4.04 .000 .721
DSCR .205 3.87 .000 .746
Bank borrowing/WC gap .206 4.07 .000 .770
Compliance of Environmental norms .178 3.33 .000 .800
PBT/TNW .122 2.39 .019 .812
Table 4.4.1.11b: Regression output with financial parameters
F= 16.76(.000); Durbin-Watson= .897 ; R - .64 ;R 2=41 ; Adj.R2= .38

Variables Standardised
Co-efficient. t Signif. Adj. R2
Constant 8.32 .000
interest/Net sales -.255 -2.53 .013 .356
PBT/TNW .198 2.15 .034 .387
Table 4.4.1.11c: Regression output with non-financial parameters
F= 37.36 (.000); Durbin-Watson= 1.58 ;R=.891 ; R2= .79^ ; Adj.R2= .772

Stand.
Variable Coeff. t Sign Adj.R2
Constant 17.14 .000
Servicing of interest & installment .544 7.04 .000 .641
Submission of stock statement .243 3.49 .001 .721
Audit qualification .104 1.66 .100 .732
Compliance of sanction terms .159 2.56 .012 .740
Statutory compliance -.181 -2.83 .006 .766
112
Table 4.4.1.l i d : Discriminant Output
Combined output parameters Combined+ Fin+ Non-fin output
Variable Discrim, Variable Discrim.

coeff. Co-eff.
DSCR .589 DSCR .694
Servicing of interest & .864 Financial control .428
installment « Servicing of interest & .665
Submission of stock statement .913 installment
Submission of stock .944
statement
Classification Table 4.4.1.11e:Combined output
combined 0 1 Total
0 count 41 3 44
% 93.2 6.8
1 count 2 30 32
% 6.3 93.8
Cross- % 0 90.9 9.1 100
validated 1 9.4 90.6 100
Correct classi Fication= 93.4%
Classification Table 4.4.1.11f: Combined output +Financial+

Non-fin. output parameters
Com+F+Non 0 1 Tot.
0 count 41 3 44
% 93.2 6.8
1 count 2 30 32
% 6.3 93.8
Cross-(%) 0 90.9 9.1 100
validated 1 9.4 90.6 100
12. Trading concerns
There are fifty-two cases in this category of loans. The regression output shows
that eleven parameters out of eighty-three parameters have given an explanatory power of
84.7% (Table 4.4.1.12a) indicating that few parameters can explain the variation in the
dependent variable. The explanatory power is 48% when only financial parameters are
considered (Table 4.4.1.12b). Five out of thirty-six financial parameters are significant.
The same set of significant financial parameters is included in the MDA model.
The same phenomenon is noted for the non-financial parameters too (Table 4.4.1.12c).
Both the sets of significant parameters could discriminate default and non-defaults with
100% accuracy (Table 4.4,1.12d). Thus, these parameters are seen to have high
explanatory as well as discriminatory power. When considered separately, the MDA
shows almost equal discriminatory power for the financial as well as the non-financial
parameters (Tables 4.4.1.12e & 4.4.1.12f).
13. Service concerns
In the regression analysis, out o f eighty-eight parameters only seven parameters
have entered the model. These seven parameters (two financial) have explained 64.5% of
the variation (Table 4.4.1.13a). Interestingly, only one parameter is found to be
significant when regression is run with only the financial parameters (36 nos.) but had
poor explanatory power (Table 4,4,1.13b).
In the MDA model, two significant non-financial parameters were dropped (Table
4.4.1.13c). In this case five parameters had a good discriminatory power and could
classify correctly 90.6% of the cases (Table 4.4.1.13d). In the second MDA using only
significant financial parameters, one parameter i.e. Margin on Security entered the model
(Table 4.4.1.13c- second column). It showed a discriminating power o f 71.7% (Table
4.4.1.13e).
14. Existing accounts

The study has tried to see the predictive and discriminatory power of the
parameters in the case of existing units i.e. units which are in operation and are already
having relationships with the banks.
Out o f the ninety-four parameters considered ten parameters (three financial
parameters) are found to be significant in the regression model (Table 4.4.1.13a) and
could explain 76.3% of the variation. In the regression run considering financial
Category 12: T rad in g concern
Table 4.4.1.12a: Regression output with financial & non-fmancial. parameters
F= 26.58 (.000); Durbin-Watson= 1.89 ; R= .938 ; R2= .880 ; Adj.R- 847
Stand.
Variable Coeff. t Sign Adj.R2
Constant 13.89 .000
PBT/ Net Assets -.399 -5.99 .000 .513
Servicing of interest & install .514 6.18 .000 .584
Management of inventory & receivables .241 3.93 .000 .660
Compliance of sanction terms -.284 -4.13 .000 .725
Increase in net profit .233 3.5 .001 .754
Renewal of limit .265 3.08 .004 .783
Regulatory aspects -.176 -2.79 .008 .802
Track record -.205 -2.56 .014 .833
Expertise .139 2.14 .039 .847
Table 4.4.1.12b: Regression output with Financial parameters

F= 12.75 (.000); Durbin-Watson= 1.37 ;R =.72 ;R L~ .52 ; Adj.R2= 480
Stand.
Variable Coeff. t Signif. Adj.R2
Constant 10.29 .000
ROCE=PAT+ interest/TNW +LT & ST borrowing -.846 -3.84 .000 .406
LT debt/ TNW -.272 -2.20 .032 .460
ROCE= pbit / TNW+LT+ ST borrowing .373 1.69 .097 .480
Table 4.4.1.12 c: Discriminant output (Category 12)
Combined Output Parameters Combined(Fin)+ Fin. out]put para.

Variable Discrim. Variable Discr
' Coeff. coeff
Increase in net profit -.658 LT debt/TNW .537
Promoter’s contribution .812 ROCE=PAT+intt/TNW 1.501
PBT/ Net Assets -.316 +LT & ST borrow
Track record -1.18 ROCE= pbit /TNW+LT -.713
Expertise -.699 + ST borrowing
Audit qualification .364 Promoter’s contribution 1.04
Compliance of sanction terms .704
Servicing of interest & installment -.919
Mgt. of inventory & receivables 1.439
Renewal of limit .756
Regulatory aspects .763
115
Table 4.4,1.12d: Classification Table
Combined npa non Total
Npa count 10 0 10
% 100 0
Non count 0 42 42
% 0 100
Cross- % 0 100 0 100
validated 1 2.4 97.6 100
Correct classification 100%
Table 4.4,1.12e: Classification Table Table 4.4.1.12f: Classification Table(NF)

Financial npa non Total Non-finan. npa non Total
Npa count 8 2 10 Npa count 10 0 10
% 80 20 % 100 0
Non count 2 40 42 non count 1 41 42
% 4.8 95.2 % 2.4 97.6
Cross- % 0 70 30 100 Cross- % 0 80 20 100
validated 1 4.8 95.2 100 validated 1 7.1 92.9 100
Correct classii ication= 92.3% Correct classiirication= 98, •%
Cross -valid. Class = 90.4% Cross -valid. Class = 90.4?4
Category 13: Service concerns
Table 4.4.1.13a: Regression output with financial & non-financial parameters
F= 14.48 (.000); Durbin-Watson= 1.44 ; R= .83 ; R"= .69 ; Ad ,R'= .645
Standardised.
Variable Coefficient t Signif. Adj.R2
Constant 11.29 .000
PBIT/Tot op. asset -.243 -2.72 .009 .446
Tenor of loan .223 2.58 .013 .494
Relationship with bank ,221 2.26 .029 .558
Current ratio .281 3.14 .003 .588
Statutory compliance -.185 -1.95 .057 .645
Table 4.4.1.13b: Regression output with only Financial parameters
F= 10.41 (.000); Durbin-Watson= 6.76 ; R= .412 ; R"= .170 ; Adj.R"=.153

Standardised
Constant. 8.30 .000
Table 4.4.1.13c: Discriminant Output
Combined output parameters Combined (fin)+ Fin.output parameters

Variable Discr Variable Discr
Co-eff Co-eff
Current Ratio .678 Margin on Security 1
PBIT/Tot op. asset -.768
Financial control 1,206
Statutory compliance -.556
Reliability of financial 9 .808
statement
Table 4.4.1.13d :Classification Table- Table 4.4.1.13e: Classification -Fin.

combined output
Financial npa non Tot.
Combined npa non Total 21 27
Npa count 6
Npa count 24 3 ' 27
% 77.8 22.2
% 88.9 11.1
non count 9 17 26
Non count 2 24 26 % 34.6 65.4
% 7.7 92.3
Cross- 0 77.8 22.2 100
Cross- % 0 81.5 18,5 100
(%) 1 34.6 65.4 100
validated 1 19.2 80.8 100 validated
Correct classiicication= 90.6% Correct classification= 71.7%
Cross -valid. Class = 81.1% Cross -valid. Class = 71,7%
117
Category 14 : Existing accounts
Table 4.4.1.14a : Regression output with financial & non-fmancial parameters
F= 22.27 (.000); Durbin-Watson= 2.01; R= .894^‘R ^ .799 ; Adj,R2=^?762
Standardised
Variable Coefficient t Signif Adj.R2
Constant 8.77 .000
Reliability of financial Statement .457 6.680 .000 .463
Management of inventory & receivables .325 5.064 .000 .516
Current ratio .281 4.162 .000
Net sales/Net Fixed Asset .304 4.464 .000 .673
Export potential -.183 -2.881 .006 .707
Cheques returned .257 3.11 .003 .749
Table 4.4.1.14b: Regression output with financial parameters
F= 5.62 (.000); Durbin-Watson= .299 ; R= .387 ; R2= .15 ; Adj .R2= .123
Standardised
Constant 4.024 .000
Interest/N sales -.320 -2.77 .007 .096
LT debt/ TNW 0.200 -1.73 .088 .123
Table 4.4.1.14c: Discriminant Output

Combined Output parameters combined output + fin.output parameter
Variable Discrim. Variable Discrim.

coeff, coeff
Current ratio .603 Current ratio .606
Net sales/ Net FA .885 Net sales/ Net FA .880
Relation with bank .961 Relation with bank .967
Audit qualification .548 Audit qualification .542
Compliance of sanction -1.06 Compliance of sanction -1.04
Mgt. Of inv. & rec. .835 Mgt. Of inv. & rec. .861
Reliability of fin. Stat. .900 Reliability of fin. Stat. .889
Cheques returned .707 Cheques returned .691
Export potential -.500 Export potential -.500
LT debt/TNW -.269
Classification Table 4.4.1.14d: Combined Classification Table 4.4.1.14e: Comb+ fin.

Comb+Fin NPA Non Total
Combined NPA Non Total NPA count 13 1 14
NPA count 13 1 14 % 92.9 7.1 100
% 92.9 7.1 100 Non count 0 53 53 '
Non count 0 53 53 % 0 100 100
% 0 100 100
Cross- % 0 92.9 7.1 100
Cross- % 0 92.9 7.1 100 validated 1 1.9 98.1 100
validated 1 3.8 96.2 100 Correct c!assification= 98.5%
Correct classification= 98.5% Cross -valid. Class = 97.0%
118
parameters alone, only two parameters viz,, interest/n Sales and LT Debt/TNW were
found to be significant. However, they had poor explanatory power (Table 4.4.1.14b).
Only one significant parameter was dropped from the first MDA model and the
same significant parameters entered the second MDA model (Table 4.4.1,14c-columns 1
& 3). The model showed good discriminatory power and could classify 98.5% of the
cases correctly into default and non-default classes (Table 4.4.1.14d). Adding a few more
financial parameters did not add to the discriminatory power (Table 4.4.1.14e). Two
financial parameters viz., Current Ratio and Net sales/ Net Fixed Assets were prominent
in the discriminant models.
15, Existing but New accounts
The study also considered a set of parameters for units which exist but new to the
bank. Out of the eighty-two parameters considered for application to the existing but new
accounts, twenty-four parameters are found to be significant with total explanatory power
of 95% which is considered to be very high (Table 4.4.1.15a). Most o f the significant
parameters have co-efficient as expected. Only three parameters are found to be counter
intuitive viz., ROCE, Composition of Board and Competence. High value of these
parameters is leading to high probability of default which is not desirable.
The discriminatory power of the parameters is found to be satisfactory to some
extent (Table 4.4.1.15b).
16. Greenfield accounts
Out o f ninety-four parameters considered only sixty-nine parameters are
found to be relevant for evaluating Greenfield accounts. Out of these, fourteen parameters
are found to be significan (Table 4.4.1.16a). Capacity Utilisation has emerged as the most
significant parameter followed by Margin on Security. PBDIT/ Interest is found to be
counter-intuitive as high PBDIT/ interest tends to increase the default probability as per
the regression model.
The discriminatory power of the parameters is found to be satisfactory (Table
4.4.1.16b).
4.4.2. Effectiveness of Parameters used in Banks’ Rating Models

The parameters/ variables used in the 19 models o f the banks are also tested to
see whether the variables are good predictors of default and their level of significance.
Here too, multiple regression and linear discriminant analysis. Logistic regression is not
used for similar reasons as cited in section 4.4.1.
Category 15; Existing but New Accounts
Table 4.4.1.15a : Regression output with financial & non-financial parameters

F= 42.05 (.000); Durbin-Watson= 2.26 ; R= .988 ; R"= .976 ; Adj.R2=.953
Stand.
Variable Coeff. t Sig Adj.R2
Tenor of loan .448 9.690 .000 .41
PBIT/ TNW+LT debt -1.049 -9.513 .000 .55
Litigation cases .207 3.225 .003 .60
Track record .298 5.746 .000 .643
PBIT/sales .756 8,734 .000 .641
Debtors Turnover .391 8.88 .000 .646
Bank Borr./ WC gap .628 8.38 .000 .704
Labour management .089 2.187 .038 .733
Compliance of environmental regulations -.237 -3.705 .001 .748
Product quality .261 6.231 .000 .764
TOL/TNW .189 4.52 .000 .784
GP/ sales -.193 -3.698 .000 .805
Expertise .312 6.86 .002 .828
Collection period .381 2.659 .004 .871
Inventory +receivables /Net sales(mthly) -.178 -4.0 .025 .883
Composition of board -.146 -3.47 .002 .900
Availability of guarantee .131 -3.18 .004 .912
Management Initiative .152 3.415 .002 .932
PBIT/ TNW+LT&ST borrowings .328 3.00 .006 .937
Current ratio -.111 -2.51 .019 .94
Competence -.126 -2.435 .022 .95
Classification Table 4.4.1.15b
Combined 0 1 Total
Count 16 7 23
0 % 69.6 30.4
Count 4 23 27
1 % 14.8 85.2
Cross 0 73.9 26.1 100
% 1 44.4 55.6 100
Correct classification3 78%

Cross -valid, Class = 64%
120
Category 16: Greenfield Accounts
Table 4.4.1.16a : Regression Output with Financial & Non-financial parameters
F 3 16.224(.000); D-W 3 1.68 ; R = .907; RJ 3 .823 ; Adjusted R* = .772

Variables Standard. t Signif. Adj. Rl
Coeff.(P)
Constant 9.84 .000
Capacity Utilisation .266 3.60 .001 .387
Margin on Security .155 2.25 .029 .445
Infrastructure .188 2.65 .011 .498
Liquidity of Security ,230 3.33 .002 .540
Inventory+Receivables/Net sales .422 5.72 .000 .593
Industry Cyclicality -.241 -3.84 .000 .668
Promoters’ contributiion .221 2.84 .006 .727
Project Implementation .241 3.43 .001 .743
PBT/Net Assets .284 3.70 .001 .755
Availability of Guarantee .152 1.99 .052 .766
Export Potential .154 2.28 .027 .777
PBDIT/Interest -.134 -1.89 .064 .772 '
Classification Table 4.4.1.16b
All Parameters NPA Non Tot.

NPA count 40-- 3 43
% 93 7 100
Non count 10 11 21
% 47.6 52.4 100
Cross- NPA 93 7 100
validated
m _____ Non 47.6 52.4
Correct classification3 79.7 %
100

1. Vijaya Bank
The model for limits from 2 lacs to 1 crore has twenty-two parameters out of
which six parameters are found to be significant in the regression model. Out of this, four
subjective parameters viz., Servicing of Instalment and Interest, Experience, Compliance
of Sanction Terms and Overdrawings in the Account could explain 38.3% of the total
variation in the dependent variable (Table 4.4.2.1a). The significant financial parameters
are PBDIT/sales and Net Profit/ Sales. Overall the model has moderate explanatory
power o f 41.5%. When regression was done using financial parameters alone, it showed
poor explanatory power and could explain only 7.3% of the variation (Table 4.4.2.1b).
Two parameters viz., PBDIT/Sales and Compliance o f Sanction Terms are found to be
counter-intuitive i.e., high o f both seems to enhance the probability of default (Table
4.4.2.1a).
The discriminating power of the parameters is satisfactory with correct
classification o f 83.2% (Table 4.4.2.Id). Both regression and discriminating models more
or less extracted the same parameters (Tables 4.4.2.1a & 4.4.2.1c).
2. UBI
Two models of UBI has been examined here.
a. Credit Rating Model more than 1 crore( Term loan)
b. Credit Rating Model more than 1 crore (Working Capital)
The term loan model consist of forty-six parameters out of which five parameters
are found to be significant and none of the parameters is found to be counter-intuitive.
The overall model predictive power is found to be high with explanatory power of 49.3%
(Table 4.4.2.2a). Though two financial parameters are found to be significant their
contribution to the predictive power of the model is low. In this model too, Servicing of
Instalment and Interest has emerged as the most powerful parameter with explanatory
power of 32.5%. Discriminitatory power of the model is also quite satisfactory with
83.9% correct classification (Table 4.4.2.2b). The model misclassifies more of healthy
units than that o f unhealthy units.
The Working Capital (WC) Model consists of forty-eight parameters out of which
six parameters are found to be effective with an explanatory power of 44.8% (Table
4.4.2.2c). There are seven financial parameters in the model. None o f the financial
parameters enter the regression or discriminating model (Tables 4.4.2.2a & 4.4.2.2d).
The significant parameters are mainly non-financial parameters. The parameters found to
YIJAYA BANK: Model for Limits - 2 lacs to 1 crore
Table 4.4.2.1a degression Output with Financial (F) and Non-ilnancial (NF) Parameters
F = 12 12(.000); D-W = .927 ; R = .673 ; R2 = .451 ; Adjusted R2= .415

Coeff.(P)
Constant 7.15 .000
Experience .218 2.66 .009 .327
Overdrawings in a/c .221 2.42 .017 .382
PBDIT/Sales -.300 -2.66 .009 .400
Net Profit/Sales .208 1.84 .069 .415
Table 4.4.2.1b : Regression Output with Financial Parameters
F = 4.68C.012); D-W - .286 ; R = .304 ; R2 = .092 ; Adjusted R - .073

Coeff.(p)
Constant 8.03 .000
PBDIT/Sales -.282 -2.78 .006 .051 ‘
PBT/TNW .180 1.77 .079 .073
Table 4.4.2.1c: Discriminant Output (F & NF)
Financial & Non-financiai Parameters

Variables Canonical
Discrim.
Coefficient
Net Profit/ Sales .569
PBDIT/Sales -.762
Experience .298
Compliance of sanction -.589
terms
Servicing of instal & intt .598
Over drawings in a/c .624
Table 4.4.2.1d: Classification T able (F & NF)
F&NF NPA Non Tot.

NPA count 23 4 27
% 85.2 14.8 100
Non count 12 56 68
% . 17.6 82.4
Cross- NPA 66.7 33.3 100
validated
(%) Non 19.1 80.9 100
United Bank o f India : Model for Term Loan with limit above Rs 100 lacs
Table 4.4.2.2a - Regression Output with Financial (F) and Non-financial (NF) Parameters
F= 17 71 (000): Durbin-Watson= 1.20 ; R= .722 . R*= 522 : Adj,Ri= 493
Stand
Variable Coerf t Sig Adj.R:
Constant 8.08 000
Servicing of interest & install. ,521 6.33 .000 .325
Submission o f stock statement .257 2.90 .005 .436
TOL/TNW -.229 -2.73 .008 .478
Current Ratio - .143 1.84 .068 .493
Table 4.4.2.2b: Classification Table (F & NF)
F& N F NPA Non Tot.

NPA count 53 6 59
% 89.8 10 2 100
Non count 8 20 28
% 28.6 71.4 100
Cross- NPA 89.8 10.2 100
validated Non 39.3 60.7 100
(%)
United Bank o f India: Model for Working Capital loan with limit above Rs 100 lacs
Table 4.4.2.2c : Regression Output with Financial (F) and Non-financial (NF) Parameters
F - 13.99 (000). Durbin Watson= 1.18: R =.695 ;R‘= .483; Adj= .448
Stand.
Variable Coeff. t Sig Adj.R2
Constant 17.81 .000
Relationship .263 3.20 .002 .314
Litigation cases .232 2.81 .006 .406
Submission o f ABS. P/L .220 2.85 .005 .426
Composition of Board -.162 -2.07 .041 .448
124
be significant in the WC model are found to be insignificant in the Term Loan model.
One parameter viz., Composition of Board is found to be counter-intuitive with
professional board increasing the default probability.
The overall discrminating power is found to be satisfactory (Table 4.4.2.2e). Here
the model misclassifies unhealthy units more than healthy units which is undesirable as
the cost o f misclassification of unhealthy units is much more.
3. Punjab National Bank
Only one model of PNB has been examined which is for limits from 20 lacs to 3.5
crores. The model has twenty parameters out of which six parameters have entered the
regression model. Explanatory power of these six parameters is quite satisfactory with the
non-financial parameter viz., Submission of Stock Statement/ MSOD/QIS emerging as
the most significant parameter (Table 4.4.2.3a). Though two financial parameters enter
the regression model, their contribution to the predictive power of the model is
negligible. None o f the parameters are found to be counter-intuitive.
The discriminating power of the model is mediocre with correct classification of
75.1% (Table 4.4.2.3b). Here too, unhealthy units are more misclassified than the healthy
units.
4. C anara Bank
Three Manual Models used by the bank have been examined here. All the
parameters in all the three models are found to have very high explanatory power as well
as high discriminating power. The model for Industrial accounts could explain 70.3% of
the variation with five significant parameters out of eighteen (Table 4.4.2.4a). None of
the financial parameters enter the regression model and discriminating model (Table
4.4.2.4a & 4.4.2.4b). The parameter Servicing of Instalment and Interest alone accounts
for 58.4% of the variation and emerged as the single largest significant parameter.
Discriminating capability is also high with 94.2% correct classification (Table 4.4.2.4c).
The model for New Accounts has also yielded good result. In case of new
accounts also, financial parameters do not contribute significantly in the regression
model. As such none of the parameters enter the regression model (Table 4.4.2.4d). The
discriminatory power o f the model is satisfactory (Table 4.4.2.4e).
The parameters for trading accounts are found to be very effective with
explanatory power o f 79.2% (Table 4.4.2.4f). There are twenty-two parameters out of
which eight parameters are found to be effective including three financial parameters.
U nited B a n k o f In d ia : M odel for W orking Capital loan with lim itabove Rs 100 lacs
Table 4.4.2.2d : D iscrim in an t o u tp u t (F & NF) Table 4.4.2.2e : Classification Table (F &
F& NF
Canonical F & N F ________ NPA Non Tot.
Variables
Discrim. NPA count 14 8 22
Coefficient % 63 6 36.4 100
Resourcefulness 1 578 Non count 11 64 75
Composition of Board -1 494 % 14.7 85 3 100
Audit Qualification I 102 Cross- NPA 95,5 4.5 100
(Inv+Rec.)/avg sales(m) 1 654 validated Non 24.0 76.0 100
Management Initiative 1.126 (%)
Utilisation o f Limit -1.138 Correct classification= 80.4 %
Product Quality 3.282 Cross-valid. Class = 80.4%
Export Potential -2.629
PU N JA B N A TIO N A L BANK. M odel for Limit from Rs 20 Lacs to Rs 3.5 Crores
T ab le 4.4,2.3a: R egression O u tp u t with Financial (F) and Non-financial (NF) Param eters
F = 24 63( .000) ; Durbin Watson = .730 ; R = .720 ; l ‘ = 519 ; Adjusted!C - .498

Variables Standard. t Signif. Adj. R-
Coeff.(P)
Constant 18.36 .000
Submission of stock statement, etc. .395 5.619 .000 .353
Experience .225 3.472 .001 .409
Reliability o f financial statement .205 3.115 .002 .455
LT Debt/TNW -.226 -2.65 .009 .488
TOL/TNW .166 1.91 .057 .498
F& NF NPA Non Tot.

NPA count 36 24 60
% 60 40 100
Non count 12 72 84
% 14.3 85.7 100
Cross- NPA 86.7 13.3 100
validated
(%) Non 25.0 75.0 100
Correct classification^ 75.1 %
Cross -valid. Class = 79 9%
126
CANARA BANK: Model for Industrial Accounts with limit 30 lacs to 2 crores
Table 4.4.2.4a: Regression Output with Financial (F) and Non -financial (NF) Parameters
F = 25.14 ; Durbin Watson =1.524 ; R = .856; R2 = .732 ; Adjuster R2= .703

Variables Standard. t Sign if. Adj.R2
Coeff.(P)
Constant 7.27 .000
Experience .294 3.67 .001 .618
Export potential -.302 -3.59 .001 .652
Submission of ABS, P/L .183 2.07 .043 .703
Table 4.4.2.4b: Discriminant Output (F & NF) Table 4.4.2.4c: Classification Table(F&NF)
Combined output parameters F& N F NPA Non Tot.
Variables Canonical NPA count 21
Discrim. % 95.2 4.8 100
Coefficient Non count 31
Experience .501 % 6.5 93.5 100
Compliance of sanction -.508 Cross- NPA 90.5 9.5 100
terms 1.155
validated
Servicing of instal & int. .371 Non 12.9 87.1 100
(%)
Subm, of ABS, P/L. -.671
Correct classification* 94.2%
Export Potential
Table 4.4.2.4d: Regression Output (with N & NF) - Model for New Accounts
F = 12.27 ; Durbin Watson =1.479 ; R = .742; R^ = .551 ; Adjusted R - .506
Coeff.(P)
Constant 12.37 .000
Experience .357 4.28 .000 .330
Ability to meet sales projection .304 3.23 .002 .392
Competition -.392 -4.16 .000 .440
Industry Prospects .256 2.73 .008 .471
Expertise -.183 -2.02 .047 .486
Table 4.4.2.4e: Classification Table ( F & NF)
F&NF NPA Non Tot.

NPA count 44 3 47
% 93.6 6.4 100
Non count 7 24 31
% 22.6 77.4 100
Cross- NPA 87.2 12.8 100
validated
(%) Non 22.6 77.4 100
Correct classification* 87.2%
Cross -valid. Class =82.1%
The financial parameters mainly Net Profit/Sales has emerged as significant contributor
but it is found to be counter-intuitive with increased net profit by sales leads to higher
default probability which is unacceptable. The discriminatory power also is found to be
high with correct classification of 83.4% (Table 4,4.2.4g). The misclassification of
default units appear to be higher than non-default units.
5. State Bank of India

Two of the SBI models have been examined for identifying significant
parameters- one for trading accounts and the other for C & I , SSI and AGL advances. The
second model used for C&l advances consist of thirty parameters out of which seven
parameters are significant (Table 4.4.2.5a). None o f the financial parameters is found to
be significant though two financial parameters enter the regression equation when only
financial parameters are considered in the regression model (Table 4.4.2.5b). This implies
that these two financial parameters viz., PBDIT/ Sales and DSCR have interaction with
other non-financial parameters entered in the regression model. The discriminating power
of the model is also found to be good (Table 4.4.2.5c).
The parameters used in the model for trading are also found to be effective with
explanatory power of 47% (Table 4.4.2.5d). Two parameters viz., ROCE 2 and Labour
Management are found to be counter-intuitive with higher / better leading to high default
probability. Discriminatory power of the model is found to be satisfactory (Table
4.4.2.5e). The model misclassifies more o f the unhealthy units than healthy units.
6. UCO Bank
Three models of UCO Bank meant for Existing accounts, Existing but New
accounts and Greenfield/ New accounts have been tested. The model for Existing
accounts is found to be the most effective one. This may be due to prior knowledge o f the
loan assessor and consideration of large number o f parameters while assessing the loan
This model considers twenty-five parameters out o f which seven parameters are found to
be effective. The significant parameters are Audit Qualification, Track Record,
Compliance o f Sanction Terms, Submission of Stock Statement/QIS/MSOD, Spread of
Market, Operations in the Account and Current Ratio (Table 4.4.2.6a). Here too, the
financial parameters have very little contribution. The discriminatory power o f the model
is found to be good (Table 4.4,2.6b),
128
C anara Bank : Model for Trading Accounts with limit 30 lacs to 2 crores
Table 4.4.2.4f: Regression Output with Financial (F) and Non -financial (NF) Parameters
F = 26.29 ; Durbin Watson = 1.47 ; R = .908 ; R2=.824 ; Adjusted R2= .792

Coeff.(p)
Constant 5.012 .000
Net Profit/ Sales -.296 -3.991 .000 .505
Renewal of Limits .364 4.416 .000 .567
Overdrawings in account .191 2.52 .015 .747
TOL/TNW .157 2.272 .028 .783
Bank borrowing/sales -.120 -1.750 .087 .792
Table 4.4.2.4g: Classification Table (F & NF;
F & NF NPA Non Tot.
NPA count 8 5 13
% 61.5 38.5 100
Non count 4 37 41
% 9.8 90.2 100
validated
m _____ Non 7.3 92.7
100
STATE BANK OF INDIA : Model for C & l, SSI and AGL Accounts (> 25 lacs)
Table 4.4.2.5a : Regression Output with Financial (F) and Non-financial (NF) Parameters
F = 24.11( .000) ; Durbin Watson = 1.30 ; R = .803 ; l 2= 645 ; AdjustedR2= .618
Coeff.(3)
Constant 7.46 .000
Financial Control .239 3.16 .002 .350
Ability to meet Profit Projection .196 2.64 .010 .458 .
Distribution Network .266 3.66 .000 .511
Tenor of Loan .201 3.13 .002 .594
Regulatory Aspects .116 1.77 .079 .618
Table 4.4.2.5b:Regression Output with Financial (F) Param eters
F = 5.88(. 014); Durbin Watson = .345 ; R = .327; R2=.107 ; Adjusted R2--= .089
Coeff.(3)
Constant 9.62 .000
PBDIT/ Interest .275 2.87 .005 .063
DSCR .188 1.96 .052 .089
129
Table 4.4.2.5c: Classification Table (F & N F ){ SBI- C & I, SSI & AGL >25 lacs}
F&NF NPA Non Tot.
NPA count 48 5 53
% 90.6 9.4 100
Non count 10 38 48
% 20.8 79.2 100
Cross- NPA 90.6 9.4 100
Validate Non 22.9 77.1 100
d(%)
Correct classification® 85.1 %
STATE BANK OF INDIA : Model for Trading accounts with limit 25 lacs to 2
crores
Table 4.4.2.5d; Regression Output with Financial (F) and Non-financial (NF) Parameters
F = 10.G6{ .000) ; Durbin Watson = 1.10 ; R = .680 ; R2 =.470 ; Adjusted R4= .470
Variables Standard. t Sign if. Adj. R'
Coeff.(3)
Constant 15.8 .000
Succession Planning .272 2.81 .006 .319
Labour Management -.285 -3.05 .003 .368
ROCE=PBDIT/ TNW+LT & ST Borr. -.286 -3.02 .004 .418
Expertise .174 1.90 .061 .443
Current Ratio .168 1.80 .067 .470
Table 4,4.2.5e : Classification Table (F & NF)
F& N F NPA Non Tot.

NPA count 17 8 25
% 68 32 100
Non count 6 44 50
% 12 88 100
validated Non 12 88 100
i% )_____
U C O B A N K : M o d e l fo r E x is tin g A c c o u n ts
T a b le 4 .4 .2 .6 a : R e g r e s s io n O u t p u t w ith F in a n c ia l (F ) a n d N o n -fin a n c ia l (N F ) P a r a m e te r s
F = 9 .4 2 ( 0 0 0 ) ; D u rb in W a ts o n = 1 ,1 6 ; R = .7 2 7 ; R 2 = . 5 2 8 ; A d j u s t e d R J == . 4 7 2
V a ria b le s S ta n d a rd . t 'S i g n i f . A d j. R 2
C o e f f.( P )
C o n s ta n t 1 6 .4 2 .0 0 0
A u d it Q u a lific a tio n .2 6 8 2 .6 7 3 .0 1 0 .1 9 1
T ra c k R e c o rd .2 0 9 1 .6 5 .1 0 4 .2 8 3
C o m p lia n c e o f S a n c tio n T e rm s - .5 5 6 - 4 .5 8 9 .0 0 0 .3 3 6
S u b m is s io n o f S to c k S t a te m e n t, e tc . 2 4 7 2 .1 0 3 .0 4 0 .3 8 9
S p re a d o f M a rk e t .2 0 9 2 .1 2 .0 3 8 4 1 4
O p e ra tio n s in th e A c c o u n t .3 5 4 2 .3 8 6 0 2 0 4 3 7
C u r r e n t R a tio 2 1 3 2 2 2 3 0 3 0 4 7 2
T a b le 4 .4 .2 .6 b : C la s s ific a tio n T a b le (F & N F )
F & N F N P A N o n T o t.
N P A c o u n t 11 3 14
0/
/o 7 8 .6 2 1 .4 1 0 0
N o n c o u n t 5 4 8 5 3
% 9 4 9 0 .6 1 0 0
C ro ss- N P A 71 4 2 8 .6 1 0 0
v a lid a te d
(% ) N o n 13 2 8 6 8 1 0 0
C o rre c t c la s s ific a tio n ^ 8 8 .1 %
C ro ss -v a lid C la s s = 8 1 6 %
U C O B A N K : M o d e l fo r E x is tin g b u t N e w A c c o u n ts
T a b l e 4 .4 .2 .6 c : R e g r e s s io n O u t p u t w ith F in a n c ia l (F ) a n d N o n -fin a n c ia l (N F ) P a r a m e te r s
F = 7 .7 2 ( .0 0 5 ); D u rb in W a ts o n = 7 9 1 , R = . 6 3 8 ; R 2 = 4 0 7 ;
A d ju s te d R - 3 5 4
V a ria b le s S ta n d a rd . t S ig n if. A d j. R 2
C o e f f .( 0 )
C o n s ta n t 9 .2 6 3 .0 0 0
T ra c k R e c o rd .3 8 4 3 .2 0 4 .0 0 2 .2 0 1
T O L /T N W .4 1 2 3 .3 9 5 .0 0 1 .2 9 5
C u rre n t R a tio .2 0 4 1 .7 1 9 • .0 9 3 3 2 7
In d u s try P ro s p e c ts .2 0 3 1 .7 1 4 0 9 3 3 5 4
U C O B A N K : M o d e l f o r G r e e n fie ld A c c o u n ts
T a b l e 4 .4 .2 .6 d : R e g r e s s io n O u t p u t w ith F in a n c ia l (F )
a n d N o n -fin a n c ia l (N F ) P a r a m e te r s
T a b le 4 .4 .2 .6 e
F = 1 1 .3 7 ( .0 0 0 ) ; D u r b in W a ts o n = .9 1 4 ; R = .6 0 2 ;R " = .3 6 2 F & N F N P A N o n T o t
; A d ju s te d R 2 = .3 3 1 N P A c o u n t 3 6 7 4 3
V a ria b le s S ta n d a rd t | S ig n i A d j. R J % 8 3 7 1 6 .3 1 0 0
C o e I T f (1 ) I f N o n c o u n t 7 14 21
C o n s ta n t '8 18 9 | 0 0 0 “ % .5 6 6 7 1 0 0
!n te g n l\ .3 9 3 3 5 3 ! 0 0 1 2 4 2 C ro ss- N P A 8 1 .4 1 8 .6 100
T ra c k R e c o rd .2 7 9 2 5 1 0 .0 1 5 3 0 1 \n h d a lc d N o n 3 3 3 6 6 7 1 0 0
In d u s try C y c lic a lity - 1 98 - 1 9 1 6 0 6 0 3 3 1
(% )
C o rre c t c la s s ific a tio n = 7 8 1 %
C r o s s -v a lid . C la s s = 7 6 .6 %
131
The model for Existing but New Accounts has nineteen parameters of which four
parameters are found to be significant, In contrast to many models, financial parameters
are found to have significant contribution (Table 4.4.2.6c).
The model for Greenfield/ New accounts has fourteen parameters out of which
three parameters are found to be significant. The three parameters, viz., Integrity, Track
Record of the Promoter and Industry Cyclicity can explain 33.1% of the total variation
(Table 4.4.2,6d). None of the financial parameters enter the model. The discriminating
power o f the model is found to be mediocre (Table 4.4.2.6e).
7. Allahabad Bank
The two models of Allahabad Bank viz., New account and Existing Accounts has
been tested. The Model for Existing Accounts (25 lacs to 2 crores) consists of thirty-five
parameters out of which seven parameters are found to be significant. Two financial
parameters have also entered the regression equation. The overall predictive power of the
parameters are found to be good (Table 4.4.2.7a). The discriminatory power of the
parameters is quite satisfactory with correct classification o f 92.5% (Table 4.4.2.7b).
On the other hand, in the model for New accounts only the non-financial
parameters have entered the regression model (Table 4.4.2.7c). None o f the financial
parameters are found to be effective in the model for New Accounts. There is one
parameter i.e., Composition of Board which is counter-intuitive, high quality of Board
enhancing the default probability. The discriminatory power of the models is also
satisfactory (Table 4.4.2.7d).
8. Union Bank
Two models of Union Bank viz., for small accounts (10 lacs to 1 crore) and
'v
medium accounts (1 crore to 10 crores) have been tested. The model for1medium
accounts has thirty-nine parameters but interestingly only three parameters enter the
model and could explain 70% of the total variation (Table 4.4.2.8a). The financial
parameter (one in number) is also found to be significant. The parameter Servicing of
Instalment and Interest has emerged as the single largest predictive parameter explaining
57.1% variation (Table 4.4.2.8a). The discriminating power of the model is also found to
be satisfactory with 89% correct classification (Table 4.4.2.8b).
The model for small accounts has thirty-one parameters out o f which seven
parameters are found to be significant with explanatory power 55% though one to two
financial parameters are found to be significant (Table 4.4.2.8c). Their explanatory power
ALLAH ABA D BANK: Model for Existing Accounts with Limit 25 lacs to 2 cr.
Table 4.4.2.7a : Regression Output with Financial (F) and Non -financial (NF) Parameters
F = 12.80C000), D-W = 1 29; R = 77 ; R2 = .603 ; Ad usted R"= .556
Coeff.(b)
Constant 9.124 .000
Servicing of Instalment & Interest .376 2 67 .010 .244
Compliance of Sanction Terms -481 -4.37 000 .423
Resourcefulness .230 2.67 010 .482
Current Ratio .250 2.91 .005 .517
Net Profit/ Sales .196 2.27 .027 ,536
Operations in the a/c .292 1.93 .058 .556
F& NF NPA Non Tot.

NPA count 13 1 14
% , 92.9 7.1 100
Non count 4 49 53
% 75 92 5 100
Cross- NPA 78 6 21.4 100
validated
(%) Non 15 1 84 9 100
Correct classification® 92 5 %
Cross-\alid Class® 83 6%
ALLAHABAD BANK: Model for New Accounts

Table 4.4.2.7c : Regression Output with Financial (F) & Non-financial (NF) Parameters
F = 8.90C.000); D-W * 1.14; R = .695 . R- = .484: Adjusted R2= .429
Variables Standard. t Signif. Adj. R*
Coeff(p)
Constant 7.93 .000
Market Reputation 370 361 .001 .235
Relationship with bank 243 2 22 030 .301
Infrastructure .242 2 39 .020 347
Competition -.336 -3 02 004 .383
Industry Prospects 270 2.25 .028 .408
Composition of Board -194 -1 78 .079 .429
Table 4.4.2.7d : Classification Table (F & NF)

F& N F NPA Non Tot.
NPA count 41 2 43
% 95.3 4.7 100
Non count 7 14 21
% 33.3 66.7 100
Cross- NPA 81 4 18.6 100
\ alidatcd
(%) Non 19.0 81.0 100
Correct classification® 85.9%
Cross -valid Class = 81 3%
UNION BA NK : Model for Limits o f 1 crore to 10 crores
Table 4.4.2.8a: Regression O utput with Financial (F) and Non-financial (NF) Parameters
F = 29.25( .000) ; R = .852 ; R2 =.727 ; Adjusted R2= .702

Variables Standard. t Signif. Adj.
Coeff.(P)
Constant 8.46 .000
LT Debt/TNW -.377 -4.05 .000 .684

F & NF NPA Non Tot.
NPA count 18 3 21
% 85.7 14.3 100
Non count 1 15 16
% 6.3 93.8 100
Cross- NPA 90.5 9.5 100
validated
(%) Non 25.0 75.0 100
UN IO N B A N K : Model for Limits o f 10 lacs to 1 crore
Table 4.4.2.8c : Regression Output with Financial (F) and Non-financial (NF) Parameters
t/i
F = 25.93(.000) ; Durbin Watson = .927 ; R = .756 ; R2 =.572 ; Adjusted
ii
o
Variables Standard. t Signif. Adj. R^
1 Coeff.(p)
Security coverage .145 2.473 .015 .527
Competition .153 2.627 .010 .538
Tenor of Loan .124 2.081 .039 .546
ROCE=PAT+Intt/tnw+LT &ST borr. -.113 -1.956 .053 .550
Table 4.4.2.8d: Classification Table (F & NF)
F & NF NPA Non Tot.

NPA count 49 11 60
% 81.7 18.3 100
Non count 18 66 84
% 21.4 78.6 100
Cross- NPA 76.7 23.2 100
validated
(%) Non 22.6 77.4 100
Correct classification 79.9 %
is low. Here again ROCE 1 and NetProfit Sales are found to be counter-intuitive, higher
of both appears to enhance the default probability. The overall discriminating power is
satisfactory with 79.9% correct classification (Table 4.4.2.8d).
9. Andhra bank
Two models o f Andhra bank - one for small accounts (10 lacs to 1 crore) and one
for large accounts (more than 1 crore) have been tested. The model for large accounts
has twenty-three parameters out of which four parameters are found to be significant with
explanatory power 75.1 % (Table 4.4,2.9a). Only one financial parameter has entered the
regression model. Though the predictive power of the parameters is high the
discriminating power of the parameters are not found to be satisfactory (Table 4.4.2.9b).
The model for small accounts has only nine parameters out of which only four
parameters are significant with explanatory power o f 35.5% (Table 4.4.2.9c). The
parameters are found to have high discriminatory power with correct classification of
86.5% (Table 4.4.2.9d).
10. Central Bank of India
Only one model of Central Bank of India has been examined for identifying
significant parameters. The model has eleven parameters out of which 4 parameters
mostly non-finaneial is found to be significant. The predictive power of the parameters is
found to be good even though the number of parameters are less (Table 4.4.2.10a). The
discriminatory power o f the parameters is found to be attractive with five parameters
correctly classifying 83.3% of the cases (Tables 4.4.2.10b & 4.4.2.10c). It misclassifies
healthy unit more than unhealthy units.
4.4.3 Summarized Findings on Effectiveness of Parameters as Default

Predictors
In the foregoing analysis, significance of parameters as default predictors are
assessed for different models and for different loan categories . This section summarizes
significance of each parameter under-
a. multiple regression
b. multiple discriminant analysis (DA)
c. univariate regression
d. univariate logistic regression (LR)
e. univariate discriminant analysis
135
ANDHRA BANK: Model for Limit - More than 1 crore
Table 4.4.2.9a degression Output with Financial (F) and Non-financial (NF) Parameters
F = 34.84(.000); D-W = 1.76 ; R = .879 ; R2 = .773 ; Adjusted Rs » .751
Variables Standard. t Signif. Adj. R*
Coeff.(0)
Constant 13.13 .000
Collection period -.266 -3.50 .001 .699
Operations in the a/c -.311 -3.18 .003 .731
Submission of stock statement, etc .204 2.065 .045 .751
Table 4.4.2.9b: Classification Table (F &NF)
F& N F NPA Non Tot.

NPA count 5 19 24
% 20.8 79.2 100
Non count 0 22 22
% 0 100 100
validated
(%) Non 18.2 81.8 100
Correct classifieation= 58.7 %
AN DH RA BANK: M odel for Limit - 1 0 lacs to 1 crore
Table 4.4 .2 .9 .C degression Output with Financial (F) & Non-financial (NF) Parameters
F = 1l.OS(.OOO); D-W = 643 ; R = .625 ; = .391 ; Adjusted R - .1155
Coeff.(P)
Constant 16.73 .000
Submission of stock statement, etc .431 3.78 .000 .274
Debt Equity ratio -.184 -1.86 .066 .355
Table 4.4.2.9d: Classification Table (F & NF)
F& N F NPA Non Tot.

NPA count 11 2 13
% 84.6 15.4 100
Non count 8 53 61
% 13.1 86.9 100
Cross- NPA 84.6 15.4 100
validated(%)
Non 18 82 100
CENTRAL BANK OF INDIA : Model for Limits - 2 lacs to 1.5 crores
Table 4.4.2.10 a : Regression Output with Financial and Non-flnanciai

Parameters
F = 32.1SC.000); D-W = .800 ; R = .704; R' - .495 ; Adjusted R '» .480
Variables Standard. t Signif. Adj. Rz
Coeff.(P)
Constant 13.55 .000
Management of inventory & receiv. .166 2.57 .011 .471
Current ratio .114 1.78 .077 .480
Table 4.4.2.10b : Discriminant Output (F & NF)
Financial and Non-financial Parameters

Variables Canonical
Discrim.
Coefficient
Relationship with bank .503
Compliance of sanction terms -.583
Servicing of Instalment & Interest .705
Renewal of Limits .471
Management of inventory & receiv ..45
Table 4.4.2.10c:Classification Table (F & NF)
All Parameters NPA Non Tot.

NPA count 46 3 49
% 93.9 6.1 100
Non count 19 68 87
% 21.8 78.2 100
Cross- NPA 85.7 14.3 100 ■
validated
(%) Non 23.0 77.0 100
137
Univariate analysis for each input parameters are also conducted as most of the
parameters used in the model is not effective in the multivariate situation (this may be
due to the fact that they are correlated with many other parameters). Univariate LR is also
used as it transforms the scores in the concerned variable or parameter into default
probabilities (1= default, 0= non-default). The summarized findings of the significance of
the parameters in these five situations are given in Table 4.4.3. Parameter-wise comments
are briefly described below.
Current Ratio (CR)

The Current Ratio is considered to be the most prominent ratio by different banks.
All the surveyed banks have considered this ratio in their models. This ratio has been
entered in sixty-five regression runs out o f which in fourteen cases (21.5%) it has been
found significant in the regression equation. In case of multiple discriminant analysis too,
this parameter enter in eleven discriminant equations out of forty-one runs. As such, the
ratio may be considered as mediocre default predictor when they are used in the
multivariate analysis. When the power is tested in univariate situation, the ratio was
found to be insignificant in regression analysis, logistic analysis and discriminant
analysis. In general, higher CR is found to be associated with healthy units and low
enhances the default probability with one exception in the case of Existing but New
accounts where it was found to be counter-intuitive. One o f the important aspect is that
this ratio is correlated with only four other financial ratios (Appendix 4.2).
TOL/TNW
Eight banks excluding Vijaya and Central Bank have used this ratio in their rating
models. This ratio was entered in fifty-nine regression runs out of which in eleven1cases it
was found to be significant. This ratio was found to be less significant when the ratio was
used in the model for different situation / categories of loans. When the ratio was used in
the univariate models, the ratio was found to be significant in the regression model and in
the discriminant model. However in the logistic model, it was found to be insignificant.
With one or two exceptions, high Total Outside Liabilities is found to be associated with
good health which appear to be counter-intuitive. It should be noted that this ratio has
very high correlation with as many as thirteen other financial parameters and four non-
financial parameters (Appendix 4.1) used in the model implying that its predictive power
can be captured through other ratios.
Table 4.4.3 : Summarised Findings of Parameter Significance under univariate and
multivariate situations
' MULTIVARIATE ANALYSIS UNIVARIATE
MULTIPLE REGRESSION MDA Reg. LR DA.
No. Parameter (Financial) situ situ situ modi modi mode Comb com com com
freq max % freq max % % freq max % sig sig sig
1 CR 7 34 20.59 7 31 22.6 21.54 11 41 27 r 1 1
2 TOL/TNW 3 34 8.824 8 25 32 18.64 9 31 29 s- 1 s
3 Ltdebt/tnw 7 32 21.88 6 19 31.6 25.49 6 28 21 i 1 1
4 Borrfund/tnw 2 28 7.143 '1 4 25 9.375 2 14 '14 i 1 1
5 NP/Sa!es% 2 34 5.882 6 14 42.9 16.67 12 30 40 s+ S s
6 GP/sales% 4 34 11.76 4 0 10 53 1 20 5 I s 1
7 ROCE 1 4 34 11.76 1 11 9.09 11.11 1 23 4.3 s+ s s
8 ROCE 2 7 34 '20 59 1 4 25 21 05 4 23 17 I 1 1
9 ROCE 3 3 34 8.824 2 0 8 333 2 22 9.1 I 1 1
10 PBDIT/Intt 2 26 7.692 2 6 33.3 12.5 3 16 19 S- s s
11 pbit/intt. 3 26 11.54 1 2 50 14.29 0 13 0 s- s s
12 PBIT/Tot op. asset 4 34 11.76 4 0 10 53 4 21 19 s+ s s
13 Bk. Borrowing/WC gap 3 26 11.54 2 0 10.71 1 17 5.9 s- s s
14 N.sal/n.FA 5 31 16.13 2 0 15.15 4 18 22 s- s s
15 Net fixed asset/T L 4 26 15.38 15.38 4 17 24 I 1 1
16 PBT/TNW 4 34 11.76 2 4 50 15.79 3 22 14 I i 1
17 Inventory/Av. Mth N sale 1 34 2.941 1 0 2.857 0 15 0 1 I 1
18 Bk borr./sales 1 26 3.846 1 6 16.7 6.25 5 19 26 1 1 1
19 PBIT/net sales 3 34 8.824 8.824 3 18 17 s+ s s
20 PBDIT/Sales » - 2 . 34 5 882 2 2 100 11.11 2 18 11 s+ s s
21 lnv.+receiv./mth n.sales 2 34 5.882 14 0 4.167 2 22 9.1 1 s s
22 op. income/sh t borr 1 28 3.571 3.571 0 12 0 1 i I
23 Collection Period (days) 5 34 14.71 2 0 13.89 2 21 9.5 1 1 1
24 Increase in net sales(%) 3 34 8 824 4 0 7.895 1 21 4.8 1 1 1
25 Promoters contribution 7 34 20 59 1 2 50 22.22 6 26 23 s+ s s
26 PBT/net sales(%) 34 0 0 0 15 0 s+ s s
27 Increase in net profit • 5 34 14.71 6 0 12.5 3 23 13 1 1 1
28 Margin on security(%) 12 26 46.15 46.15 7 19 37 s- s s
29 DSCR 4 26 15.38 4 27 14.8 15.09 8 30 27 s- s s
30 Intt payment/net sales 2 32 6.25 6.25 0 17 0 S+- s s
31 Net cash fr oper./Ltdebt 3 34 8.824 8.824 0 16 0 I 1 1
32 PBT/Net assets 5 34 14.71 14.71 3 21 14 1 1 I
33 Net assets turnover 7 34 20.59 20.59 4 21 19 s-. s s
34 Debtors turnover 2 34 5 882 5.882 3 17 18 1 s 1
35 Inventory turnover 6 34 17.65 2 8 25 19.05 7 23 30 s- s s
36 np/cas flow 2 30 6.667 4 0 5.882 1 10 10 s- s 1
139
Table 4.4.3 (...co ntd)
MULTIVARIATE ANALYSIS UNIVARIATE
MULTIPLE REGRESSION MDA Reg. LR DA.
No. Param eter (Non-financial) situ situ situ modf modi mode Comb conn com com
freq max % freq max % % freq max % sig sig sig
37 Experience 3 32 9.375 8 22 36.4 20.37 13 23 57 S- S s
38 Integrity 3 32 9.375 2 13 15.4 11.11 3 25 S- s s
39 Competence 2 22 9.091 5 0 7.407 0 7 0 I 1 1
40 Mkt reputation 2 32 6.25 5 15 33.3 14.89 2 11 18 S- s s
41 Track record 4 28 14.29 5 13 38.5 21.95 8 11 73 S- s s
42 Expertise 6 32 18.75 1 18 5.56 14 2 20 10 s - s s
43 Succession planning 6 32 18.75 1 18 5.56 14 1 12 8.3 s - s s
44 Labour management 7 21 33.33 1 9 11.1 26.67 2 10 20 s - s s
45 Resourcefulness 6 32 18.75 6 17 35.3 24.49 8 16 50 s- s s
46 M anagement inititative 5 26 19 23 5 0 16 13 16 17 s- s s
47 Composition of board 7 32 21 88 3 9 33 3 24.39 4 15 27 I 1 1
48 Relationship with Bank 12 32 37.5 12 15 80 51.06 13 33 39 s- s s
49 Audit qual. 14 26 53 85 6 11 54.5 54.059 18 50 s - s s
50 Ability to m eet sales proj. 4 32 12 5 2 22 9.09 11.11 3 15 20 s - s s
51 Ability to m eet profit pro]. 32 0 2 17 11.8 4.082 1 12 8.3 s - s s
52 Fin. Control 9 23 39.13 2 4 50 40.74 49 44 s - s s
53 Statutory compliance 4 26 15.38 7 0 12.12 2 729 I 1 1
54 Litigation cases 5 32 15.63 1 11 9.09 13.95 1 10 10 I 1 1
55 Performance of group cos. 4 32 12.5 4 0 11.11 06 0 I 1 1
56 Shareholdings of promoter 1 32 3.125 3.125 0 4 0 s+ s s
57 Compliance of saction terr 10 24 4187 11 18 61.1 50 17 24 71 s - s s
58 Servicing of instal& intt 11 16 68.75 16 17 94.1 81.82 15 18 83 s - s s
59 Submission of financial sts 5 24 20.83 4 15 26 7 23.08 5 12 42 s - s s
60 Renewal of limits (forW C) 4 18 22.22 2 5' 40 26.09 4 6 67 s- s s
61 Submission of qis/M SOD/ 7 18 38 89 12 18 66.7 52 78 14 20 70 s - s s
62 Project implementation 5 25 20 2 0 18.52 2 8 25 s- s s
63 Managem ent of inv & rec 11 26 42 31 1 - 6 16.7 37.5 6 12 50 s - s s
64 Turnover in account 3 18 16 67 9 0 11 11 7 0 s- s s
65 Utilisation of limit: 3 22 13.64 2 0 12.5 16 17 I 1 1
66 Overdrawings in A/C 4 18 22.22 4 7 57.1 325 7 71 s - s s
67 Diversion of fund 7 24 29.17 4 0 25 2 4 50 I 1 1
68 Operations in A/C 2 18 11.11 4 14 28.6 18.75 3 10 30 s - s s
69 Reliability of financial statn 15 26 57.69 2 2 100 60.71 5 18 28 s - s s
70 Cheques returned 4 20 20 9 0 13.79 26 33 s - s s
71 Overall A/C conduct 7 24 29.17 3 0 25.93 3 11 27 s - s s
72 Mgt.Of creditors 26 0 3 0 0 1 0 1
73 Loans & advances 26 0 0 0 1 0 I 1 1
74 Tenor of loan 5 24 20.83 3 10 30 23.53 2 15 13 s- s s
75 Margin on term loan 2' 24 8333 1 3 33 3 11.11 1 3 33 I 1 1
76 Security coverage 5 32 15.63 1 10 io 14.29 2 11 18 I 1 1
77 Liquidity of security 11 32 34.38 2 0 32.35 2 12 17 s - s
s
78 Availability of guarantee 7 32 21.88 7 0 17.95 1 10 10 I I 1
79 Competition 6 32 18.75 3 20 15 17.315 24 21 I 1 1
80 Technology 3 25 12 16 0 7.317 1 13 7.7 I 1 1
81 Capacity utilisation 4 25 16 4 0 13.79 16 17 s - s s
82 R aw material 1 21 4.762 14 0 2.857 3 12 25 I 1 1
83 Infrastructure 3 25 12 6 0 9.677 7 15 47 I t 1
84 Location 3 28 10.71 6 0 8.824 1 11 9.1 I 1 1
85 Product quality 5 30 16.67 4 18 22.2 18.75 8 22 36 s - s s
86 Spread of market 4 30 13,33 2 21 9.52 11.76 3 14 21 s - s s
87 Distribution network 2 28 7.143 1 23 4.35 5.882 1 14 7.1 s - s s
88 Export potential 10 21 47,62 2 5 40 46.15 7 14 50 I 1 1
89 Import policy 1 28 3 571 3 571 5 0 I 1 1
90 Track- rec. of knowhow su D 21 0 0 4 0 1
91 Regulatory aspects 4 32 12 5 3 14 21,4 15.22 5 19 26 I 1 1
92 Compliance of environ. Re 5 26 19 23 13 0 12.82 15 0 I 1 1
93 Industry prospects 3 32 9.375 5 20 25 15.385 18 28 s - s s
94 Industry cycles 3 32 9.375 3 16 18.8 12.5 7 12 58 I 1 1
140
LT Debt/ TNW
This ratio is used by six banks in their models, The level of effectiveness was
found to be mediocre. Out of fifty-one regression runs, it was found to be effective in
thirteen cases. Similarly, out of twenty-eight discriminant runs it was found to be
effective in six runs. Under univariate situation, it was found to be insignificant in
regression, LR and DA. The positive aspect is that it was not found to be counter
intuitive. High ratio is leading to high default probability.
Borrowed Fund/TNW
This ratio is used by only two banks. The level o f effectiveness was found to be
much lesser than the previous two related ratios. Its discriminating power is also very
low. Its discriminating and predictive power was also found to be insignificant in
univariate regression, LR and DA. Higher ratio indicates high default probability as
expected.
NP/ Sales (%)
This ratio has been used by five banks in their rating models. Among all the
financial parameters , its discriminating power is found to be the best in multivariate
situation and good in univariate situation. Its predictive power is also found to be high in
case of model but found to be counter-intuitive in many situations i.e. high Net Profit
margin increasing the default probability.
GP/Sales(%)
This ratio has been used by only one of the sample banks. The ratio was not found
to be very effective both in univariate as well as multivariate analysis. It is not a good
default predictor and is giving counter-intuitive results. Since it has high correlation with
the previous ratio, this ratio need not be included. !
ROCE 1
Three banks have used this ratio in their rating models. The ratio was found to be
insignificant in most of the regression model when multivariate situation was considered.
Further, the ratio is found to be counter-intuitive with high ratio leading to high default
probability. It has low discriminatory power.
ROCE 2
This ratio is similar to the previous one except the components considered in the
numerator. This ratio is used by Allahabad Bank. The ratio as such is not very effective
141
both in terns of discriminating and predictive power both in multivariate and univariate
situations.
ROCE 3
This ratio is similar to the previous one except the components considered in the
denominator. This ratio is used by only one of the sample banks. The results in this case
is similar to the previous ratio viz., ROCE 2.
PBDIT/ Interest
Three banks have used this ratio in their rating models. Though it is used by few
banks it is found to be effective in two cases out of six cases. In the univariate situations
too this parameter found to be effective and it is in the line of expectation. The ratio has
high correlation with eleven financial parameters and eleven non-financial parameters
implying that it can reflect the characteristics of these parameters.
PBIT/Interest
Only one bank has used this ratio in their rating model. This ratio is not found to
be very effective when applied to different situation but found to be effective in the UBI
model. Its discriminatory power is considered to be least effective. However in the
univariate model it is found to be effective in regression, LR and DA. Like the previous
ratio, this ratio has correlation with large number non-financial parameters. High PBIT/
Interest ratio and high PBDIT/ Interest probably have influenced credit officer to look at
the proposal favourably and consequently to rate high in non-financial parameters.
PBIT/ Total operating assets
This ratio is used by only one bank viz., UBI in its rating model. This ratio does
not appear to have good predictive value but have reasonable discriminating power.
Further it appears to be counter-intuitive as high ratios is indicating high default
probability. Under univariate situation the ratio seems to influence the viability of a unit.
This ratio is found to interact with the highest number financial parameters indicating the
possibility o f clubbing with other parameters when reduction o f parameters is of great
concern.
Bank Borrowing/ WC gap
Only one bank viz., UBI has used this ratio. This ratio is also not found to be very
effective in predicting and discriminating the default units. Further it appears to be
counter-intuitive in most cases with high bank borrowing /WC gap leading to low default
probability. It is also found to be effective in the univariate regression, LR and DA.
142
N. Sales/N Fixed Assets and Net Assets Turnover
UBI is the only bank using the first ratio for assessing term loan proposals and
none of the banks have used the second ratio though the second one is one of the prime
ratio in the Altman z-score model. In the univariate settings, both the ratios are found to
have high predictive and discriminating power with low ratio indicating high default
probability. They are however not found to be very effective when used in the
multivariate setting applied to different situations. Specially the second one has high
correlation with a large number o f non-financial parameters. This implies that this ratio
can be captured through non-financial parameters.
Net Fixed Assets/Term Loan
Though this parameter has not been used by the sample banks , the study has
used it for testing the various situations/ loan categories described earlier. As such the
parameter is not found to be significant in univariate situation and also in multivariate
situation too.
PBT/TNW
Three banks have used this parameter in their rating models. This parameter is
also not found to be very effective both in terms of predictive and discriminatory power
Inventory/Average Mthly Sales
Though only PNB has used this parameter in its rating model, the parameter is not
found to be effective in the model as well as in the situations.
Bank Borrowing / Sales
Two banks have used this parameter mainly for assessing working capital loans
and the overall effectiveness is low.
PBIT/Net Sales and PBDIT / Net Sales
None o f the banks have used the first ratio and two banks have used the second
ratio. Since these ratios are very similar to gross and net profit margin, results are more or
less same. The ratios are significant in the univariate set up but not significant in many
situations under multivariate setting . Further they are found to be counter-intuitive with
high ratios indicating high default probability .
Inventory + Receivables/ Net sales per month
Five banks have used this parameter for WC loan but not found to be effective in
the model as well as in the situations. The discriminating power is also low.
143
O perating Income/ ST Borrowing
None of the banks have used this parameter and it is not found to be effective in
any of the situations.
Collection Period
Only Andhra bank has used it but is not found to be effective in any situation.
Increase in Net Sales
Two banks hav.e used this parameter in their models but is not a powerful default
predictor. As such discriminating power is low.
Promoters Contribution in Business
This parameter is used by only two banks in their rating models. The parameter is
found to be effective in many situations both in terms of predictive and discriminating
power but appears to give counter-intuitive result. High stake of promoters should reduce
the default risk but the regression result indicates the opposite. Similar result is found in
the univariate analysis too. High promoter’s stake is reflected in as many as twenty-two
financial parameters.
PB T/N et sales
This variant of the net profit margin is also giving similar result as the other
variants of the net profit margin ratio.
Increase in Net Profit
Like increase in net sales, this ratio is also not giving the desired result.
M argin on Security
This ratio is not being considered by any banks but is found to be most effective
in terms of predictive and discriminatory power. In the univariate set up the parameter
alone can classify 75% cases correctly indicating high discriminating power of the
parameter. Further it is not giving counter-intuitive result under any situation indicating
high Margin on Security leading to low default probability. One of the interesting
observation is that it has very high correlation with as many as 23 non-fmancial
parameters.
DSCR
Eight banks have used this parameter in their rating models for assessing term
loan proposals. The ratio is found to be effective when tested in the univariate setup
using regression, LR and DA. However, it is not that effective when used with other
parameters in the multivariate analysis.
144
Interest/ Net Sales
None of the banks have used this ratio. Like the previous one, performance of this
parameter is found to be very effective when tested in the univariate set up using
regression, LR and DA. However, it is not that effective when used with other
parameters in the multivariate analysis. High interest component as % of sales signals
high default probability.
Net cash from Operations/ LT debt
Only one bank has used this ratio and it is not found to be effective under various
situations.
PBT / Net assets
None of the banks have used this parameter. It is not found to be effective under
various situations.
Debtors Turnover
It is also not found to be effective in any of the situations
Inventory Turnover
Three banks have used this ratio and it is found to be effective both in terms of
predictive value and discriminating power. High Inventory Turnover decreases the
probability of default.
Net Profit/ Net operating Cash Flow
This ratio has not been effective in any of the models and most of the situations
in the multivariate analysis. Discriminatory power is also poor. In the univariate analysis
it showed poor discriminatory power.
Experience .
Seven banks have used this parameter in their rating models. Experience
influences the default probability. This parameter is found to be effective in most of the
models though it is found to be less effective when applied to different situation. In the
univariate situations too the parameter is found to be effective with high experience
reducing the default probability. Its discriminating power is also found to be satisfactory.
The parameter has very high correlation with as many as thirty-three financial and non-
finaneial parameters (Appendix 4.1).
Integrity
This parameter has been used by four o f the banks. Though in the univariate
situation the model is found to be effective but it is not so in many cases when the
145
parameter is considered in the model Its role in MDA is also poor. The parameter has
correlation with many other parameters considered in the study.
Competence
This has been considered by two banks but its role is not found to be significant in the
model both the predictive and discriminatory power is poor. In the univariate analysis too
the parameter is found to be a poor default predictor and discriminator.
M arket Reputation •
Five banks have considered this parameter and it was found to be effective when
the parameter was considered in the model . However, its role was not found to be
prominent in many cases when the parameter was considered in the different situations.
In the univariate situations too the parameter is found to be a good default predictor and
discriminator with high reputation indicating low default probability. It has significant
correlation with as many as thirty-four other parameters, mainly with non-financial
parameters (Appendix 4.1).
Track Record
Track record of promoters is considered by four banks in their rating models. It is
found to be good predictor and discriminator when considered in the models of the
respective banks. However under different situations its role is not found to be significant
in most of the cases. In univariate models it is found to be good predictor and
discriminator with the firm having good track record indicating low default probability. It
has very high correlation with as many as thirty-six parameters (mostly non-fmancial).
Expertise
Six banks have used this parameter in their rating models. However, its role is
not found to be prominent when used in the models of the respective banks. The
discriminating power is also not encouraging. Further it is found to be counter-intuitive
in few cases with high expertise increasing the default risk. However, in the univariate
situations, they are effective and the results are as per our expectation.
Succession Planning
Five banks have used this parameter in their rating models. However its role is
not found to be prominent when used in the models o f the respective banks. The
discriminating power is also not encouraging. Further it is found to be counter-intuitive
in few cases with high expertise increasing the default risk. However, in the univariate
146
situations, they are effective and the results are as per our expectation. This parameter has
very high correlation with twenty-seven parameters.
Labour M anagement
Five banks have used this parameter. It is not found to be significant when used in
the models but shows somewhat encouraging results when applied to different situations.
Its discriminating power is also not encouraging. In the univariate setting, it is found to
be effective.
Resourcefulness
Six banks have considered this parameter and its role is found to be effective
when used in the models of the respective banks. Further it is found to be a good
discriminator. In the univariate situation too the parameter has proven its predictive and
discriminating p o w e r ^ *' -
Management Initiative
Three banks have considered this parameter in their rating models. But it was not
found to be significant in any one of the bank’s model and its discriminating power also
is not appreciable. However, its role is clearly visible when this parameter is considered
alone. It alone could classify 69% correctly. It has interaction with a large number of
other parameters.
Composition of Board
This parameter has been considered by four of the sample banks. The
Composition o f Board is considered to be very crucial specially SEBI’s emphasis on
corporate governance. However, it is not found to have good predictive and
discriminatory power in most of the cases. In few cases it is found to be counter intuitive
with good composition indicating high default probability. In univariate situation the
parameter is found to be ineffective.
Relationship with Bank
Six o f the sample banks have used this parameter in their rating models. This
parameter is found to be very effective in terms o f predictive capability as well as
discriminating power. In the univariate situation too the parameter plays a very
significant role in predicting the default probability and classify 71% correctly.
Audit Qualification
Five banks have used this parameter. It has been found to very high predictive and
discriminating value both in model and situations. Further in the univariate analysis too
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the parameter has proven to be good predictor and discriminator. Further it correlation
with thirty-four other parameters.
Ability to meet Sales projection and Ability to meet Profit Projection
Eight banks have considered the first parameter and seven banks have considered
the second parameter. Both the parameters however are not found to be significant when
used in the model. In the univariate analysis they are found to have very good
discriminating and predictive value. Both the parameters have correlation with thirty
other parameters.
Financial Control
Two banks have considered this parameter. It has been found to have good
predictive and discriminating value under different situations as well as in models. In
univariate setting also it is found to be effective.
Statutory Compliance
Three o f the sample banks have considered this parameter. The parameter is not
effective when used in models. In univariate setting too the parameter has failed to
influence the default probability.
Litigation Cases
Three banks have used this parameter. Similar result has been observed with this
parameter as in the previous case.
Performance of Group Companies
Two banks have used this parameter. Performance of the Group has very little
influence in predicting the health of new units as can be seen from both multivariate and
univariate analysis.
Shareholding of Promoters
One bank has used this parameter. The parameter has little influence in predicting
the health. In the univariate analysis, it has been found to be counter-intuitive.
Compliance of Sanction terms
Seven banks have used this parameter. Its role is found to be very significant
when used in the model and applied to different situation. It is a very good predictor as
well as discriminator but appears to provide counter-intuitive results with the proposal
having higher compliance indicating high default probability in most cases. It is however
giving good result in the right direction when the parameter is used alone in the
univariate analysis.
148
Servicing O f Instalment and Interest
Seven banks have used this parameter. Amongst the financial and non-financial
parameters used in this study, the parameter has shown the highest predictive and
discriminating power. Further in the univariate set up too the parameter has displayed
tremendous capability to classify the cases correctly.
Submission of Audited Financial Statement
Six banks have used this parameter in their rating models. This has moderate
predictive value in the case of renewal of accounts. In the univariate set up it is found to
be effective with reasonable discriminatory value.
Renewal of Limits
Three banks have used this parameter, the parameter is found to be effective in
some cases only, however, its predictive and discriminatory power is found to be very
high when it is analysed in univariate situation.
Submission of MSOD/ Stock Statement, etc.
The parameter is used by eight banks and is found to be very effective when used
in the models of the respective banks. Its discriminating power is also high. When it is
used as a parameter of univariate analysis, its discriminating power is found to be very
high with correct classification of 83% in LR and DA.
Project Implementation
Only one bank has used this parameter and it is not found to be effective in that
model. In the univariate set up it is found to be effective.
Management of Inventories and Receivables
Three banks have considered this parameter. It appears to have good predictive
value and discriminating value when applied to different situation. In the univariate set up
it has given significant results.
Turnover in Account
Three banks have used this parameter. It is not found to be very effective when
used in the models of the respective banks. Further it is not found to be significant in
MDA too. However in contrast it is found to be very effective when it is used alone in the
univariate analysis with high turnover in accounts indicating low default risk.
Utilization of Limit
Only one bank has used this parameter. The parameter as such is ineffective in
indicating the default risk.
149
Overdrawing* in Account *
Three banks have used this parameter. The parameter appears to have good
predictive and discriminating power. Further in the univariate analysis too, it displays
high predictive and discriminating ability.
Diversion of Fund
Two banks have used this parameter and its contribution towards predicting the
health is found to be minimal.
Operations in the Account
Eight banks have used this parameter and it is found to be effective to some extent
only when used in the model of respective banks. In the univariate setup the parameter
displays good predictive and discriminating ability.
Reliablility of Financial Statement
Though the' parameter is not used by nine banks it is found to be good indicator of
default risk both in multivariate and univariate set up.
Cheques Returned
Three banks have used this parameter. Cheque returns could be good indicator of
default probability as can be seen from its ability to predict and discriminate in the
univariate analysis. However when used in the banks’ model this parameter did not show
satisfactory results.
Overall Account Conduct
Three banks have considered this parameter. Here too it is a good indicator of
default probability as can be seen from its ability to predict and discriminate in the
univariate analysis. However when used in the banks’ model this parameter did not show
satisfactory results.
Management of Creditors
Only one bank has used this and has not been found to be effective in any
situation or model.
Loans and advances
One bank has used it and it does not indicate the quality of the accounts.
Tenor of Loan
Four o f the ten banks have considered this parameter. This parameter shows
mediocre predictive and discriminating power.
150
Margin on Term Loan
The parameter used by only one bank is not indicating the quality of the borrower
in most o f the cases. In the univariate set up too, it is not found to be effective.
Security Coverage
Four banks have considered the parameter. This parameter in no way indicates the
quality of borrower. High security coverage helps banks to recover loans in case of
defaults but does not indicate that unit will be healthy if security coverage is there. In the
univariate set up too it is not found to be effective.
Liquidity of security
This parameter in no way indicates the quality o f borrower. High liquidity of
security helps banks to recover loans in case o f defaults but does not indicate that unit
will be healthy if liquidity of security is there.
Availability of Guarantee
This parameter used by only one bank Like the previous two parameters this
parameter is found to have similar implication.
Competition
This parameter though important is not found to be a good indicator of the quality
of the accounts. The reason being that the parameter measures the level of competition
not the competitive position of the concerned firm in the market. Probably competitive
position could be good predictor of default risk.
Technology
This parameter also found to have very little predictive and discriminating value.
Capacity Utilisation
Three banks have used the parameter in their rating models. It has very little
predictive value when used in the respective model of the banks. However it was found to
be effective in the univariate analysis with higher capacity utilization indicating low
default risk.
Raw Material Availability
Raw material availability is essential for survival o f the unit but availability of
raw material no way indicates ensure good health. As such this parameter is not found to
be effective.
Infrastructure
Similarly infrastructure is essential but mere availability of infrastructure does not
151
distinguish between healthy and unhealthy units. As such this parameter is not found to
be effective.
Location
It is not a good indicator of quality of the borrower.
Product Quality
Six banks have used this parameter and it is found to be significant only in few
cases. Its discriminating power is also mediocre. But in univariate set up it has been
found to have good discriminating and predictive power. The parameter has correlation
with twenty-nine other parameters.
Spread of Market
Seven banks have considered this parameter but it was not found to be significant
in most of the models. However in the univariate set up it is found to have good
predictive and discriminating power.
Distribution Network
This parameter finds place in the rating models o f seven o f the sample banks.
Like the previous parameter the result in the case o f this parameter is similar.
Export Potential
Three banks have considered this parameter while assessing the industry risk. The
parameter was found to be insignificant.
Import Policy
Only one bank has considered this parameter. The parameter was found to be
insignificant.
Track Record of Supplier
None of the sample banks have used this parameter. The parameter was found
ineffective in the situations in which it was considered.
Regulatory Aspects
Seven banks have considered this parameter in their rating models. The parameter
was found ineffective in the situations in which it was considered.
Compliance of Environmental Regulations
This parameter is used by several (seven) of the sample banks. The parameter was
found ineffective.
Industry Prospects
Six banks have considered this parameter while assessing the industry risk. In
most of the models the parameter was found to be significant. In the univariate set up too
the parameter is found to be significant.
Industry Cyclicity
Seven banks have considered this parameter while assessing the industry risk. The
parameter was found ineffective.
4.5 Effectiveness of Risk Rating Models - Analysis and

Findings
The study has reassessed each o f the 181 cases using nineteen models of the
banks and scores are assigned to the cases where applicable as prescribed in the
respective model without any minor modification so that the score reflects actual
evaluation of the cases by the model. It is to be noted that each of the 19 models are not
applicable to' all the 181 cases as different models are developed for specific
requirements in terms of loan limit , type of activity and nature of accounts.
The scores so obtained for each of the models are considered as independent
variable and this along with current status i.e., default or non-default, has been used to
estimate:
1. Predictive power o f each model using simple regression
2. Discriminatory power of each model using linear discriminant analysis (LDA)
3. Area-under-curve (AUC)
4. Logistic regression (LR)default probabilities
5. Brier Scores
The findings of the above are described in the following Sections.
4.5.1 Predictive and Discriminatory Power of the Models of the

Surveyed Banks
Model-wise results are described in the following paragraphs.
1. Vijaya Bank- 2 lacs to 1 crore
Vijaya Bank has developed three basic models for internal rating purpose -
153
1. V ijaya B ank : Model for limits o f 2 lacs to 1 crore
Table 4.5.1a : Regression Output with Total/ overall Scores
F = 29.5( .000); Durbin Watson =.534; R = .517 ; R2 =.267 ; Ad usted R2= .251
Variables Standard.Coeff.(3) t Signif. Adi. R2
Constant -2.84 .005
Overall Scores .491 5.43 .000 .233
Table 4.5.1b : Regression Output with Financial and Non Financial Scores
F = 16.74(.000); Durbin Watson =.967 ; R = .70 ; R2 =.490; Ad usted R2= .481
Variables Standard, Coe ff,((3) t Signif. Adi. R2
Constant -2.98 .004
Subjective .508 5.65 .000
Financial .054 .607 .545
Table 4.5.1c: Classification Table (overall scores)

Overall Scores NPA Non Tot.
NPA count 19 8 27
% 70.4 29.6 100
Non count 16 52 68
% 23.5 76.5 100
Cross- NPA 66.7 33.3 100
vaiid(%) Non 23.5 76.5 100
Table 4.5.1d: Classification Table(Fin. scores) Table 4.5.1e: Classification Table (Non-fin)
2. U nited B ank of India: Model for Limits less than 100 lacs
Table 4.5.2a : Regression Output with Overall Scores

F=1.606( .207^1; Durbin Watson =, 100 ; R = . 110 R2 =.012; Ac justed R2= .005
Variables Standard.Coe ff.(P) t Signif. Adj.R2
Constant 1.895 .060
Overall Scores .110 1.267 .207 .005
Table 4.5.2b : Regression Output with Financial Scores
F = .215(.601); Durbin Watson =.644 ; R = .04 ; R2 =.002 ; Adjusted R2= -.006
Variables Standard.Coeff.(3) t Signif. Adj. R2
Constant 4.164 .000
Financial Scores .040 .463 .644 -.006
Table 4.5,2c: Regression Output with Non-Finaneial Scores
F = 6.951 (.009); Durbin Watson =.170; K= .224; R2=.05; Adjuste<JR 2=.043
Variables Standard.Coeff.(P) t Signif. Adj. R2
Constant -.378 .706
Subjective Scores .224 2.636 .009 .043
154
A) Model for limits of Rs. 2 lacs to Rs. 1 crores
B) Model for limits from Rs. 1 lacs to Rs. 3 crores
C) Model for limits from above Rs. 3 crores
This study has taken only one model that is used for accounts with limits of Rs. 2
lacs to Rs. 1 crores. Other two models could not be tested on account o f low sample size.
Overall the tested model is found to be effective in predicting the overall health of
the borrowers though the score explains 25.1% of the variation in the status (Table
4.5.1a). While the non-financial score has significant influence on the prediction of
health, the financial score have been found to have little predictive value as can be seen
from t-value in Table 4.5.1b. The model has been found to have moderate discriminating
power and could correctly classify 74.7% of the cases (Table 4.5.1c). Here too, financial
scores have very little discriminating power while subjective score has moderate
discriminating power (Table 4.5. Id & 4.5. le). One o f the important finding is that the
model misclassifies default cases more than the non-default cases indicating that the
model is not desirable if the cost of misclassification of default cases is much higher than
cost of misclassification of non-default cases.
2. UBI
In response to the Basel II requirements UBI has evolved 3 models
A) Credit Rating Model less than Rs. 1 crore;
B) Credit Rating Model for Term loan with limit more than Rs. 1 crore;
C) Credit Rating Model for Working Capital with limit more than Rs.l crore.
Model A does not seems to have good predictive power with a meager
explanatory power o f 0.5% (Table 4.5.2a). Financial score given by the model is
insignificant in predicting health of the borrower (Table 4.5.2b). Subjective or non-
financial scores though effective to some extent , contributes little to the predictive
capability o f the model (Table 4.5.2c). As such, the discriminating power of the model is
quite unsatisfactory with correct classification o f 54.5% - 61.9% (Table 4.5.2d & 4.5.2e).
Models B and C are also not found to be effective as their explanatory power is
very low (Table 4.5.2f) though financial and subjective scores are significant their
contribution to predictive power of the model is negligible. Further, discriminatory power
of model B is moderate and discriminatory power of model C is poor (Tables 4.5.2g &
4.5.2h). It should be noted that model C is tested considering only a few observations.
155
Table 4.5.2d: Classif. Table-Overall Scores Table 4.5.2e : Classif. Table - Fin &Non-fin,
Overall Scores NPA Non Tot. Fin.&Non-fin. NPA Non Tot.

% 52.5 47.5 100 % .66.1 33.9 100
% 44.0 56.0 100 % 41.3 58.7 100
valid(%) Non 44.0 56.0 100 Valid(%) Non 41.3 58.7 100
Correct classification= 54.5 % Correct classification** 61.9 %
Cross -valid. Class = 54.5 % Cross -valid. Class ~ 6 1.9 %
2. United Bank of India: Model for Term Loan with Limit more than 100 lacs and
Model for Working Capital more than 100 lacs
Table 4.5.2f: Regression Output (Overall Scores) - UBI TL >100 lacs Model
F = 2 .77( .106); Durbin Watson =.956 ; R = .282 ; R2=.080; Adjusted R2= .051
Variables Standard.Coeff.(p) t Signif. Adj. Ra
Constant -.901 .374
Overall Scores .282 1.665 .106 .051
Table 4,5.2g: Regression Output with Overall Score - UBI WC >100 lacs
Model_____________________________________ ________________ ______
F = .018(,895); Durbin Watson =1.089; R = .041 ; Rz =.002; Adjusted R* = -.Q89
UBI T L >100 lacs UBI W C >100 lacs

Table 4.5.2h: Classif. Table (overall scores) Table 4.5.2i: Classif. Table (overall scores)
Overall Scores NPA Non Tot, Overall Scores NPA Non Tot.
% 66.7 33.3 100 % 100 0 100
Non count 3 10 13 Non count 12
% 23.1 76.9 100 % 58.3 41.7 100
Cross- NPA 66.7 33.3 100 Cross- NPA 0 100 100
valid(%) Non 23.1 76.9 100 valid(°/o) Non 58.3 41.7 100
Correct classification** 70.6 % Correct classification** 46.2 %
Cross -valid. Class = 70.6 % Cross-valid. Class = 38.5%
156
Hence the results shown in Table 4.5.2f & Table 4,5,2h) should be interpreted with
caution,
3. PNB
The three credit rating models in use in PNB are as follows-
A) Small Loans where limit is from Rs.20 lacs to Rs.3.5 crores
B) Mid-Corporates where limit is from Rs.3.5 crores to Rs.12 crores
C) Large Corporates where limit is above Rs.12 crores
D) New Projects -Above Rs.5 crores
The study has tested only model A and could not test models B, C & D due to
insufficient sample size. The PNB model for small loans is found to be effective in
predicting the health of the accounts with explanatory power of 24.5% ( Table 4.5.3a).
Here too the non-fmancial score is found to be dominant in the regression model with
financial score explaining virtually nothing (Tables 4.5.3b & 4.5.3c). Similarly
discriminating power of the non-fmancial score is also found to be very high at around
86% against poor discriminating power o f financial score (Tables 4.5.3d & 4.5.3e).
4. Canara Bank
Three models are currently being used by Canara bank. The models are as
follows-
A) Portfolio Model for less than equal to Rs.30 lacs;
B) Manual Model for limits between Rs.30 lacs and Rs.2 crores (three variations
used);
C) RAM Model for limits above Rs.2 crores.
The study, however, has tested each of the three variations of model B viz., for a)
Trading accounts, b) Industrial accounts and c) New accounts . The first two models (A
& B) have been developed in-house while the RAM model has been outsourced. Model
A could not be tested again due to insufficient sample size.
In the model for New Accounts both financial and non-fmancial parameters is
found to be significant when each considered alone or combined. The financial score
could explain 14.8% whereas non-fmancial score could explain 16.1%. The combined
score however could explain only 20.3% (Tables 4.5.4a, 4.5.4b & 4.5.3c). The
discriminating power of the both financial and non-financial score is found to be
mediocre (Tables 4.5.4d & 4.5.4e).
157
3. Punjab National Bank : Model for Small Loans - 20 lacs to 3.5 crores
Table 4.5.3a : Regression Output (Overall Scores)- PNB Model
F = 37.35(,000) Durbin Watson =.556 ; R = .502 R" =.252; Ac justed Ri = .245
Constant -2.056 .042
Overall Scores .502 6.145 .000 .245
Table 4.53b : Regression Output (Financial Scores)- PNB
F = .171(.680 ); Durbin Watson =.119 ; JFt = ..39 ; Rl =.002 ; Adjusted R2= -.002
Variables Standard.Coeff.(P) t Signif. Adj. Ra
Constant 5.23 .000
Financial Scores .039 .413 .680 -.002
Table 4.5.3c : Regression Output (Non-financia! Scores) - PNB
F = 105.2 K.OOO ); Durbin Watson =.951; R = .696 ; R' =.484; Adjusted R2= .480
Variables Standard.Coeff.(P) t Signif. Adj. R^
Constant -4.96 .000
Table 4.5.3d: Classif.Table (Finan.) Table 4.5.3e:Classif. Table (Non-fin. score)

Financial scores NPA Non Tot. Non-fman. score NPA Non Tot.
% 45.9 54.1 100 % 89.2 10.8 100
% 54.5 45.5 100 % 15.6 84.4 100
Cross- | NPA 45.9 54.1 100 Cross- NPA 89.2 10.8 100
Va!id(%) | Non 54.5 45.5 100 Valid(%) Non 15.6 84.4 100
Correct classification= 45.6 % Correct c!assification= 86, 0%
4. Canara B a n k : Model for New Accounts with Limit from 30 lacs to 2 crores
Table 4.5.4a : Regression Output with Overall Scores - Canara Bank

F = 20.39(.000); Durbin Watson =1621 ; R = .462; R' =.214; Adjusted R2= .203
Variables I Standard.Coeff.(p) t Signif. Adj. R'
Constant -3.56 .001
Overall Scores | .462 4.51 .000 .203
Table 4.5.4b : Regression Output with Financial Scores - Canara Bank
F = .14.17(.000 ); Durbin Watson = 587; R = .399 ; R2 =.159 ; Adjusted R'i= .148
Variables Standard. Coeff.( P) t Signif. Adj. R"
Constant -2.95 .004
Financial Scores .399 3.76 .000 .148
Table 4.5.4c : Regression Output with Non-financial Scores - Canara Bank
F = 15.6(.000); Durbin Watson =.537; R = .415 ; R2 =172; Adjusted R'i= .161
Variables Standard.Coeff.(p) t 1 Signif. Adj. Rl
Constant -2.80 .006
Subjective Scores .415 3.95 1 .000 .161
158
The model for Industrial accounts is found to be most effective amongst the three
models of Canara bank with explanatory power of 44.4% (Table 4.5.4Q- Here too the
financial score is found to have influence in predicting the health of the borrowers when
the power of the financial score is examined separately (Table 4.5.4g). Same is true for
the non-financial parameters (Table 4.5.4h). However, explanatory power has gone down
when scores are combined. The relatively low explanatory power in case of combined
indicates score in one is being offset by the score in the other. Though the financial score
has high predictive power its discriminating power is found to be low (Table 4.5.4i).
Overall the model’s discriminating power appears to be high (Table 4.5.4j).
The model for trading accounts is found to be less effective than the previous two
models with insignificant influence of financial score. Its discriminating power also
appears to be unsatisfactory as it classifies correctly only 63% of the cases (Table 4.5.4k).
5. State Bank of India
SBI has introduced the new CRA (Credit Risk Assessment) system in 2004. With
its introduction the bank now has two models
A) New CRA- C&I, SSI and AGL segments for limits above Rs.25 lacs;
B) Existing CRA- Simplified (Trade) for limits below Rs.2 crores
- Regular (Trade) for limits Rs.2 crores and above.
The study has tested model A and Simplified model in case of B. The Regular
model under Model B could not be tested again for the same reason cited earlier. The
existing CRA simplified model (used for trading accounts below 2 crores) largely relies
on financial parameters with some adjustment for management and industry parameters.
If management and industry risk parameters are unfavourable to the units/ borrowers five
marks is deducted for each management and industry parameters from the financial score.
There is no provision for awarding score for good performance in management and
industrial parameters. In the new CRA which is mainly for C&I, SSI and AGL segments
for limits above 25 lacs , there is separate score for management, industry and business
risk parameters. In fact weightage given to these non-financial parameters is more than
that given to financial parameters.
The existing CRA Simplified model which is based on financial parameters is not
at all effective in predicting the health of the borrower. It could explain only 2% in the
variation of the status score (Tables 4.5.5a) and could correctly classify only 50.7%
159
4. C an ara B ank : Model for New Accounts with Limit from 30 lacs to 2 crores
Table 4.5.4d: Classifiable (Finan.) Table 4.5.4e:Classif. Table (Non-fin. score)

Financial scores NPA Non Tot. Subjective score NPA Non Tot.
NPA count 48 NPA count 30 18 48
% 70.8 29.2 100 % 62.5 37.5 100
Non count 29 Non count . 5 24 29
% 31.0 69.0 100 % 17.2 82.8 100
Cross- | NPA 70.8 29.2 100 Cross- NPA 62.5 37.5 100
Valid(%) j Non 31.0 69.0 100 Valid(%) Non 24.1 75.9 100
Correct classification= 70.1 % Correct classification3 70.1 %
Cross-valid. Class = 70.1 %• Cross -valid. Class = 67.5 %
4. C an ara B an k : Model for Industrial Accounts with Limit from 30 lacs to 2 crores
Table 4.5.4f: Regression Output with Overall Scores - Canara Bank(Industrial)
F = 40.86( .0001; Durbin Watson =.97 ; R = .674 ; R2=.455 ; Adjusted R" = .444
Variables Standard.Coeff.( 3) t Signif. Adj. Rz
Constant -5.39 .000
Overall Scores .674 6.39 .000 .444
Table 4.5.4g: Regression Output with Financial Scores- Canara Bank
F = 3.252(.077); Durbin Watson =.288 R = .249 ; R2=.062; Adjusted R*= .043
Variables Standard.Coeff.(P) t Signif. Adj. R'
Constant -.708 .482
Table 4.5.4h : Regression Output with Non-financial Scores - Canara Bank
F = 52.45(.000 ); Durbin Watson =1.23; R = .719 ; R" = 517; Adjusted R' = .507
Variables Standard.Coeff.(3) t Signif. Adj. R"
Table 4.5.4i: Classif. TabIe(overall scores) Table 4.5.4J: Classif. Table (Finan. Scores)
Overall Scores NPA Non Tot. Financial scores NPA Non Tot.
% 81 19 100 % 66.7 33.3 100
% 20 80 100 % 50.0 50.0 100
Cross- NPA Cross- NPA 66.7 33.3 100
valid(%) Non Valid(%) Non 50.0 50.0 100
Correct classification= 80.4 % Correct classification3 56.9 %
Cross -valid. Class = 78.4% Cross -valid. Class = 56.9 %
C an ara B a n k : Model for Trading Accounts with Limit from 30 lacs to 2 crores
Table 4.5.4k: Classification Table (overall scores)
NPA count 9 4 13
% 69.2 30.8 100
Non count 16 25 41
% 39.0 61.0 100
Cross- NPA 61.5 38.5 100
v a lid ^ ) Non 39.0 61.0
Correct classification3 63. 0%
Cross -valid. Class =61.1 %
160
5. State Bank of India : Model for Trade accounts
Table 4.5.5a : Regression Output with Overall Scores - SBI

F = 2.514(. 117 ; Durbin Watson =.205 ; R = .182 ; R2 = 033 ; Adjusted R2= .02
Variables Standard,Coeff.(p) t Signif. Adj. R2
Constant 4.678 .000
Overall Scores -.182 -1.586 .117 .02
Table 4.5.5b: Classification Table (overall scores)
NPA count 13 12 25
% 52.0 48.0 100
Non count 25 25 50
% 50.0 50.0 100
Cross- NPA 52.0 48.0 100
va!id(%) Non 50.0 50.0 100
5. State Bank of India : Model for C&I, SSI & AGL accounts
Table 4.5.5c : Regression Output with Overall Scores- SBI
F = 23.59( .000); Durbin Watson =.569 ; R = .444; R2 =.197 ; Ad usted R2= .189
Variables I Standard.Coeff.(P) t Signif. Adi. R2
Overall Scores | .444 4.858 ,000 .189
Table 4,5,5d: Regression Output with Fin. Scores &Non-fin Scores - SBI______
P = 23 70( 000 Durbin Watson =.818 ; R = .577 ; R2 =333; Adjusted .319
Variables Standard.Coeff.(p) t Signif. Adj. R2
Financial -.026 -.305 .761
Subjective .577 6.885 .000 .319
Table 4.5.5e degression Output with Non-ftnancial Scores - SBI

F = 47.46(.000 ); Durbin Watson =.803; R = .576 ; R =.332; Adjusted R2= .325
Table 4.5.5f: Classif. Table (overall score)
Overall Score NPA Non Tot.

NPA count 34 17 51
% 66.7 33.3 100
Non count 12 35 47
% 25.5 74.5 100
Cross- NPA 66.7 33,3 100
valid(%) Non 25.5 74,5 100
161
(Table 4.5.5b) indicating very poor discriminating power. The model is in no way better
than assigning random rating to the borrowers.
The new CRA model where more weightage is given to non-financial parameters
have shown moderate effectiveness in predicting the health of the unit with explanatory
power of 18.9% when the total score is taken (Table 4.5.5c) and 31.9% when financial
and non-fmancial scores are entered separately (Table 4.5.5d). In fact, non-financial
parameters alone copld explain 32.5% of the variation in the univariate model (Table
4,5.5e), Further the new CRA has also displayed moderate discriminating power and
could classify 70.4% cases correctly (Table 4.5.50-
6. UCO Bank
UCO bank uses 3 credit rating models for risk assessment of borrowers. These are
for
A) Exposures over Rs.25 lacs and upto Rs.5 crores with three variation- Existing,
Existing but new and Greenfield;
B) Exposure over Rs.5 crores with term facilities upto Rs.5 years;
C) Exposure over Rs.5 crores with term facility more than Rs.5 years.
The study has tested only Model A and could not test the other two models again
due to insufficient sample size. In case o f Greenfield and Existing but new accounts, five
marks is deducted from the total score to take into account the uncertainty associated with
the assessment of merit o f the proposal. This treatment of Greenfield and existing but
new accounts does not appear to distinguish between good and bad borrowers as both
good and bad accounts are penalized equally. Our discriminant analysis tends to support
this argument. The discriminating power of Greenfield model and Existing but New
model is found to be poor (Tables 4.5.6b & 4,5.6c). Whereas the discriminating power of
the Model for existing accounts is found to be very effective (Table 4.5.6d).
Discriminating power is not found to be effective when all the three types of accounts are
combined (Table 4.5.6e). In case of all the models o f UCO Bank, financial parameters
neither have predictive power nor discriminatory power. Further among all the three
variation, the model for new accounts has given the highest explanatory power (Table
4.5.6a).
7. Allahabad Bank
This bank has six credit risk grading modules each meant for different category of
borrowers.
162
6. U C O B a n k : Risk Rating M odel for Limits from 25 lacs to 5 crores
Model for New Accounts- UCO Bank

Table 4.5.6a : Regression Output with Overall Scores- UCO Bank
F = 9.416( .006] ; R = .363; R2 =.132 ; Adjusted R2= .118
Overall Scores .363 3.069 .003 .118
Table 4.5.6b:Classif. Tabte-new accounts Table 4.5.6c: Classif. Table- Existing but new a/c
Overall Scores NPA Non Tot. Overall Scores NPA Non Tot.
% 58.1 41.9 100 % 47.1 52.9 100
% 38.1 61.9 100 % 52.4 47.6 100
Cross- NPA 58.1 41.9 100 Cross- NPA 47.1 52.9 100,
valid(%) Non 38.1 61.9 100 valid(%) Non 52.4 47.6 100
I Correct classification= 59.4 % Correct classification® 47.4 %
Cross -valid. Class = 59.4% Cross -valid. Class = 47.4 %
Table 4.5.6d: Classif. Table- Ixisting accounts Table 4„5.6e: Classi Table- All a/c
Overall Score NPA Non Tot. Overall Score NPA Non Tot.
% 100 0 100 % 57.8 42.2 100
% 19.5 80.5 100 % 35.0 65.0 100
valid(%) Non 19.5 80.5 100 . valid(%) Non - 35.0 65.0 100
Correct classification53 82.2 % Correct classification® 62.4 %
Cross-valid. Class = 82.2% Cross -valid. Class = 62.4 %
7. Allahabad Bank: Model for New Accounts

Table 4.5.7a: Regression Output with Overall Scores - Allahabad Bank
F = 10.54(.002) Durbin Watson =. ; R = .452 ; R2 = 205 ; Adjusted R2= . 185
Overall Scores .452 3.247 .002 .185
Table 4.5.6b: Regression Output with Financial Scores - Allahabad Bank
F = 1 384(.246); Durbin Watson =.316 ; R = .181 ; R2 = 033 ; Adjusted R2= .009
Constant .852 .399
Table 4.5.6c: Classif. Table - New Accounts

NPA count 16 8 24
% 66.7 33.3 100
Non count 5 14 19
% 26.3 73.7 100
Cross- NPA 66.7 33.3 100
valid(%) Non 31.6 68.4 100
163
A) CRG-01- Retail Credit, Liquid Security, Clean Advances and others with limit
below 25 lacs.
B) CRG-02 - Existing units with limits Rs.25 lacs to Rs. 2 crores;
C) CRG-03 - Existing units with limits above Rs.2 crores;
D) CRG-04 - New units with limits above Rs.25 lacs;
E) CRG-05 - Service sector / Municipality or Development Authority/
Educational institute;
F) CRG-06 - NBFC/ Financial Corporation.
The study has tested model B and Model D. Model A . Model E and Model F are
outside the purview of this study. Model C could not be tested due to insufficient sample
size.
The model for New Accounts is found to be effective to some extent with
explanatory power of 18.5% (Table 4.5.7a). Here too, financial score does not appear to
influence the health of the account (Table 4.5.7b). The discriminatory power of the model
is also not very effective (Table 4.5.7c). On the other hand the model for existing
accounts is found to have less predictive power but relatively higher discriminatory
power (Tables 4.5.7d & 4.5.7e). However, it must be cautiously interpreted as the testing
sample has very few default cases leaving ample scope for biased test result.
8. Union Bank
Union Bank is currently using four models as given below :
A) Exposures from Rs.2 lacs to Rs.10 lacs;
B) Exposures from Rs.10 lacs to Rs.l crore;
C) Exposure from Rs. 1 crore to Rs.10 crore ; e
D) Exposures of Rs.10 crores and above.
Model A is outside the purview of the study. Model C and Model D could not be
tested due to insufficient sample size. We have tested only Model B.
The model has relatively high explanatory power and subjective score explain
most of the variation in the health status (Table 4.5.8a). Its discriminating power is found
to be moderate (4.5.8b). But however discriminating power has improved substantially
when subjective scores are used for discrimination (Table 4.5.8c).
9. Andhra bank
The bank uses 2 models for rating borrowers -
164
7. Allahabad Bank : M odel for Existing Accounts with Lim it from 25 lacs to 2 crores
Table 4.5.7d : Regression Output with Overall Scores - Allahabad Bank

F = 6.125(.018); Durbin Watson = 1.02 ; R = . 361 ; R2 =130; Ac justed R2= .109
Variables Standard.Coeff.(P) t Signif. Adj, R2
Constant 2.461 .018
Overall Scores .361 2.475 .018 .109
Table 4.5.7e: Classification Table - Existing accounts
NPA count 3 0 3
% 100 0 100
Non count 10 30 40
% 25.0 70.0 100
valid(%) Non 25.0 75.0 100
Correct elassification= 76.7 %
8. Union B an k : M odel for Lim it from 10 lacs to l crore

Table 4.5.8a : Regression Output with Overall Scores - Union Bank
F = 44.42C.000); Durbin Watson =.563 ; R = .517 ; R2 =.267 ; Ac justed R2= .261
Variables Standard.Coeff.(3) 1 t Signif. Adj. R2
Overall Scores .517 16.665 .000 .261
Table 4.5.8b:CIassif. Table- overall score Table 4.5.8c:Classif. Table-Non-finan.score

Overall Score NPA Non Tot. Non-financial NPA Non Tot.
% 72.0 28.0 100 % 84.0 16.0 100
% 27.0 73.0 100 % 16.2 83.8 100
valid(%) Non 27.0 73.0 100 Valid(%) Non 16.2 83.8 100
Correct cIassification= 72.6 % Correct classification^ 83.9 %
9. Andhra B ank : M odel for WC /TL w ith lim its from 10 lacs to 1 crore
Table 4 .5 .9a : Regression Output with Overall Scores- Andhra Bank
F = 14.91(.000); Durbin Watson =. 51 ; R = . 414 ; R2=.172; Ac justed R2= .160
Variables Standard.Coeff.(3) t Signif. A dj.R2
Constant .167 .867
Overall Scores .414 3.861 .000 .160
Table 4.5. 9b: Classification Table for limit 10 lacs to 1 crore

NPA count 10 4 14
% 71.4 28.6 100
Non count 18 42 60
% 30.0 70.0 100
Cross- NPA 71.4 28.6 100
valid(%) Non 30.0 70.0 100
Correct classification5170.3 %
165
A) For borrowers enjoying WC/TL limits o f above Rs.10 lacs and below Rs.100
lacs;
B) For advances with credit limits of Rs.100 lacs and above.
The first model (model A) appears to have good predictive power and moderate
discriminating power (Tables 4.5.9a & 4.5.9b). The second model (model B) appears to
be less effective both in terms of predictive and discriminating power (Tables 4.5.9c &
4.5.9d). The financial score doe's not have any significant contribution (Tables 4.5.9e &
4.5.9f).
10. Central Bank of India
The bank uses two models -
A) Model for limits of over Rs.2 lacs and up to Rs.l .5 crores;
B) Model for limits above R s.l.5 crores.
This study has evaluated scores of the rating model that the bank uses for
borrowal accounts with limits over Rs.2 lacs and up to R s.l.50 crores. The examination
was done separately for existing accounts only and new & existing accounts together. In
case of existing accounts the model is found to be more powerful than when combined
with new accounts (Tables 4.5.10a & 4.4.3.10b). Similarly, discriminating power also is
more when parameters are examined considering only the existing units (Tables 4.5.10c
& 4.5.10d).
4.5.2 Area-Under- Curve (AUC)

The AUC is a summarizing accuracy measure. As mentioned earlier (section 3.3
of chapter 3) it is equivalent to the two independent sample Mann-Whitney non-
parametric test statistic 9, which estimates the probability that the score of a randomly
chosen defaulted company from the sample of defaulted companies is lower than the
score o f a randomly chosen solvent company from the sample o f solvent companies.
The value o f 9 may range from 0% to 100%. A perfect 9 value of 100 is attained
if exactly those borrowers defaulting in future receive the lowest credit scores. The
analysis of Table 4.5.11 indicates that none of the models is a perfect one and the
maximum 9 value is found to be 91 for Allahabad Bank and five models score above 80.
A value o f below 50% indicate that the model performs worse than a system
which randomly allocates credit scores to borrowers. Fortunately none of the models
9. Andhra Bank : Model for Advances with limits above 1 crore
Table 4.5.9c : Regression Output with Overall Scores- Andhra Bank (>lcr.)
F = 4.426(.041) Durbin Watson = 1.06 ; R = . 309 ; R2 =.095; Ac justed R2= .074
Variables Standard.Coeff.(P) t Signif, Adj: R2
Overall Scores .309 2.104 .041 .074
Table 4.5. 9d: Classification Table - Limit above 1 crore

•Overall Scores NPA Non Tot.
NPA count 15 7 22
% 68.2 31.8 100
Non count 8 14 22
% 36.2 63.8 100
Cross- NPA 68.2 31.6 100
valid(%) Non 40.9 59.1 100
Correct classification* 65.9 %
Table 4.5.9e: Regression Output with Financial Scores - Andhra Bank (lOIac-lcr)
F = . 133(.716 ); Durbin Watson =.267 ; R = .043 ; R2=.002 ; Adjusted R2= -.012
Variables Standard,Coeff.(P) t Signif.
Constant 4.951 .000
Financial Scores .043 .365 .716
Table 4.5.9 f : Regression Output with Financial Scores - Andhra Bank (Above 1 crore)
F = 1.36(.249); Durbin Watson =1.205 ; R = .177 ; R2=.031 ; Adjusted R2= .008
Variables Standard.Coeff.(P) t Signif.
Constant 2.494 .017
Financial Scores -.177 -1.168 .249
167
C entral B ank of In d ia : Existing accounts 2 la c s -1.5 crore
Table 4.5.10a: Regression Output with Overall Scores - Central Bank Model
for Existing accounts
F = 9.168(.004); Watson = .375 ; R=.361 ; R2=.131; Adjusted R2= . 116
Variables Standard. Coeff.(fS) t Signif. Adj.R2
Constant .016 .987
Overall Scores .361 3.028 .004 .116
C entral B an k of In d ia : Existing and New Accounts 2 la c s - 1.5 crore
Table 4.5.10b : Regression Output (Overall Scores)- Central Bank Model

F = 10,979(.001); R -275 ; R2=.076; Adjusted R2= .069
Variables Standard .Coeff.( P) t Signif. Adj.R2
Constant -.315 .753
Overall Scores .275 3.313 .001 .069
Table 4.5.10c: Classification Table - Existing accounts

NPA count 9 5 14
% 64.3 35.7 100
Non count 9 40 49
% 18.4 81.6 100
Cross- NPA 64.3 35.7 100
valid(%) Non 18.4 81.6 100
Table 4.5.10d: Classification Table - Existing and New accounts

NPA count 39 10 49
% 79.6 20.4 100
Non count 9 40 87
% 35.6 64.4 100
Cross- NPA 79.6 20.4 100
va!id(%) Non 35.6 64.4 100
Correct classification^ 69.9 %
score below 50% indicating that the model performance is better than the naive model.
Amongst the banks, UBI performs worst followed by UCO Bank.
4.5.3 Logistic Regression Default Probability Estimates

Though the banks do not transform credit scores into individual default
probabilities parametrically, most of the researchers uses logistic regression to transform
the credit scores into individual default probability estimates. Like others, we have also
converted scores obtained in each case into individual default probability estimates and
the same has been used to measure the model’s ability to correctly classify or misclassify
default and non-default cases. Further, the probability estimates may be used to calculate
Brier score which indicate the accuracy of the model to estimate the default probabilities.
In the LR estimate we assume 0 value for non-default and 1 for default. Hence,
the estimated probability reflects the probability of default. If estimated probability of
NPA or default cases is above 0.5 then it is considered to be correctly classified and if it
is below 0.5 then it is considered to be misclassified. Similarly in case of non-default
cases, if LR estimated probabilities is below 0.5 then it is considered to be correctly
classified and if it is above 0.5 then it is considered to be misclassified. The results of the
LR estimate of different models along with the classification capability and explanatory
power is given in Table 4.5.11,
The Wald statistic of LR indicates that five out of nineteen models are not found
to be effective. The results are similar to the findings in the case o f discriminant analysis
(Table 4.6.2a). One of the interesting observation is that in case of nine models the level
of NPA misclassification is more than 80% which is not at all a desirable feature though
overall correct classification rate under LR is better than LDA. This implies most of the
banks’ models fail to estimate the default probability correctly in the case of NPA. In
other words, most of the models underestimate the default probabilities of NPA cases
resulting in high misclassification in the case of NPA accounts.
4.5.4 Brier Score

Brier score measures the accuracy o f the default probability estimates. These
estimates may be either taken from logistic regression or banks own historical default
probabilities. Since LR is found to severely underestimate the default probability of NPA
cases (as discussed in Section 4.5,3) we have taken historical default probabilities as
169
Table 4,5.11 : Effectiveness of models in terms of LR, AUC & Brier score
■ Logistic Regression Estimates AUC B

Signif. Correct % Misclassif (%)
Bank Models Classif (%) Non NPA
UCO Bank
a. Existing accounts .05 88.89 2.44% 100% 82 .08
b. Existing but New accounts .602 60.53 4.76% 82.35% 54 .42
c. New / Greenfield accounts .007 79.69 52.38% 4.65% 69 .5
United Bank of India (UBl)
a. Term Loan (more than 100 lacs) .112 76.47 53.85% 4.76% 72 .50
b. Working Capital (more than 100
lacs) .88 92.31 0% 100% 54 .07
c. Limits less than or equal to 100 lacs .201 58.21 12% 79.66% 56 .37
Canara Bank
a. Trade model ,022 72.22 4.88% 100% 73 .23
b. Industrial model .000 80.39 16.67% 23.81% 87 .41
c. New accounts model .031 76.62 48.28% 8.33% 77 .61
Allahabad Bank
a. Existing accounts (25 lacs to 200 .056 93.02 0% 100% 91 .05
lacs)
b. New Projects (above 25 lacs) .006 74,42 36.84% 16.7% 76 .50
Union Bank
a. Limit of 10 lacs to 1 crore .000 80.52 6.25% 84.62% 81 .34
Andhra Bank „
a. Limit of 10 lacs to below 100 lacs .002 81.08 3.33% 85.71% 79 .79
b. Limit of 100 lacs and more .061 61.36 45.45% 31.82% 71 .47
Punjab National Bank
a, Model for small loans (20 lacs to .000 78.07 11.69% 33.24% 81 .20
3,5 crores)
State Bank of India
a, Trade Model (Below 2 crores) ,120 66.7 0% 100% 62 .44
b. New CRA (excluding trade & .000 70.41 27.66% 31.37% 75 .41
NBFC)
Vijaya Bank
a. Limits from 2 lacs to 1 crore .000 76.84 10.29% 55.56% 82 .26
Central Bank of India

a. Limits of 2 lacs to 1.5 crore .002 61,76 10.34% 87.76% 72 .34
B -Brier score
170
estimated default probability and the same has been taken from research articles
(Fernandes, 2005 and Chaubal, 2003). The respective banks default probability was not
available for this purpose and hence could not be taken here.
The Brier score ranges from zero (defaulters are attached a default probability of
100% percent and non-defaulters one of 0%) to some maximum value (defaulters are
attached a default probability of 0% percent and non-defaulters one of 100%). A system
with an AUC of 100% does not necessarily have a Brier score of zero, as default
probabilities for defaulters will mostly be below 100%, and those for non-defaulters
above zero. Vice versa, a system with a Brier score o f zero will have an AUC of 100%
showing that the Brier score evaluates ranking accuracy plus the accuracy of default
probability estimates.
High Brier score indicate poor accuracy and low Brier score indicates high
accuracy of default probability estimates of the model. Table 4.5.11 shows the Brier core
of each of the models. Allahabad model for existing accounts has the lowest Brier score
indicating high accuracy of default probability estimates of the model. Surprisingly, Brier
score of UBI show relatively better performance than measured in terms of theta.
4.6 Testing Of Hypothesis

For testing the hypothesis i.e. Weaknesses in credit appraisal is a major cause of
accounts turning into bad loans, the major thrust is on assessing the effectiveness of the
credit rating models used by banks for the credit appraisal of borrowers. This hypothesis
is closely linked with the research question - What is the level of effectiveness of the
credit appraisal process?
Hence, for testing this hypothesis and measuring the overall effectiveness o f the
models, we have considered the following criteria based on some of the ‘generally
accepted principles’ discussed in Section 4.2 and suggestions of researchers and experts
in the field (Fernandes, 2005; Frerichs & Wahrenburg, 2003 ; Treacy & Carey, 1998).
The criteria are further reiterated below .
• Predictive and discriminatory power of parameters
• Predictive and discriminatory power of the models
• AUC (Area-under-curve)
• Logistic regression default probability estimates
• Brier scores
• Rating migration
• Monotonicity
• Complexity
• Fineness
These criteria may be considered as standards against which effectiveness of credit
appraisal and rating models may be assessed. Any rating system meeting these standards
may be considered to be effective and absence of these features or standards may be
considered as an indication of weakness in the credit appraisal and internal rating
systems.
4.6.1 Predictive and Discriminatory Power of the Parameters

The predictive and discriminating power of the parameters used in the different
models of ten banks are tested under multivariate and univariate situation. For
multivariate we have used multiple regression and DA and for univariate testing we have
used Regression, LR and DA. The results of the multivariate and the univariate test for
different models of the banks are summarized in Table 4.6.1.
In the case of UCO bank more than 50% of the financial parameters used in the
model are not found to be significant in the multivariate as well as univariate situation. In
case o f non-financial parameters more than 50% is not found to be significant in multi
variate situation though majority of them is found to be significant in the univariate set
up.
UBI has used a large number of parameters in their model but a very few are
found to be significant both in multivariate and univariate situation. This implies that
most of the variables are redundant making the model relatively ineffective compared to
the models of other banks.
In case of Canara Bank too, most of the financial parameters are not found to be
effective both in multivariate and univariate situation. In the case of non-financial
parameters, in two models most of the parameters are ineffective in multivariate situation
though they are effective in univariate situation.
Compared to other banks, Allahabad Bank uses less number of financial
parameters and most of them are found to be effective both in univariate and multivariate
situation. However, the models uses relatively higher number o f non-financial parameters
and most of them are not found to be effective both in multivariate and univariate
situations.
172
Table 4.6.1: Predictive and Discriminatory Power of Param eters used in Rating Models
Bank Models No. of Multiple Regression MDA Univariate analysis
param. Significant
used in Parameter RJ Parameters
moc els Effectiveness
F NF F NF Sig Correct Regre- LR DA
Nos.(%) Nos.(%) F N Classif. F N F N FN
UCO Bank
a Existing accounts 8 17 2 (25%) 6 (35%) 0.472 2 4 85.1% 4 14 4 14 4 14
b Existing but New 8 11 2 (25%) 3 (27%) 0.354 2 1 78% 4 10 4 10 4 10
c. New / Greenfield 6 8 . 0(0) 3 (38%) 0.331 - 2 78.1% 3 8 2 8 3 8
United Bank of India

a. WC (> 100 lacs) 9 39 0(0) 5(12.8%) 0.448 1 7 80.4% 4 13 5 13 5 13
b. TL(> 100 lacs) 8 38 3 (37.5%) 5(13.2%) 0.493 1 4 83.9% 5 11 5 11 5 11
-Canara Bank
-a. Trade model 8 15 3 (37.5%) 6 (33.3%) 0.792 2 3 83.4% 2 12 3 12 4 12
Industrial model 5 22 0 (0%) 5 (22.7%) 0.703 - 5 94.2% 2 15 2 15 3 15
=c. New accounts 3 9 1(33%) 6 (66.7%) 0.506 - 6 87.2% 2 9 2 9 2 9
.Allahabad Bank
a.Existing a/c(25 lacs 4 31 3 (75%) 5 (16.1%) 0.556 2 5 92.5% 3 13 2 13 4 13
to 2 crores)
t>. New Projects >251 3 27 3 (100%) 5 (18.5%) 0.429 3 5 85.9% 3 8 2 8 2 8
Union Bank
3.Limit 10 lacs to Icr 6 25 3 (50%) 6 (24%) 2 4 79.9% 4 17 4 17 3 17
d . limit 1 crore -10 cr 8 31 3 (37.5%) 4 (12.9%) 0.702 I 1 89.2% 4 23 3 23 3 23
Andhra Bank
s. 10 lacs to <100 lac 2 7 1 (50%) 3 (42.9%) 0.355 3 86.5% 0 4 0 4 0 4
=>. >= 100 lacs 6 16 5 (83.3%) 5 (31.3%) 0.751 1 3 81.2% 4 13 3 13 3 13
03
u
z
a.20 lacs to 3.5 cr. wc 5 12 2 (40%) 4 (33.3%) 0.498 2 2 81.3% 2 10 1 10 2 10
State Bank of India

a. Trade Model <2cr 6 - 4 (66.7%) - 0.47 2 - 81.3% 4 - 4 - 4 -
a. C&I,SSI,AGL 6 24 1 (16.7%) 6 (25%) 0.618 " 4 85.1% 3 17 3 17 4 17
Vijaya Bank
a. Limits 2 lacs to lcr 7 15 3 (43%) 5 (33.3%) 0.415 2 4 83.2% 2 7 3 7 1 7
a. Limits of 2 lacs to 2 9 1 (50%) 3 (33.3%) 0.48 - 5 83.8% 1 6 0 6 0 6
3.5 crore
F- Financial N- Non-financial
Union Bank also uses relatively large number o f non-fmancial and most of them
are not found to be significant in multivariate situation though majority o f them are
significant in the univariate situation showing better/ significant predictive value.
In case of the model of Andhra Bank for large accounts, most of the financial
parameters are found to be effective both under the multivariate and univariate situation
but most of the non-fmancial parameters are found to be effective in univariate situation
only.
PNB uses relatively less number of parameters and most of the non-financial
parameters are found to be effective in univariate situation but less effective in
multivariate situation.
SBI uses only financial parameters in case of Trade model for less than 2 crores
limit and most o f the financial parameters are found to be effective. Whereas in case of
the model other than Trade accounts (new CRA) uses large number of non-financial
parameters and most of them are not-effective in the multivariate situation though they
are effective in univariate situation.
In case of Vijaya Bank, both financial and non-financial parameters are not found
to be effective under multivariate and univariate situation.
In the case of Central bank of India , very few financial and non-financial
parameters are used in its model for small limits and most of them are not found to be
effective in multivariate situation.
The following general conclusion can be drawn from this analysis-
1. Most of the parameters used in the models are not effective in the
multivariate situation (i.e., when parameters are used in the model
together with other parameters) though most o f them are significant in
the univariate situation. They are also highly correlated with most of
them making many of them redundant when used in the model.
2. Just mere comparison of multiple regression and MDA reveal that, with
a few exception, less number of parameters are effective in the MDA
model compared to that of regression.
3. Large number of parameters in no way indicates that more number of
parameters will be effective in the multivariate situation. Large number
of parameters in the models is making more and more number of
parameters ineffective.
4. Though financial parameters together contribute relatively much lesser
than non-financial parameters, proportionately more number of
financial parameters has entered the multivariate analysis than non-
fmancial parameters. This may be due to much higher number of non-
financial parameters in each model compared to financial parameters.
4.6.2 Predictive and Discriminatory Power of the Rating Models

The explanatory and discriminatory power of the models is summarized in Table
4.6.2a. F-statistic indicates that five models out of nineteen models are not found to be
effective. The relationship between the score and the current status is weak in these five
models signaling poor capability to predict the health o f the units. O f the fourteen
effective models, only four models have explanatory power of above 25% and there is
low or poor explanatory power. The highest explanatory power is found in the case of
PNB model with 50%. This implies that most of the variation o f the status can be
attributed to the features not included in most of the models. Amongst the banks, Canara
bank appears to have the most effective model and UBI has the most ineffective model.
In contrast to our belief the model for New Accounts are found to have better
explanatory power than the model for existing accounts. However, the same is not true
when it comes to the discriminating power. The discriminatory capability of the models
for Existing Accounts is more than the discriminatory power of the models for New
Accounts. Further model for Trading Accounts does not seem to fare well both in terms
of explanatory and predictive power.
In terms of discriminating capability three models show performance capability
worse than the nai've model or randomly assigned probability of defaults to the unit. Only
two models demonstrate good discriminating power with correct classification of more
than 80% and another ten models showing mediocre performance with correct
classification of above 70%. The remaining five have exhibited poor to mediocre
discriminating power. In cross-classification (excluding sample in the model estimates)
too, performance of models is similar to that of the normal one. Though the trend is not
visible the models appear to misclassify non-npa more than npa cases. In three models
npa misclassification is zero (Table 4.6.2a) which is a very desirable feature as the cost of
misclassifying npa is much more than the cost of misclassifying non-npa cases.
175
Table 4.6.2a : Predictive and Discriminatory Power of Rating Models of Banks
Bank Models F (sig) Adj. R 2 Correct Cross % M isclassif
Classif Classif Non NPA
UCO Bank
a. Existing accounts . ' 5.704(.021) 0.097 82.2% 82.2% 19.5% 0%
b. Existing but New accounts 0,26l(.612) -0.02 47.4% 47.4% 52.4% 52.9%
c. New / Greenfield accounts 9.4! (.007) 0.118 59.4% 59.4% 38.1% 41.9%
United Bank o f India (UBi)
a. Term Loan (more than 100 lacs) 2,77(.106) 0.051 70.6% 70.6% 23.1% 33.3%
b. Working Capital (more than 100 lacs) .018(.895) -0.089 46.2% 38.5% 58.3% 0%
c. Limits less than or equal to 100 lacs 1.61 (.207) 0.005 54.5% 54.5% 44% 47.5%
Canara Bank
a. Trade model 6.29( .023) 0.091 63% 61.1% 39% 30.8%
b. Industrial model 40.86(,000) 0.444 80.4% 78.4% 20% 19%
c. New accounts model 20.39(,000) 0.203 72,7% 72.7% 24.1% 29.2%
Allahabad Bank
a. Existing accounts (25 lacs to 200 lacs) 6.125(.018) 0.109 76.7% 76.7% 25% 0%
b. New Projects (above 25 lacs) 10.54(.002) 0.185 69.8% 67.4% 26.3% 33.3%
Union Bank
a. Limit o f 10 lacs to 1 crore 44.42(.000) 0.261 72.6% 72,6% 27% 28%
Andhra Bank
a, Limit o f 10 lacs to below 100 lacs 14.9K.000) 0.160 70.3% 70.3% 30% 28 6%
b. Limit o f 100 lacs and more 4.426(,041) 0.074 65.9% 63.6% 36.2% 31,8%

a. Model for small loans (20 lacs to 3.5 crores) 37.75(.00Q) 0.502 74.6% 74.6% 27.3% 21.6%
State Bank o f India

a. Trade Model (Below 2 crores) 2.514(.117) 0.02 50.7% 50.7% 50% 48%
b. New CRA (excluding trade & NBFC) 23.59(,000) 0.189 70.4% 70.4% 25.5% 33.3%
Vijaya Bank
a. Limits from 2 lacs to 1 crore 29.5(.000) 0.251 74.7% 73.7% 23.5% 29.6%
Central Bank o f India

a. Limits o f 2 lacs to 1.5 crore 10.979(,001) 0.069 69.9%% 69.9% 35.6% 20.4%
176
The examination of effectiveness of financial and non-fmancial scores reveals an
interesting finding. Financial scores are found to be significant only in four models out of
nineteen models considered whereas the non-fmancial score are found to be significant in
eighteen models out of nineteen models considered (Table 4.6.2b). Further in three out of
four models where the financial scores are significant, the scores appear to give counter
intuitive result with high score leading to high default probability. There may be two
plausible results- 1) the borrower may inflate the financial figures to make the project
more attractive though project is actually not healthy based on non-fmancial
consideration and 2) the financial score itself do not have good predictive value.
Further models are, in general, found to be more effective when financial and
subjective scores are used separately in the model instead o f combining them into overall
scores. For example, five models are found to be ineffective when financial and non-
fmancial scores are combined and the combined scores are entered in the regression as a
single variable (Table 4.6.2a). On the other hand, only one model is found to be
ineffective when financial and non-fmancial scores are separately entered in the
regression (Table 4.6.2b).
Model effectiveness based on AUC and Brier score has been described in the
section 4.5.2 and 4.5.4 respectively and comment on model effectiveness is described in
section 4.7.
4.6.3 Rating Migration

The analysis of the transition matrix is helpful in order to study the stability of the
rating systems. As time passes the risk changes in one of the direction; it either improves
or deteriorates. This shift can be captured by the transition matrix between risk classes.
Such transition matrix is tabulated for each pair of ratings. Within a given period the
transfer frequency can be recorded as a transition rate (%) between classes.
The fewer transitions, i.e., low percentages in the off-diagonal elements of the
matrix, the more stable the rating system. Furthermore, transitions involving jumps of
several notches (for example, a transition from AAA to C) are undesirable. Thus a stable
rating system is one whose rating transitions are concentrated in the vicinity of the main
diagonal elements of the matrix. Another relevant aspect of the transition matrix is the
transition from each rating class to default. In terms of discriminatory power, a better
177
Table 4.6.2b: Effectiveness of Financial & Non-financial scores
Bank Models F (sig) Adj.R* St Beta t
F S F S
UCO Bank
a. Existing accounts 11.29(.000) 0.319 -0.14 0.628 -1.07(0.28) 4.70(.000)
b. Existing but New accounts 5.55(.008) 0.197 -0.18 0.474 -1.23(.224) 3.21 (.003)
c. New / Greenfield accounts 12.I8(.000) 0.262 0.001 0.534 0.005(.996) 4.83(,0Q0)
United Bank of India (UBI)
a. Term Loan (more than i 00 iacs) 6.13(,006) 0,237 -0.03 0.577 -1,85(.073) 3.46(.002)
b. Working Capital (more than 100 lacs) .314(.738) -0.129 -.178 .242 -0.54(.601) ,735(.479)
c. Limits less than or equal to 100 lacs 3.45C035) 0.036 0.007 0.223 0.08{.934) 2.58(.011)
Canara Bank
a. Trade model 10.58 (.000) 0.266 -0.18 0.501 -1.6(,116) 4.25(.000)
b. Industrial model 26,66(,000) 0.507 0.099 0.698 0.97(.337) 6.85(.000)
c. New accounts model li.02(.000) 0,209 0.267 0.297 2.34(.022) 2.61(.011)
Allahabad Bank
a. Existing accounts (25 lacs to 200 lacs) 4.7(.015) 0.150 -0.06 0,440 -0.41 (.679) 3.06(.004)
b. New Projects (above 25 lacs) 7.87(.00i) 0.247 0.083 0.509 0.609(.526) 3.73(,001)
Union Bank
a. Limit of 10 lacs to 1 crore 44.42(,000) 0.426 -0.06 0.655 -0.89(.374) 9.47(.000)
Andhra Bank
a. Limit of 10 lacs to below 100 lacs 12.64(.G00) 0.242 -0.03 0.517 -0.34(.733) 5.01 (.000)
b. Limit of 100 lacs and more 6.Q0(.005) 0.189 0.006 0.478 0.042(,967) 3.21(,003)

a. Model for small loans 53.3(.000) 0.245 -0.07 0.708 -1.09(.276) 10.3(.000)
(20 lacs to 3.5 crores)
State Bank of India
a. Trade Model (Below 2 crores)* 4.731 (.040) 0.056 -0.23 - -2.09(.040) -
b. New CRA (excluding trade & NBFC) 23.7(.0Q0) 0.319 -0.02 0.577 -.305(,761) 6.88(.000)
Vijaya Bank
a. Limits from 2 lacs to 1 crore 16,74{,000) 0.481 0.054 0.508 .607(.545) 5.65(.000)

a. Limits of 2 lacs to 1.5 crore 19,55(,000) 0.216 -0.15 0.438 -2.01 (.046) 5.72(,000)
* Only financial scores
178
rating system is one where the transitions to default rise at an exponential rate, from the
higher rating to the lower rating classes.
Accordingly, zero elements should occur mostly in the upper-right comer
reflecting that the initially high rated counterparts are not downgraded very far or very
often. Likewise transition o f poorly rated counterparts are not in the direction o f better
grades. The transition matrices for the ten banks are presented in Tables 4.6.3a to 4.6.3j.
The transition matrix of PNB shows that there is no heavy concentration in all of
the diagonal cells of the matrix indicating that rating changes abruptly. While 50% of the
AAA rated units changes to the next level , the AA rated units have downgraded very
far. In the case of A rated units few remain in the original position , most of them
improves and relatively few downgrades. Similar is the case for BB rated units. In case of
B rated units, most of them shifted downwards. Interesting observation is seen in case of
C and D where none of the units remain in the original position. Most shifted up in case
of C and all shifted down in case of D rated units. As expected default probability has
increased for the low rated units but gone down monotonically for better rated units.
Overall transition matrix have not shown the result as expected from a good rating
model.
In case of UCO bank model, there is no concentration of frequencies along the
diagonal. Heavy down gradation was noticed in case o f A rated units. In case of B and C
few upgraded and most o f them downgraded. Default probability is found to be more in
case o f B and C rated accounts. However, overall result is not inconsistent with a good
rating model.
In case of Vijaya Bank model, severe transitions were noticed in case of AAA and
B rated units. Here too, default probability has gone up monotonically with the decrease
in the grade.
In case of Central Bank there has been abrupt changes in the position in the
transition matrix with good rated units shifting towards poor grades and low graded units
shifting towards better ratings. The overall result is found to be very disturbing.
The transition analysis shows that the UBI model is least effective amongst
models considered in the study. Apart from lean concentration along the diagonal, many
good rated units downgraded to default category indicating high default probability for
good grades. In fact, the model is showing high default for all the grades.
179
Table 4 * .3a : TRANSITION MATRIX - PUNJAB NATIONAL BANK
AAA AA A BB B C D DEFAULT
AAA 50% 50%
AA 15.7% 42% 21.2% 10.5% 5.3% 5.3%
A 26.3% 21.1% 21.1% 5.2% 26.3%
BB 17.3% 10.3% 10.3% 24.2% 17.2% 20.7%
B 10% 15% 10% 10% 55%
C 16.7% 50% 33.4%
D 100%
Table 44J.3b: TRANSITION MATRIX - UCO BANK

A++ A+ A B+ B C DEFAUL
T
A++ 100%
A* 5.68% 17.6% 29.4% 23.5% 11.76% 11.76%
A 3.44% 6.89% 24.13% 13.79% 17.24% 3.44% 31.03%
B+ 4.17% 12.5% 8.35% 15.5% 60.41%
B 3.85% 15.38% 7.69% 7.69% 11.54% 53.85%
C 5% 95%
Table 4.6.3c: TRANSITION MATRIX - VIJAYA BANK

AA+ AA A B C D DEFAULT
AA+ 80% 20% ’
AA 7.31% 19.51% 34.15% 17.07% 2.44% 19.51%
A 17.39% 17.39% 13.04% 8.69% 43.47%
B 7.14% 7.14% 14.28% 7.14% 64.28%
C
D
Table 46.3d: TRANSITION MATRIX - ANDHRA BANK

A+++ A++ A+ A B C DEFAULT
A+++
A++ 50% 50%
A+ 5.6% 11.1% 16.7% 27.8% 33.3% 5.6%
A 5.3% 10.5% 21.1% 26.3% 15.8% 21.1%
B 4.3% 17.4% 4.3% 21.7% 13.% 39.1%
C 10.5% 10.5% 26.3% 52.6%
Table 4.6.3e: TRANSITION MATRIX - CANARA BANK

III IV V VI VII VIII DEFAULT
III 45.4% 19.5% 5.2% 3.1% 26.8%
IV 17.4% 4.3% 78.3%
V 100% 1
VI
VII
VIII
Table 4.*.3f: TRANSITION MATRIX - CENTRAL BANK
A++ A+ A B+ B C D+ D DEFAULT
A++ 9.5 % 14.2% 23.8% 19% 4.7% 4.7% 4.7% 19%
A+ ■16.6% 25% 16.6% 25% 8.33% 8.3%
A 6.3% 6.3% 18.7% 6.3% 25% 12.5% 25%
B+ 5% 10% 30% 25% 10% 19%
B 7.7% 7.7% 7.7% 76.9%
C+
c 100%
D+ 50% 50%
D 20% 20% 60%
Table 40.3g : TRANSITION MATRIX - UBI

UBO UBI UB2- UBS UB4 UBS DEFAULT
UBO 50% 50%
UBI 25% 25% 25% 25%
UB2 27.3% 9.1% 9.1% 54.5%
UB3 25% 25% 6.3% 43.7%
UB4 8.6% 11.4% 17.1% 17.1% 45.8%
UB5 7.3% 2.4% 9.7% 26.8% 53.8%
Table 4.ff.3h : TRANSITION MATRIX - ALLAHABAD BANK

AB1 AB2 AB3 AB4 AB5 AB6 AB7 AB8 DEFA
ULT
AB1
AB2 28.6% 14.3% 42.9% 14.3%
AB3 10.5% 15.8% 26.3% 10.5% 15.8% 5.3% 15.8%
AB4 4.2% 8.3% 4.2% 12.5% 16.7% 5.4%
AB5 6.7% 13.3% 6.7% 6.7% 6.7%
AB6 50% 25% 25%
AB7
AB8
Table 4.fl.3i: TRANSITION MATRIX - UNION BANK

CR1 CR2 CR3 CR4 CR5 CR6 CR7 CR8 DEFAULT
CR1
CR2
CR3 14,3% 14.3% 42.8% 14.3% 14.3%
CR4 6.6% 13.3% 26.7% 20% 26.7% 6.6%
CR5 16.7% 27.7% 11.1% 11.1% 5.5% 27.9%
CR6 10.3% 10.3% 10.3% 13.8% 6.9% 48.4%
CR7 3.4% 3.4% 10.3% 82.8%
CR8 5.6% 11.1% 83.3%
Table 4 / . 3 j : TRANSITION MATRIX - STATE BANK OF INDIA

SB1 SB2 SB3 SB4 SB5 SB6 SB7 SB8 DEFAULT
SB1
SB2 38.5% 7.7% 15.4% 7.7% 30.7%
SB3 4.2% 16.7% 16.7% 4.2% 58,2%
SB4 3.1% 15.6% 9.4% 3.1% 68.8%
SB5 16.7% 16.7% 66.6%
SB6 100%
181
In the Union Bank model too lean concentrations in the diagonal cells with more
concentration in the upper right comer o f the transition matrix implying that units are
downgraded far from the original position. However, default probability has increased
monotonically as one moves from good grade to poor grade.
In case of SBI model also many good rated units downgraded far to even default
category indicating high default probability for good rated units. Concentration along the
diagonal is thin. Default probability has gone up monotonically with the decrease in
grades.
4.6.4 Monotonicity
This requirement defines the relation between ratings and expected default
frequencies. If two PODs are identical their rating also has to be identical. If the POD of
company X is smaller than that of company Y the rating o f company X has to be as good
as that o f company Y. An analysis of transition matrices show that the monotonicity
property is observed in the case of models of Vijaya bank , Andhra bank , Union Bank
and SBI. The other six banks’ monotonicity is not found in the case of rating of 181
cases.
4.6.5 Complexity
A bank should have as many different rating systems as necessary and as few as
possible. Moreover the reasons for choosing the rating system should be made
transparent. For instance, different rating models for different categories of loans like
term loans, working capital loans or for different activities like trading, manufacturing or
for different industries.
The following table shows the sample bank’s status with regard to the number of
different rating systems in use.
Table 4.6.4: Variations in the Rating Models of Banks
C om plexity uco UBI CAN ALLAH U N ION ANDH PNB SBI VIJ CBI
Facility-w ise nil 2 nil 1 nil 2 nil 2 3 1

(T L / W C )
A ctivity-w ise nil 3 2 5 nil nil nil 2 4 nil
(m fg/trad/serv)
Lim it-w ise (in 3 2 3 2 4 2 4 3 3 2
num ber)
A ccount type 3 nil 1 2 nil 3 1 2 1 nil
(E xisting/ N ew )
Number o f models 9 6 5 9 4 7 4 16 10 2
1S2
The total number of possible models for the above mentioned categories is 72
excluding specific models for a particular industry. Against that the banks so far has
developed relatively less number of models to meet the requirements of different
situations. The cross-sectional analysis o f the effectiveness of the various models and the
number o f models used by the banks does not appear to show any relationship between
effectiveness o f the model and number of models used by the banks. Higher number of
models used by the banks does not lead to better effectiveness of the model. Similarly,
lesser number also does not seem to indicate better quality of the models. For example,
Canara Bank has five models and models are found to be effective. UBI has also six
models and most of them are not found to be effective.
4.6.6 Fineness
’ This requirement is regarding the degree of fineness or the number of categories
or grades that a rating system should have. But the fineness cannot be considered
independently from back-testing. A large number of rating classes will be of no use if,
due to lack of data, back-testing is not possible.
As per the guidelines of RBI (RBI, 2002), the internal credit rating system should
have minimum of six to nine borrower grades for performing loans and a minimum of two
grades for non-performing loans. The internal rating systems of commercial banks in the US
typically have six to ten rating classes (Krahnen & Weber, 2001). Table 4.6.5 presents the
number of rating classes in the in internal rating systems of the surveyed banks. The number
of categories/ grades in the risk rating models of the sample banks varied from six to nine in
case of the non-default category. Interestingly only two banks had defined default classes
and have three classes in this category. Other banks are silent on the default categories/
grades.
Table 4.6.5 : Fineness in Rating Systems of the Sample Banks
Fineness UCO UBI CAN ALLAH UNION ANDH PNB SB! VIJ CBI
Standard 6 6 8 8 8 6 T 8 6 9
Default - 3 - 3 - - - - -
+ three notches in four o f the seven classes
183
4.7 Overall Performance of the Models and comment on
hypothesis
Overall performance of each model under multiple criteria has been commented
upon in Table 4.7 alongwith remarks on weaknesses in the model. As can be seen from
the table, all the models have exhibited poor performance (weaknesses) in at least one
criterion. O f course, the level of weakness varied widely across the models. For example,
seven models (UCO- model for existing accounts, Canara model for trade, Canara model
for industrial accounts, Canara model for new accounts, Allahabad model for existing
accounts, PNB model and Vijaya Bank model) has exhibited low weakness whereas five
models (UBI model for working capital above Rs.lQO lacs, SBI model for trading units,
Central Bank of India model, UCO Bank model for existing but new accounts) have
displayed high to very high presence of weaknesses in the model. Another seven have
displayed low to moderate weakness (Union Bank model for limits of Rs.10 lacs to Rs.l
crore, Andhra Bank model for limits Rs.10 lacs to Rs.l crore, Andhra Bank model for
limits more than Rs.l crore, SBI model for C&I, UCO Bank model for new units,
Allahabad Bank model for new projects and UBI model for term loan above R s.l00 lacs).
This implies that the models need to be improved upon which most of the banks is in fact
doing. Otherwise the model might select few cases which are not viable and intrinsically
sick. Thus the findings tentatively support the hypothesis that presence of weaknesses in
the existing credit appraisal is a major cause o f accounts turning into bad loans. A
proposal may turn into a bad loan either because of poor selection of proposal at the
initial stage or lack of monitoring the same thereafter. As can be seen from chapter 5,
lapses in monitoring is not very high and lapses visible in the Inspection Reports no way
signals the quality of the account and health of the borrowers. Hence proposals turning
into bad loans may be attributed to the existence o f weaknesses in the credit appraisal of
proposals.
4.7 Conclusion
The following conclusions have been drawn:
• Financial parameters are found to be less effective than non-fmancial parameters.
So any attempt to develop models based on financial parameters (which many
researchers are doing for e.g,, Hayden, 2003; Fernandes, 2004) may not lead to
184
Table 4.7 : Overall Performance of the Models based on multiple criteria
Bank Models Scores Parameters A B R M c Fine Comment
U M 0 0 on
R DA LR R DA weakness
C n m
UCO Bank 4 +
a. Existing a/c + +++ *# ++ ++ + 4- 444 + * Low

b. Existing but new ** ** ** 4* + * * + * V. High
accounts
c. New / greenfield + ♦ 4*4* + 4* 4 * + * Moderate
a/c
United B ank of * ++ *
India (UBI)
a.T L >100 lacs * ++ * i i
X H ++ 4 #* ** * Moderate
b.WC > 100 lacs ** ** ** 4-4* 4*4* * +++ ** *
High
c.Limits <= 1001 * * * * + * « ** * V. High
C anara Bank 4 +
a. Trade a/c 4 + ** +•++ ++ + 444 ♦ * Low
b. Industrial a/c +++ +++ ++ 4*4-4' 4*4-4* ++ * * * Low
c. New a/c ++ + ** * *
4 ++ 4*4- 44* Low
Allahabad Bank + +
** 111
a. Existing a/c + X..i-.r
X ++ 4*44* T IT 4*44 4 ♦
Low
(25 lacs to 2 cr.)
+ i i ** *
b. New Projects + ++ + XX 4 + Moderate
(above 25 lacs)
Union Bank
** * *
a. Limit o f 10 lacs to + + ++ 4*4" 4* ++ ++ 4 ++ LtoM
1 crore
A ndhra Bank + +
**
a. 10 lacs - 1 cr. + ++ + ++ 4 44 4 4 L to M
b. > 100 lacs + + + +++ ++ 4 * + 4 L to M
Punjab National * +
Bank
a. Model for small ,^ j j ++ + 4*4" TT ++ 4 4 * Low
loans (20 lacs to
3.5 crores)
State Bank o f India ++ +
a. Trade Model
(Below 2 cr.) * ** ** TT
ii
XT + * * 4 High
b. C&I, SSI, AGL + XX + +++ L 1
XX + * * 4 L to M
Vijaya Bank + 4
a. Limits from 2 lacs ++ ++ * ++ ++ ++ 4 + + Low
to 1 crore
C entral Bank of
India
a.Limits of 2 lacs to + 4*4* ** ++ ++ 4 * * * *
.+ High
1.5 crore
+++; very good + + : good + : fair * : poor ** : very poor

R : regression DA; discriminant analysis L R : logistic regression B : Brier score
R M : Rating migration M on : Monotonicity Com : Complexity Fine: Fineness
L to M : Low to moderate
185
good models to be used for credit appraisal. Banks have already recognized the
need for it and have added more and more non-financial parameters to their
models.
• Only few parameters are sufficient to achieve the desired predictive and
discriminating power o f the model. Large number o f financial and non-financial
have been taken Thus inclusion of more parameters does not necessarily increase
the predictive and discriminatory power. And different situations demand
different parameters to be included in the model.
• Though banks are experimenting with different models and improving the same
yet there are scope for further refinement of their models as most of the models
have failed to deliver the outcomes as expected. Though some of the models are
useful, in most cases either they are poorly predicting the health o f the firm or
misclassifying beyond the expected limit.
• Further in three out of four models where the financial scores are significant, the
scores appear to give counter-intuitive result with high score leading to high
default probability. There may be two plausible results- 1) the borrower may
inflate the financial figures to make the project more attractive though project is
actually not healthy and 2) the financial score itself do not have good predictive
value.
• Further models are, in general, found to be more effective when financial and
subjective scores are used separately in the model instead of combining them into
overall scores.
• The analysis of the transition matrices of the ten banks shows that none of the
banks produce a clearly more attractive transition matrix. Proposals high rated by
most of the banks’ models have downgraded very far even upto the default
category.
• The number of categories/ grades in the risk rating models of the sample banks
varied from six to nine in case o f the non-default category. Interestingly only two
banks had defined default classes and the rest have not defined the same which is
inconsistent with Basel II requirements.
• Overall, bank models have exhibited weaknesses in one or more criteria which
needs to be removed through refinement of the model. Otherwise, models will
continue to make adverse selection turning accounts into bad loans.
186
CO CO in CN N- CN in N. 0)
8 8 3 8 8 8 8 CN 3 CO 3 8 8 8 CM CN 8 8 8
f
4 4 4 4
i 4 - 4 4 4
** significant at £, % * significant at|T %

<r* r
b k b K 5 CO 0-
0 b F» 8 b
4 4 4 4
4 4
cn CO 4“ b
b 1 i CO h- h- h s b b
*« 4
« 4
4
4
4
4
4
S 5 i b £ 1 £ 5 i 1 1 fe b 1
«
• 4
4
4 4
4
4
& h
4—
s b fe 1 k 1 CO 1 8 S b CO
*
* 4
4 4
4
4
4
o PO o
£ r-* b 1 8 CO k h* 1 b b CO £ GO "b
,p
4
4 4
b Co CO * « 4
b CO £ CM
CO N> b CD
h N* CD CO co b b CO b 5
4 « 4
4 4
b Is
O)
CO b s £ CD
ON bCO b
h-
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b
CD b
o
8 N- in
o
r- N*
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4 4
4
4
4
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N- f O)
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in (O b k CO CO b 3 fe b CO is in CO CO b s 1
4 ‘ 4 4
* 4 4 4
4“ 4“
in b CO b 1 b N b i b b b b h» b b b b
4 ' 4
4 4
s b s b k b b CD b b
N
b s 3 b b
■w
8 b
4 4 4
h hi 4 4 i. 4
b *8 w in 8 b b b I s & £ b eo b b b k <0 b
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4
b b
4
s 1 b 1
b 4“
h* in
4
b b b
bins
4
t co n
4 N 4 4* N 4
4
Note: Numbers in the body indicate the parametens(nos.) with which the particular parameter is correlated
4 4
4“ 4-
1 1 in b b b b b b b 1 b I b CO co i in b &
4 N 4 4 4
N 4
4 4 4 4 4 * 4
o> in cn CO b r- b cn
b 8 in in b in in in in b in (0 co b b b in b 8 8 N
** rt 4 4 4
N
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4-
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4
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4
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t
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4 4 4 ’ 4 "
30"
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b b b 1 s:
GO k b t h b b in b b b i b b b in b b b b
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00
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4
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h- ?M h» b in
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Experience
ii
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37
a
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9
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ft! CO h- 00 CO i CO k CD
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CO ft k in CO K T* ■4— fti
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9
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k 1 k 1 CO tZ i h co b k & £ £ fe ft
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9 9
9
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9
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* N * N « 4«>’ «« 9
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•
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«
5 b ii
$ 5 8 Is £ h> £ Is £ 1 k I h- £ 1 k h in £
N « 4*1 4*1 N 4t
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Note: Numbers in the body indicate the parameters(nos.) with which the particular parameter is correlated
T — 4“
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$ 1 1 to k I 1 in 1 1 k k s 1 k co CD i u> k h-
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43“
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4— N T*
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9
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9
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tb CO 8
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|37 Experience
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8 CO 9 5 9 § 9 $ § 8 § 8 £ tn 8 3 8 8 £
32|
CM CO *** tr r- o> Mr GO 0 CO CO M- 0 ID <0 CO
8 8 8 8 8 § 8 8 CO
!
«
*
Q%
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GO fe is i fe fe fe
* 0 «
significant at h % * significant at
CO b c~
r-- CO 1 co 1 fe fe
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CO £ fe fe CD CO 5 s
«
*
t
r~ o
co r*- £ fe fe h fe fe
♦
*
CM CM CO
fe CO CO CO CO h- f:
« 0 00 «
«
«
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1 8 fe lb fe l fe 8 fe
* «
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1 CO 1 fe CO ID ID fe fe i
* «* 0 *
« •
1 fe 1 is £ 8 b fe fe £
62 * .4
0 * TT
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V' Tf
* *' N
«
£ CD fe 1 fe fe fe fe fe
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N-
£ fe fe fe CO h fe s is 8
00
60*2
• * *’
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ID £
bID CM r^.
(0 1 ID 10 fe
N « *’
Note: Numbers in the body indicate the parameters(nos.) with which the particular parameter is correlated
*
& fe 1 1 b 55 55 is fe fe
00
Is *8 i fe CO 1? fe i b ii
*‘ N 0 ' 0 *
i! •*
b T~
ID fe h Is 8 fe fe fe ID 55
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0
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1
|
|
|
I
|
|
|
|
|
|
|
|69 ReiiabHlty of fin Statmt
1 75 Margin on Term Loan
| 9 0 Track rec. of supplier

|T3 Loans and advances
(92 Compl environ regul

87 Distribution network
I?1 Overall a/c conduct
1 77 Liquidity of security
|78 Avail. Of guarantee

|70 Cheques Returned
|93 Industry prospects

|d1 Capacity utilisation
1
1 76 Security coverage
|86 Spread of market
E
|68 Operations in a/c
|67 Diversion of fund
c
(68 Export Potential
|72Mgt of creditors
[85 Product Quality
j f
| 8 3 Infrastructure
|74 Tenor of loan
18 9 Import Policy
a <
5 ? C l
0 I
IS g*
|84 Location
5
0 1
1 c "1
3
1
-
i
1 8s
cc c
5 I O 1
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3 8 r-H 00 CO c5 a
1

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CHAPTER 4

Effectiveness on Credit Appraisal

Effectiveness Of Credit Appraisal And Internal Rating

4.3 Features of New Internal Risk Rating Models of Ten

4.3.1 Parameters/ Variables

Box 1: Financial Parameters

B. N on-fm ancial R isk a n d its M e asu re m e n t

78 pertains to facility risk factors; 79 to 94 pertains to business/ industry risk factors

Shareholding of Promoters - This parameter reflects the borrower’s commitment and

Industry/ Business Parameters

Box 3: Industry / Business Parameters

4.3.2 Scales and Weights Assigned to the Factors / Categories of Factors

CM cst •o- CO CM CM CM CO CM O'

[M arg in o n term loan

58 [S e rvo f instate intt

Weights assigned tothe group of Financial and Non-Financial Parameters/ Factors

4.4 Effectiveness of Parameters/ Variables as Default

S 90% 80% <=60% to <=50%

ANDH S | > 95% 91%-95% 81%-90% 71%-80% 61%-70%

%£9=< >= 50% >= 35% >=25% <25%

85% <= 70% <= 60% <=45%

4.4.1 Effectiveness of Parameters under Different Categories of Loans

F= 19.02(.000); Durbin-Watson = 1.495. R=.88 1 R2= 775 ; Adj.Ri= .735

Table 4.4.1.1b : Regression output with Financial parameters only

Constant 5.33 .000

Table 4.4.1.1c : Regression output with Non-financial parameters

F= 18.591 (.000); Durbin-Watson= 1.34 ;R= .733 ; R = .538 ; Adj.R2= .509

Classification Table 4.4.1.le: Combined Output Classification Table 4.4.1.If: Comb.+Fin+Non-fin.

Com.+F+NF npa non Tot.

validated 1 23.1 76.9 validated 1 30.8 69.2 100

Fin. Output npa non Tot.

F = 24.04C.000); D-W = 1.941 ; R = .953; R2= .908; Adjusted Rl = .870

Table 4.4.1..2b: Regression Output with Financial Parameters

F = 9.23C.000); D-W = .863 ; R = .535; R'= .287 ; Adjusted R" = .256

Table 4.4.1.2c : Regression Output with Non-financial Parameters

Classification Table 4.4.1.2e:Com.+fin.+non-fin. Classification' fable 4.4.1.2f:1 ;in.

Classification Table 4.4.1.2g: Combined Output Parameters

Combined Out. NPA Non Tot.

T a b le 4 .4 .1 ,3 a : R e g r e s s io n O u tp u t w ith b o th fin a n c ia l & n o n -fin a n c ia l p a ra m e te rs

C o rre c t c la s s ific a tio n ^ 8 6 .5 %

F = 23.69f.000); D-W = 2.039; R = .952; R2= .906; Adjustec R' = .861

Table 4.4.1.4b : Regression Output with Financial parameters

F = 8.67(.000); D-W =1.12 ; R = .f122; R '= .675; Adjusted R" = .598

PBDIT/TNW+LT & ST Borrow.

-4,140 .000 .433

TOL/TNW .947 2.978 .006 .495

Table 4.4.1.5a : Regression Output with both financial & non-financial

F = 14.3K.000); D-W = 1.85; R = .905; R2= .819; Adjusted R2 = .762

Table 4.4.1.5b : Regression Output with Financial parameters

F = 5.901 (.002); D-W = .845 ; R = .727; R - .529; Adjusted R1= .439

Table 4.4.1.5c : Regression Output with non-financial parameters

F = 16.44f.000); D-W = 1.549 ; R = .767; R2= .588; Adjusted R2 = .553

Combined NPA Non Tot. All Financials NPA Non Tot.

F= 17.64 (.000); Durbin-Watson= 1.788 ; R=%884 ; R2=.781 ; Adj.R2= .737

Table 4.4.1.6b: Regression output with Financial parameters only

F= 3.79 (.000); Durbin-Watson = .21n ; R= .27; R2=.07; Ad .R2= .056

Table 4.4.1.6 d : Discriminant output

Combined Output Parameters Combined +Fin, Output Para.

Combined Default Non-default Total Com(F)+Fin, Default Non-default Total

Table 4.4.1.7a : Regression Output with Financial parameters

Table 4.4.1.7e : Discriminant Output

Subj. Output + Fin. Out put Financial Parameters Combined +Fin+Subj

Non-Fin + Fin. NPA Non Tot. Financials NPA Non Tot.