Bank Credit Opportunities and Challenges (India)

Background:-
Basic characteristic of banking business is; accepting money from depositors and lending it to the borrowers. Hence banking is a risky
business exposed to credit default.
Risk taking ability works as an engine of growth for banks, where better the diversification safer will be the bank. Like in India we have
largely safe and sound Banking environment, where most of the banks are excelling in retail model of business from earlier corporate lending,
where focus was on a few large corporate.
Considering the recent developments in Cypriot Banking sector, the argument of sticking to traditional form of banking (Taking deposits and
Lending) to be the right way in banking than to invest, borrowed money in bonds and other assets even backed by sovereign countries is back
on table thus highlighting the importance of credit business in Banking.
It is the success of credit portfolio which enables the bank to ideally borrow more and more from public as deposits to be deployed in loan
book to show growth in size and profits, which in turn attracts investors and capital.
Basics of credit business:-
Initially banks lend money as well as took money from only those customers who were known to the bank. As the banking system grew to its
present form the process got institutionalized and today we have KYC or know your customer as a regulator driven mandate while opening
any type of relationship for any type of customers.
Knowing the customer has always been important to know the repayment capacity of borrower as well his track record on willingness to
repay and on depositors side it was to know about the source of funds; genuine or illegal.
General practice of Bankers while processing a loan applicant:-
Analyzing the 5 Cs of Credit
Every banker goes through 5 aspects of an applicant of a loan, before making his final decision.
Lets understand these Cs.
1. Capacity
Capacity to repay the loan. Capacity of the applicant will be judged from his existing/ projected future income and expenditure statement.
Capacity also includes analysis of applicants credit history.
2. Collateral
Collateral refers to forms of security provided by customer to the bank. Collateral may be buildings/land/stocks etc owned by the customer. It
can also include guarantee by a third party committing repayment of loan in case of default by the applicant.
3. Capital
Capital brought by the owner to the project, it may be his own funds or borrowed from friends and relatives etc. Bank will analyze the
quantity and quality of capital offered.
4. Conditions
Condition means, the overall economic climate and external factors affecting the business/ performance of the loan.
Secondly it refers to the purpose of the loan. Purpose should be clear and should not be vague, suggesting diversion of funds.
5. Character
Character of the applicant is a subjective judgment and applicants education, exposure, presentation, references, family back ground all
matters here.
Now 5Cs scope will change according to the profile of the customer from retail to smes to large corporate. But essentially 5C analysis enables
the bank in knowing/ making a judgment on the applicant with respect to his capacity & willingness to repay the loan.
Various tools available for banks to know the applicant/customer:-
KYC Definition by Reserve Bank of India
KYC is an acronym for Know your Customer, a term used for customer identification process. It involves making reasonable efforts to
determine true identity and beneficial ownership of accounts, source of funds, the nature of customers business, reasonableness of
operations in the account in relation to the customers business, etc which in turn helps the banks to manage their risks prudently. The
objective of the KYC guidelines is to prevent banks being used, intentionally or unintentionally by criminal elements for money laundering.
KYC has two components - Identity and Address. While identity remains the same, the address may change and hence the banks are required
to periodically update their records.
Thus KYC requirements ensure the proof on individuals identity and his address proof ensures about his whereabouts or existence.
Once Customers identity and address is verified and satisfied, next information required is his willingness & capacity to repay the loans.
In India we have Credit Information Companies set up, providing the necessary information on loan applicants from across the country, lets
discuss.
Credit Information Companies
A working group constituted by RBI under the chairmanship of N H Siddiqui, recommended setting up a company by the name of CIBIL,
promoted by SBI in collaboration with HDFC and two foreign technology partners in 2001 to act as the first credit information company in
India.
CIBIL since then is Indias pioneer credit information company. It creates immense value for financial institutions by providing objective
data and tools to help them manage risk, and devise appropriate lending strategies thus reducing cost and maximizing portfolio profitability.
CIBIL benefits both credit grantors and consumers by collecting, analyzing, and delivering information on credit histories of millions of
borrowers. It provides its members with information on both consumer and commercial borrowers, thus enabling them make sound credit
decisions across both individuals and businesses.
Banks are able to know the credit history of borrower, his credit exposure, repayment habits, essentially helps Banks in identifying the
customers track record or credit behavior.
Present Indian banking scenario and opportunities on credit business:-
India has one of the most, well regulated and sound Banking sector in the world. Our banks are well capitalized with low levels of NPAs
(1.28% as of 2011-12, RBI Data).
But while being sound and secure, if we analyze Indias % of domestic credit to private sector as a % of GDP was pretty low at 50.6% (2011,
World Bank Report), compare to the 100% + ratio of major economies like US /UK/Germany and China, thus highlighting a major gap and
opportunity for Indian banks.
In India our banking system is fairly matured when it comes to lending to Corporate, SMEs and Consumer/ Retail loans and majority of
customers comes with good past track records and good professional/ salaried backgrounds, hence the 50% we discussed earlier comes under
the existing loan book where Banks have excelled in credit delivery and management and the real challenge lies ahead in tapping in to the
remaining 50% or more potential who are yet to be banked profitably.
Lending in small towns, unbanked centers is still considered a risky business by big players and mostly serviced by small regional banks,
which have been successful purely based on KYC principle.
Ways and means to improve credit business portfolio to more than 100% to GDP:-
Identifying and encouraging the entrepreneurships
Entrepreneurship culture is pre requisite to increased business activity. In India unfortunately barring a few communities like Gujaratis ,
Marwaris etc , not many communities have rich entrepreneurship culture , which meant many opportunities available around are not
exploited by want of knowledge and experience or background.
But it does not mean, it is a taboo, as many entrepreneurs from other communities have made it big at national and international level.
Hence if there is a focus on building entrepreneurships amongst larger public, there can be a business boom in our country, providing more
and more opportunities for banks to deploy their funds effectively.
Banks for a start can look to replicate their success in loan melas on consumer loans (Home/Car etc), where Banks gets both Builders /
Dealers to the table along with interested applicants. Same model can be replicated between Industrial houses / forums, Government
Agencies and Interested applicants.
Modalities needs to be worked out, as unlike consumer loans here the industrial houses / forums are the buyers of various products and
services presented by the applicants, many of which might be covered under various government schemes for concessions, promotions etc
and Banks role is to provide loan to the applicants based on his order book.
Banks needs to attract and involve Universities, Management and Engineering Colleges and even Medical Colleges, where there have many
instances of students/doctors developing medical equipments, now sold by companies like Johnson & Johnson.
The model if developed effectively as a channel to deliver credit growth and thus development can effect a remarkable improvement in the
overall economy along with banking.
Some banks may be already practicing the model, but success will come when the model is picked up by the giants and small alike and spread
it to the nooks and corner of country.
Changing the engagement method
Under the conventional banking method, Loan customers relationship with the Bank is that of a debtor owning money to the bank.
Loans risk is completely owned by the loan customer from the time loan amount is debited in his account.
Under Islamic Banking, there is a different concept, where risk is shared equally by Bank and the customer; in India we dont have Islamic
Banking systems in practice but government agencies like CGTMSE (credit Guarantee Corporation for micro and small enterprises) shares
the risk on a fee.
When we are discussing about increasing the credit volumes by more than 50% by active engagement and identification of entrepreneurships,
it wont be a bad idea to try out the concept of risk sharing by banks not in terms of material risk but performance risk. This will be an
internal mechanism, nothing to do with the customer on letter but spirit.
Banks has Credit sourcing , processing and recovery /NPA management channels implemented successfully over the years but till now there
is no channel which will act as a cure and not prevention for loss accounts.
Thats where a Loan Performance Ownership Channel will add to the existing channels in making the credit management process robust
along with targeted higher growth.
Loan Performance Ownership Channel:-
Key attribute to the channel will Relationship management /Knowledge support /Handholding the customer throughout the period of loan so
as to ensure the performance of the loan.
Relationship Management:-
It is practiced even now, but we know many a times RMs either looks to cross sell few products or do a courier service between customer
requests and banks demands.
But under LPOC, relationship managers should be assigned to a LPOC Manager, who needs to have complete access to the customers
business by way of agreement to start with.
Who will act as a link between customer and knowledge support help facilitated by the bank.
Knowledge support:-
Knowledge support help involves Technical / Managerial / Marketing & Sales and Legal and Tax experts services on behalf of the banks to
the customer.
Customer being small and inexperienced will be benefited with such services available to him at every stage of business, referred by his
banker. This may become a major differentiator to the performance of loans.
Hand Holding:-
LPOC Manager should be experienced and knowledgeable to identify the areas of help needed by customers and refer them to the right
services. LPOC Manager should visit the customers to understand the performance of business, difficulties and guide them to respective
knowledge support helps.
LPOC model, modalities and process have to be worked out by banks as per their respective business models and success of such a model will
have huge bearing on banks reputation and future business prospects.
Banks will be not merely known for their ability to process loan faster or service customer faster and adequately but also for guidance and
support, which will be a big business differentiator amongst Banks.
Conclusion:-
Thus Credit- Business remains the most critical aspect of banking business and those banks that are able to increase their credit portfolio
without deteriorating its quality by innovative methods will lead the banking space in the coming years. Challenge will be in identifying the
opportunities and handholding the opportunities by innovative ideas.