2010

A Grand Project Report on Credit Risk Management at State Bank of Mysore

Chapter 1

Research Methodology

1.1) Introduction to Credit Risk Management

Credit risk "is the risk to a bank's earnings or capital base arising from a borrower's failure to meet the terms of any contractual or other agreement it has with the bank. Credit risk arises from all activities where success depends on counterparty, issuer or borrower performance". Credit appraisal means an investigation/assessment done by the bank before providing any loans & advances/project finance & also checks the commercial, financial & industrial viability of the project proposed its funding pattern & further checks the primary & collateral security cover available for recovery of such funds.

1.2) Objectives of the Study

The main objective of the study is, to evaluate the Credit Appraisal system & Risk Assessment Model for effective credit risk management.

Sub-Objectives: To understand the commercial, financial & technical viability of the proposal proposed & it's funding pattern. To understand the pattern for primary & collateral security cover available for recovery of such funds and management of credit risk.

1.3) Research Design 1.4) Sources of Data

It is a descriptive research. Primary Data: Information collected from the Credit Appraisal Officer of Bank as well as informal interviews with Assistant General Manager and Assistance Manager.

Page 1 Research Methodology Secondary Data: Details regarding the Live Cases of applicant companies which are provided by the Bank

 E-circulars of Bank Books Library research Websites

1.5) Expected contribution of the study

This study will help in understanding the credit Risk Management system at SBM& to understand how to reduce various risk parameters, which are broadly categorized into financial risk, business risk, industrial risk & management risk, associated in providing any loans or advances or project finance.

1.6) Beneficiaries of the Study

Researcher This report will help researcher in improving knowledge about the credit appraisal system and to have practical exposure of the credit appraisal scenario in bank. Management Student The project will help the management student to know the patterns of credit appraisal in bank. Bank The project will help bank in reducing the credit risk parameters. It will also help to reduce risk associated in providing any loans & advances or project finance in future and to overcome the loopholes.

1.7) Limitations

As the credit risk management is one of the crucial areas for any bank, some of the technicalities are not revealed which might cause destruction to the information and our exploration of the problem. Credit appraisal system includes various types of detail studies for different areas of analysis, but due to time constraint, our analysis will be of limited areas only.

Page 2 Credit Risk Management at SBM

2 Introduction to Banking Sector

Chapter
2.1) History of Banking in India
Without a sound and effective banking system in India it cannot have a healthy economy. The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factors. The word bank is derived from the Italian banca, which is derived from German and means bench. The terms bankrupt and broke are similarly derived from bancarotta, which refers

to an out of business bank, having its bench physically broken. Moneylenders in Northern Italy originally did business in open areas, or big open rooms, with each lender working from his own bench or table. Banking in India originated in the first decade of 18th century with The General Bank of India coming into existence in 1786. This was followed by Bank of Hindustan. Both these banks are now defunct. The oldest bank in existence in India is the State Bank of India being established as "The Bank of Bengal" in Calcutta in June 1806. A couple of decades later, foreign banks like Credit Lyonnais started their Calcutta operations in the 1850s. At that point of time, Calcutta was the most active trading port, mainly due to the trade of the British Empire, and due to which banking activity took roots there and prospered. The first fully Indian owned bank was the Allahabad Bank, which was established in 1865. By the 1900s, the market expanded with the establishment of banks such as Punjab National Bank, in 1895 in Lahore and Bank of India, in 1906, in Mumbai - both of which were founded under private ownership. The Reserve Bank of India formally took on the responsibility of regulating the Indian banking sector from 1935. After India's independence in 1947, the Reserve Bank was nationalized and given broader powers. For the past three decades India's banking system has several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. This is one of the main reasons of India's growth process.

Page 3 Introduction to Banking Sector The government's regular policy for Indian bank since 1969 has paid rich dividends with the nationalization of 14 major private banks of India. Not long ago, an account holder had to wait for hours at the bank counters for getting a draft or for withdrawing his own money. Today, he has a choice. Gone are days when the most efficient bank transferred money from one branch to other in two days. Now it is simple as instant messaging or dials a pizza. Money has become the order of the day. The first bank in India, though conservative, was established in 1786. From 1786 till today, the journey of Indian Banking System can be segregated into three distinct phases. They are as mentioned below: Early phase from 1786 to 1969 of Indian Banks Nationalization of Indian Banks and up to 1991 prior to Indian banking sector

Reforms New phase of Indian Banking System with the advent of Indian Financial & Banking Sector Reforms after 1991 Scenario of Bank as per Phase I, Phase II and Phase III Phase I The General Bank of India was set up in the year 1786 followed by Bank of Hindustan and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank of India was established which started as private shareholders banks, mostly Europeans shareholders. In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. The Reserve Bank of India which is the Central Bank was created in 1935 by passing Reserve Bank of India Act, 1934 which was followed up with the Banking Regulations in 1949. These acts bestowed Reserve Bank of India (RBI) with wide ranging powers for licensing, supervision and control of banks. Considering the proliferation of weak banks, RBI compulsorily merged many of them with stronger banks in 1969. During the first phase the growth was very slow and banks also experienced periodic

Page 4 Credit Risk Management at SBM failures between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers for the supervision of banking in India as the Central Banking Authority. During those day public has lesser confidence in the banks. As an aftermath deposit mobilization was slow. Abreast of it the savings bank facility provided by the Postal department was comparatively safer. Moreover, funds were largely given to traders. Phase II Government took major steps in this Indian Banking Sector Reform after independence. In 1955, it nationalized Imperial Bank of India with extensive banking facilities on a large scale especially in rural and semi-urban areas. It formed State Bank of India to act as the principal agent of RBI and to handle banking transactions of the Union and State Governments all over the country.

Seven banks forming subsidiary of State Bank of India was nationalized in 1960 on 19th July, 1969, major process of nationalization was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country were nationalized. Second phase of nationalization Indian Banking Sector Reform was carried out in 1980 with seven more banks. This step brought 80% of the banking segment in India under Government ownership. The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country: 1949: Enactment of Banking Regulation Act. 1955: Nationalization of State Bank of India. 1959: Nationalization of SBI subsidiaries. 1961: Insurance cover extended to deposits.

Page 5 Introduction to Banking Sector 1969: Nationalization of 14 major banks. 1971: Creation of credit guarantee corporation. 1975: Creation of regional rural banks. 1980: Nationalization of seven banks with deposits over 200 crore. After the nationalization of banks, the branches of the public sector bank India rose to approximately 800% in deposits and advances took a huge jump by 11,000%. Banking in the sunshine of Government ownership gave the public implicit faith and immense confidence about the sustainability of these institutions. Phase III This phase has introduced many more products and facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberalization of banking practices. The country is flooded with foreign banks and their ATM stations. Efforts are being put to give a satisfactory service to customers. Phone banking and net banking is introduced. The entire system became more convenient and swift. Time is given more importance than money. The financial system of India has shown a great deal of resilience. It is sheltered from any crisis triggered by any external macroeconomics shock as other East Asian Countries suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital account is not yet fully convertible, and banks and their customers have limited foreign exchange exposure. Page 6 Credit Risk Management at SBM

2.2) Reserve Bank of India (RBI)

The central bank of the country is the Reserve Bank of India (RBI). It was established

in April 1935 with a share capital of Rs. 5 crore on the basis of the recommendations of the Hilton Young Commission. The share capital was divided into shares of Rs. 100 each fully paid which was entirely owned by private shareholders in the beginning. The Government held shares of nominal value of Rs. 2,20,000. Reserve Bank of India was nationalized in the year 1949. The general superintendence and direction of the Bank is entrusted to Central Board of Directors of 20 members, the Governor and four Deputy Governors, one Government official from the Ministry of Finance, ten nominated Directors by the Government to give representation to important elements in the economic life of the country, and four nominated Directors by the Central Government to represent the four local Boards with the headquarters at Mumbai, Kolkata, Chennai and New Delhi. Local Boards consist of five members each Central Government appointed for a term of four years to represent territorial and economic interests and the interests of co-operative and indigenous banks. The Reserve Bank of India Act, 1934 was commenced on April 1, 1935. The Act, 1934 (II of 1934) provides the statutory basis of the functioning of the Bank. The Bank was constituted for the need of following: To regulate the issue of banknotes To maintain reserves with a view to securing monetary stability and

To operate the credit and currency system of the country to its advantage

Page 7

Banking structure
Page 8 Credit Risk Management at SBM

2.3) Types of banks

2.3.1) Scheduled Banks Scheduled banks are those banks that come under the purview of the second schedule of Reserve Bank of India act 1934. The banks that are included under this schedule are those that satisfy the criteria laid down vide section 42(6) of the act. 1) The bank is dealing in banking business in India only. 2) The paid up capital and total funds of the bank should not be less than five lacs. 3) It should convince RBI that its activities would not be against the interest of the investors. 4) The bank must be: State co-operative bank, or A company according to the definition of the companies act 1956, or An institution notified by the central government, or A corporation or a company incorporated by or under any law in force in any place outside India. Thus, Indian Commercial Banks, Foreign commercial banks, and state cooperative banks fulfilling the above conditions are considered as scheduled banks. Moreover under

the RBI Act section 42, the central Government has declared the following banks as scheduled banks. i. ii. iii. State bank of India and its 7 subsidiary banks, 20 Nationalized banks, and Urban banks In June 1980 there were 149 scheduled banks which included i. ii. iii. iv. Public Sector banks Private sector banks Foreign exchange banks and State cooperative banks. A bank which wants to register its name as scheduled bank has apply to the central government. On receiving such applications, the central government orders RBI to

Page 9 Introduction to Banking Sector investigate Banks accounts. If RBI gives favorable reports, the central government sanctions its proposal, and the bank is listed under schedule annexure II and is considered as a scheduled bank. Some co-operative banks come under the category of scheduled commercial banks though not all cooperative banks. # PUBLIC SECTOR BANKS Public sector banks are those in which the government of India or the RBI is a majority shareholder. These banks include the State Bank of India (SBI) and its subsidiaries, other nationalized banks, and regional rural banks (RRBs). Over 70% of the aggregate branches in India are those of the public sector banks. Some of the leading banks in this segment include Allahabad Bank, Canara Bank, Bank Of Maharashtra, Central Bank Of India, Indian overseas bank, state bank of India, State bank of Patiala, state bank of Bikaner and Jaipur, state bank of Travancore, bank of Baroda, Bank of India, oriental bank of commerce, UCO Bank, Union Bank of India, Dena Bank and corporation Bank. # PRIVATE SECTOR BANKS Private Banks are essentially comprised of 2 types: Old banks The old private sector banks comprise those, which were operating before banking nationalization act was passed in 1969. On account of their small size, and regional operations, these banks were not nationalized these banks face intense rivalry from the new private banks and the foreign banks. The banks that are included in this

segment include: Bank Of Madura ltd.(now a part of ICICI bank), Bharat overseas bank ltd., Bank of Rajasthan, Karnataka bank ltd., Lord Krishna bank ltd., the Catholic Syrian bank ltd., the Dhanlakshmi bank ltd., the federal bank ltd., the Jammu & Kashmir bank ltd., The KarurVyasya bank ltd., The Lakshmi Vilas bank ltd., The Nedungadi Bank ltd. and Vysya Bank.

Page 10 Credit Risk Management at SBM New banks The new private sector banks were established when the banking regulation act was amended in 1993. Financial institutions promoted several of these banks. After the initial licenses, The RBI has granted no more licenses. These banks are gearing up to face the foreign banks by focusing on service and technology. Currently, these banks are on an expansion spree, spreading into semi-urban areas and satellite towns. The leading banks that are included in this segment includes bank of Punjab ltd., Centurion Bank ltd., HDFC Bank ltd., ICICI Bank corporation ltd., CITI Bank ltd., IndusInd Bank ltd. And UTI bank ltd. # Co-operative banks Co-operative banks act as substitutes for money lenders, and offer timely and adequate short-term and long-term institutional credit at reasonable rates of interest. Cooperative banks are relatively similar in terms of functions to the other banks except for the following: a) They are organized and managed on the principle of co-operation, self-health, and mutual health. b) They operate under the rule of One member, one vote. c) Operate on No profit, no loss basis. d) Co-operative bank conducts all the main banking functions of the deposit mobilization, supply of credit and provision of remittance facility. Co-operative Banks offer limited banking products and are functionally specialists in agriculture- related products, and even in providing housing loans of late. Urban co-operative banks offer working capital loans and term loan as well. e) Co-operative banks primarily operate in the agriculture and rural sector. However, UCBs, SCBs, and CCBs function in the semi urban, urban, and metropolitan areas too. f) Co-operative banks are probably the first government sponsored, governmentsupported, and government- subsidized financial agency in India. They get financial and other aid from the reserve bank of India NABARD, central governments and state governments. They are the Most favored banking sector with risk of nationalization. g) Co-operative banks normally concentrate on High revenue niche retail segments. Page 11 Introduction to Banking Sector

Development Banks Development banks are primarily intended to encourage industrial development by providing adequate flow of funds to industrial projects. In other words, these institutions undertake the responsibility of aiding all- round development in the countrys economy by promoting new industrial projects, and providing financial assistance for the expansion, diversification, and up gradation of the existing units. Development banks may be classified as all India developments banks and regional development banks. While all India development banks include industrial development banks of India and industrial finance corporation of India, examples of regional development banks include state finance corporation and state industrial development corporation.

2.3.2) Non-scheduled banks: The banks, which are not included in the second schedule of RBI act, 1934, are known as non-scheduled banks. Such banks total share capital is less than 5 lacs. These banks are not governed according to the RBI act and they receive no benefits from the RBI. These banks have no place in the list of recognized banks of the RBI. These banks are not much trusted by the people and they do not get handsome deposits. Since 1951 the numbers of such banks have been gradually decreasing. In 1979 there were only 5 non-scheduled banks. Generally now days we found many co-operative banks which are belongs to the nonscheduled co-operative banks. Following are the types of non-scheduled banks they are work like the schedule banks but here the difference in it status and it not having the status of the scheduled banks. a. Deposits bank b. Co-operative banks c. Central banks d. Exchange banks e. Investment or industrial banks f. Land development banks g. Savings banks a) Deposits banks: Generally, banks which provide short-term loans to business and industrial units and which mobilize savings of people as deposits are called deposit banks. Deposit banks accept deposits from people, and provide short-term advances. They provide over draft and cash Page 12 Credit Risk Management at SBM credit facilities to merchants. To meet long-term requirement of industrial units is not possible for these banks. They accept 3 types of deposits saving bank deposits, fix deposits and current account deposits. They accept these deposits which are payable on

demand or on short notice, and provide funds to trading and commercial units for short durations. b) Cooperative Banks Cooperative banks meet the short-term financial needs of farmers. Agriculturists, Petty farmers and artisans organized themselves on cooperative principles and form cooperative societies and banks. Cooperative banks raise funds through various means, besides receiving all kinds of deposits to make them available as lendable funds to its members. In India developed cooperative banks supply finance for agriculture and non-agriculture activities. c) Central Banks A central bank is a special institution which controls and regulatesthe entire banking structure of country. It also strives to maintain monetary stability of the country. Central bank is also known as the Apex bank of the country. Since it functions in the best interest of the country and making profits is unknown to it, it is entrusted the right it issue currency notes. No other bank is allowed this right. It operates in close cooperation with the government of implementing economic policies, thereby promoting economic development. d) Exchange Banks: There is a difference in financing of foreign trade and financing of internal trade. Generally a person carrying on international trade requires foreign currencies to meet this obligation. It is here that exchange banks play the role of financing the dealer for setting transactions involved in foreign trade, there are specialized banks for exchange business. In India, there is an export-import bank (EXIM). e) Investment or industrial banks: Investment banks provide long-term credit to industries. They raise their funds by way of share capital, debentures, and long-term deposits from the public. They also raise fund by the issue of bonds for business operations and government agencies. Usually they underwrite fresh issue of shares and debentures of companies. Such banks also buy the

Page 13 Introduction to Banking Sector entire issue of new securities of public limited companies and try to get them subscribed at a higher price by the public. f) Land Development Banks: Land development banks were earlier known as land mortgage banks. In India, there is limited number of such banks. There are special institutions providing long-term loans to agricultures and farmers. They provide loans on security of land and other immovable properties. They supply long-term funds for periods exceeding 6 years. Agriculturists

and farmers need such funds for making permanent improvements to land and for buying farming machinery and equipment. g) Savings Banks: Saving banks are specialized institutions, which encourage general public to save something from their earnings. In other words such banks pool the small savings of middle and lower income sections of society. They are the banks in the true sense of the term and their main aim is to promote and collect of the public. Not only the depositors are given interest, but also they are allowed to withdraw in times of need. The numbers of withdrawal are, however, restricted. Separate saving banks are organized in various nations. The government can also run a savings bank. In India the postal department runs the postal saving bank allover the country. It is very popular in rural areas where no branches of established commercial bank operate. In urban areas, commercial bank handles savings business.

2.4) Opportunities and Challenges for Players

The bar for what it means to be a successful player in the sector has been raised. Four challenges must be addressed before success can be achieved. First, the market is seeing discontinuous growth driven by new products and services that include opportunities in credit cards, consumer finance and wealth management on the retail side, and in feebased income and investment banking on the wholesale banking side. These require new skills in sales & marketing, credit and operations. Second, banks will no longer enjoy windfall treasury gains that the decade-long secular decline in interest rates provided. This will expose the weaker banks. Third, with increased interest in India, competition from foreign banks will only intensify. Fourth, given the demographic shifts

Page 14 Credit Risk Management at SBM resulting from changes in age profile and household income, consumers will increasingly demand enhanced institutional capabilities and service levels from banks.

2.5) Current trend in banking

Currently (2009), banking in India is generally fairly mature in terms of supply, product range and reach-even though reach in rural India still remains a challenge for the private sector and foreign banks. In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region. The Reserve Bank of India is an autonomous body, with minimal pressure from the government. The stated policy of the Bank on the Indian

Rupee is to manage volatility but without any fixed exchange rate-and this has mostly been true. With the growth in the Indian economy expected to be strong for quite some timeespecially in its services sector-the demand for banking services, especially retail banking, mortgages and investment services are expected to be strong. One may also expect M&As, takeovers, and asset sales. Currently, India has 88 scheduled commercial banks (SCBs) - 28 public sector banks (that is with the Government of India holding a stake), 29 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 31 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs. According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75 percent of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively.

Page 15 Industry Analysis

Chapter3

Industry Analysis
3.1) Competitive Forces Model (Porters Five-Force model)
Prof. Michael Porters competitive forces Model applies to each and every company as well as industry. This model with regards to the Banking Industry is presented below:

Page 16 Credit Risk Management at SBM 1. Rivalry among existing firms With the process of liberalization, competition among the existing banks has increased. Each bank is coming up with new products to attract the customers and tailor made loans are provided. The quality of services provided by banks has improved drastically. 2. Potential Entrants Previously the Development Financial Institutions mainly provided project finance and development activities. But they now entered into retail banking which has resulted into stiff competition among the exiting players. 3. Threats from Substitutes Banks face threats from Non-Banking Financial Companies. NBFCs offer a higher rate of interest. 4. Bargaining Power of Buyers Corporate can raise their funds through primary market or by issue of GDRs, FCCBs. As a result they have a higher bargaining power. Even in the case of personal finance, the buyers

have a high bargaining power. This is mainly because of competition. 5. Bargaining Power of Suppliers With the advent of new financial instruments providing a higher rate of returns to the investors, the investments in deposits is not growing in a phased manner. The suppliers demand a higher return for the investments. Overall Analysis The key issue is how banks can leverage their strengths to have a better future. Since the availability of funds is more and deployment of funds is less, banks should evolve new products and services to the customers. There should be a rational thinking in sanctioning loans, which will bring down the NPAs. As there is an expected revival in the Indian economy Banks have a major role to play. Funding corporate at a low cost of capital is a special requisite.

Page 17 Industry Analysis

3.2) SWOT Analysis

The banking sector is also taken as a proxy for the economy as a whole. The performance of bank should therefore, reflect Trends in the Indian Economy. Due to the reforms in the financial sector, banking industry has changed drastically with the opportunities to the work with, new accounting standards new entrants and information technology. The deregulation of the interest rate, participation of banks in project financing has changed in the environment of banks. The performance of banking industry is done through SWOT Analysis. It mainly helps to know the strengths and Weakness of the industry and to improve will be known through converting the opportunities into strengths. It also helps for the competitive environment among the banks. STRENGTHS 1. Availability of Funds There are seven lakh crore wroth of deposits available in the banking system. Because of the recession in the economy and volatility in capital markets, consumers prefer to deposit their money in banks. This is mainly because of liquidity for investors. 2. Banking network After nationalization, banks have expanded their branches in the country, which has helped banks build large networks in the rural and urban areas. Private Banks allowed operating but they mainly concentrate in metropolis. 3. Large Customer Base This is mainly attributed to the large network of the banking sector. Depositors in rural areas prefer banks because of the failure of the NBFCs. 4. Low Cost of Capital

Corporate prefers borrowing money from banks because of low cost of capital. Middle income people who want money for personal financing can look to banks as they offer at very low rates of interests. Consumer credit forms the major source of financing by banks.

Page 18 Credit Risk Management at SBM WEAKNESSES 1. Loan Deployment Because of the recession in the economy the banks have idle resources to the tune of 3.3 lakh crore. Corporate lending has reduced drastically 2. Powerful Unions Nationalization of banks had a positive outcome in helping the Indian Economy as a whole. But this had also proved detrimental in the form of strong unions, which have a major influence in decision-making. They are against automation. 3. Priority Sector Lending To uplift the society, priority sector lending was brought in during nationalization. This is good for the economy but banks have failed to manage the asset quality and their intensions were more towards fulfilling government norms. As a result lending was done for nonproductive purposes. 4. High Non-Performing Assets Non-Performing Assets (NPAs) have become a matter of concern in the banking industry. This is because of change in the total outstanding advances, which has to be reduced to meet the international standards. OPPORTUNITIES 1. Universal Banking Banks have moved along the valve chain to provide their customers more products and services. For example: - SBI is into SBI home finance, SBI Capital Markets, SBI Bonds etc. 2. Differential Interest Rates As RBI control over bank reduces, they will have greater flexibility to fix their own interest rates which depends on the profitability of the banks. 3. High Household Savings Page 19 Industry Analysis Household savings has been increasing drastically. Investment in financial assets has also increased. Banks should use this opportunity for raising funds. 4. Overseas Markets Banks should tape the overseas market, as the cost of capital is very low. 5. Interest Banking The advance in information technology has made banking easier. Business can effectively carried out through internet banking. THREATS 1. NBFCs, Capital Markets and Mutual funds

There is a huge investment of household savings. The investments in NBFCs deposits, Capital Market Instruments and Mutual Funds are increasing. Normally these instruments offer better return to investors. 2. Change in the Government Policy The change in the government policy has proved to be a threat to the banking sector. 3. Inflation The interest rates go down with a fall in inflation. Thus, the investors will shift his investments to the other profitable sectors. 4. Recession Due to the recession in the business cycle the economy functions poorly and this has proved to be a threat to the banking sector. The market oriented economy and globalization has resulted into competition for market share. The spread in the banking sector is very narrow. To meet the competition the banks has to grow at a faster rates and reduce the overheads. They can introduce the new products and develop the existing services.

Page 20 Credit Risk Management at SBM

Chapter4

Introduction to SBM STATE BANK OF MYSORE

Working for a better tomorrow
Mission

A premier commercial Bank in Karnataka, with all India presence, committed to provide consistently superior and personalized customer service backed by employee pride and will to excel, earn progressively high returns for its shareholders and be a responsible corporate citizen contributing to the well being of the society. 4.1) SBM - Introduction

State Bank of Mysore was established in the year 1913 as Bank of Mysore Ltd. under the patronage of the erstwhile Govt. of Mysore, at the instance of the banking committee headed by the great Engineer-Statesman, Late Dr. Sir M.Visvesvaraya. Subsequently, in March 1960, the Bank became an Associate of State Bank of India. State Bank of India holds 92.33% of shares. The Bank's shares are listed in Bangalore, Chennai, and Mumbai stock exchanges. The Bank has a widespread network of 682 branches (as on 30.09.2009)and20 extension counters spread all over India which includes5 specialized SSI branches, 4 Industrial Finance

branches, 3 Corporate Accounts Branches, 4 specialized Personal Banking Branches, 10 Agricultural Development Branches, 3 Treasury branches, 1 Asset Recovery Branch and 8 Service Branches, offering wide range of services to the customers. The Bank has a dedicated workforce of 9720 employees consisting of 3169 supervisory staff, 6551 non-supervisory staff (as on 31.03.2008). The skill and competence of the employees

Page 21 Introduction to SBM have been kept updated to meet the requirement of our customers keeping in view the changes in the environment. The Chairman of State Bank of India is also the Chairman of this Bank; The Managing Director is assisted by a Chief General Manager and 6 General Managers. The paid up capital of the Bank is Rs.360 Millions as on 31.03.2009 out of which State Bank of India holds 92.33%. The net worth of the Bank as on 31.03.2009 is Rs.1619.44 Crores and the Bank has achieved a capital adequacy ratioof12.99% as at the end of March 2009. The Bank has an enviable track record of earning profits continuously and uninterrupted payment of dividend since its inception in 1913. The Bank earned a net profit of Rs.336.91 Crores for the year ended March 2009 and earnings per share are at Rs.94. Total deposits of the Bank as at the end of March 2009 isRs.32915.76 Crores and the total advances stood at Rs. 25616.05 Crores which include export credit of Rs. 1158.13 Crores. The Forex Merchant turnover of the Bank is Rs.19607.42 Crores and the Forex Trading turnover is Rs.82197.27 Crores at the end of March 2009.

4.2) Key areas of operation:

1) Personal Banking Schemes: The personal banking scheme consists of the following types of services: Personal loan Mortgage loan Housing loans Educational loan Cash Key: To meet unforeseen expenses, without premature withdrawal of term deposit. Immediate overdraft facility is available ATM Facility: Round the clock ATM facility for customers of Bangalore city and different parts of the country. 2) Commercial And Institutional Banking Schemes: Scheme for Traders-Liberalized Trade Finance: State Bank of Mysore has designed schemes for traders to meet their working capital needs under C&I and SME Segment. The following categories of borrowers will be covered: Small business enterprises. Retail traders/ wholesale traders.

Page 22 Credit Risk Management at SBM

 Professional and Self employed. Handy Loans Scheme - For Trade and Services sector: Handy Loan can be availed for : Holding stocks / Receivables Acquisition of land and buildings for establishing trading house Building construction & renovation of offices, showrooms, godowns, etc. Purchase of equipment, furniture & vehicles Augmenting networking capital Payment of long term deposits / advances to supplier General trade purposes Corporate Loan (Earlier Name: Short Term Corporate Loan):The Short Term Corporate Loan is essentially in the form of Term Loan for corporate for certain specific purposes with maturity not exceeding three years Current Account Plus: The services offered under this services are as follows: Issue of 30 DDs cumulative value not exceeding Rs.25 lacs per month free of charges Collection of 30 outstation cheques per month with a cumulative value of Rs.10 lacs, free of collection charges (This facility is only for the account holders instruments and not for third party cheques). Handling charges of Rs.20/- per instrument to be collected SBI Life policy of Rs. 1 lakh coverage. In the unfortunate event of death, SBI Life would pay the assured to the nominee. In the event of the death due to an accident, SBI Life would pay the Nominee double the sum assured. Free of cost, for individuals/proprietor of concern. In case of Partnership firms / Company Accounts any one partner/ Director. Rent Plus: This scheme is to meet liquidity mismatch / any other purpose of the applicants. 3) Agricultural Schemes: The schemes under agricultural are as under: Kisan Gold Card Scheme Kisan Credit Card Scheme GraminBhandaranYojana (GBY) Scheme for Combined Harvesters

Page 23 Introduction to SBM Kisan Chakra Scheme 4) Micro & Small Enterprises Scheme: The various schemes under MSE schemes are as follows: Credit Guarantee Fund Trust Scheme For Micro & Small Enterprises (CGTMSE) Loans to Micro & Small Enterprises (MSEs) Small Business Finance Small Business Enterprises Professionals & Self-Employed persons Transport Operators LaghuUdyami Credit Card Scheme

4.3) Technical Initiatives:

State Bank of Mysore is the first Karnataka-based Bank with fully networked branches. The Bank made significant investment in order to upgrade technology and the major developments are as under: (1) Core Banking Solution: Which contains, Facilitates 24 X 7 Banking

 Anywhere Banking Integration with strategic sectors Business Process Re-engineering (BPR) enabler (2) (3) (4) (5) Internet Banking Real Time Gross Settlement (RTGS) National Electronic Funds Transfer (NEFT) System Mobile Banking

Page 24 Credit Risk Management at SBM

Chapter5

Credit Risk Management

Banks are in the business of managing risk, not avoiding it
5.1) Introduction
Lending has always been the primary function of banking, and accurately assessing a borrower's creditworthiness has always been the only method of lending successfully. The method of analysis varies from borrower to borrower. It also varies in function of the type of lending being considered. For example, the banking risks in financing the building of a hotel or rail project, or providing lending secured by assets or a large overdraft for a retail customer would vary considerably. For the financing of the project, you would look to the funds generated by future cash flows to repay the loan, for asset secured lending, you would look at the assets and for an overdraft facility, you would look at the way the account has been run over the past few years. Credit risk is the oldest risk among the various types of risks in the financial system, especially in banks and financial institutions due to the process of intermediation. Managing credit risk has formed the core of the expertise of these institutions. While the risk is well known, growth in the markets, disintermediation, and the introduction of a number of

Page 25 Credit Risk Management innovative products and practices have changed the way credit risk is measured and managed in today's environment.

5.2) Definition

Credit risk "is the risk to a bank's earnings or capital base arising from a borrower's failure

to meet the terms of any contractual or other agreement it has with the bank. Credit risk arises from all activities where success depends on counterparty, issuer or borrower performance". Credit risk enters the books of a bank the moment the funds are lend, deployed, invested or committed in any form to counterparty whether the transaction is on or off the balance sheet.

5.3) Scope of Credit Risk

It can be understood from the above that credit risk arises from a whole lot of banking activities apart from traditional lending activity such as trading in different markets, investment of funds, provision of portfolio management services, providing different type of guarantees and opening of letters of credit in favour of customers etc. For example, even though guarantee is viewed as a non-fund based product, the moment a guarantee is given, the bank is exposed to the possibility of the non- funded commitment turning into a funded position when the guarantee is invoked by the entity in whose favour the guarantee was issued by the bank. This means that credit risk runs across different functions performed by a bank and has to be viewed as such. The nature, nomenclature and the quantum of credit risk may vary depending on a number of factors. The internal organization of credit risk management should recognize this for effective credit risk management. Credit risk can be segmented into two major segments viz. intrinsic and portfolio (or concentration) credit risks. The focus of the intrinsic risk is measurement of risk at individual loan level. This is carried out at lending unit level. Portfolio credit risk arises as a result of concentration of the portfolio to a particular sector, geographic area, industry, type of facility, type of borrowers, similar rating, etc. Concentration risk is managed at the bank level as it is more relevant at that level.

Page 26 Credit Risk Management at SBM

5.4) what is the role of Credit Analysis?

The role of credit analysis generally encounters the following questions: In which stage of the life cycle the companyis? Is the company's business cyclical or counter cyclical? How will this affect the long-term cash flow of the firm? where the company is operating? Credit analysis supports the work of marketing officers by evaluating companies before lending money to them. This is essential so that new loan requests can be processed,

a company's repayment ability assessed, and existing relationships monitored. The extent of the credit analysis is determined by The size and nature of the enquiry, The potential future business with the company, The availability of security to support loans, The existing relationship with the customer. The analysis must also determine whether the information submitted is adequate for decision-making purposes, or if additional information is required. An analysis can therefore cover a wide range of issues. For example, in evaluating a loan proposal for a company, it may be necessary to: Obtain credit and trade references, Examine the borrower's financial condition, Consult with legal counsel regarding a particular aspect of the draft loan agreement. By making these checks you are ensuring that your report does not look at a company's creditworthiness in a narrowly defined sense. You will be taking the further step of deciding whether the provisions in the loan agreement are appropriate for the borrower's financial What are the considerations of generaleconomic conditions and, if appropriate, political conditions in the country

Page 27 Credit Risk Management condition. Often it will be necessary for the analyst to place the assessment of the borrower's financial condition within the wider context of the conditions existing in the industry in which it is operating.

5.5) Credit Risk Management Process

Credit risk is the largest and most elementary risk faced by banks. It essentially focuses on determining likelihood of default or credit deterioration and how costly it will turn out to be if it does occur. And this is true for consumer lending (retail) or corporate lending (commercial) in banking. A comprehensive Credit Risk Management Process encompasses the following steps:

5.5.1) Collect Obligor and Loan data The very foundation of a sound credit risk management system lies in the data that it gets. The inputs needed in this stage are the obligor (borrower), Facility (Loan) and external (ratings) data. This is first critical step in any loan process and all necessary data about the obligor needs to be collected. Fig 2. highlights the key tasks and challenges involved in this step. Page 28 Credit Risk Management at SBM

The key steps here include, Get the Obligor Data: The crucial task here is to get the financial, demographic and qualitative data related to the obligor. A majority of the data comes from the financial statements but other sources also exist for example past repayment performances. Get the Loan Data: Next on, the system must beadequately designed to capture Loan data related to the type of loan, amount, maturity etc accurately. Of particular concern here is data related to collaterals, guarantees and contract terms on netting and liquidation. These must be accurately captured in the system as they are crucial in the rating process. Get External Ratings Data: The system must be capable enough to pull relevant data from external systems such as data from rating agencies and also information such as loan data from internal systems.

5.5.2) Compute Credit Risk The next and one of the most crucial phases is calculating the credit risk in the form of risk ratings to meaningfully differentiate risk among different firms or exposures. Fig 3 shows a typical credit risk calculation scenario. Key Tasks The basic approach involves combining internal rating models (point of time) with external risk information (through the cycle). The basic tasks involved in the rating process of a Commercial obligor are highlighted as follows: Page 29 Credit Risk Management Develop Rating Model: The obligor has to be rated using an appropriate model for example there are different models for a Commercial & Industrial category obligor and a Commercial Real Estate category obligor. Calculate Probability of Default (PD): The Probability of Default is the likelihood that a loan will not be repayed and fall into default. The credit history of the counterparty and nature of the investment will all be taken into account to calculate the PD figures. The following steps will commonly be used
Analyze the credit risk aspects of the counterparty; This will involve not only the quantitative aspects of the obligor based on his/her financial statements but also qualitative factors related to contingencies, management quality and other factors which are yet to be reflected. and qualitative factors in a typical risk grading model for a commercial obligor. Map the counterparty to an internal risk grade which has an associated PD. Calculate Loss Given Default (LGD), Exposure At Default (EAD) & Expected Loss

(EL):The Credit Risk Solution also needs to calculate Loss Given Default It is the magnitude of likely loss on the exposure in the event of default. Both quantitative and qualitative factors are used to calculate Facility LGD which may include Government guarantees, Collateral Support, Guarantor Support etc. Exposure At Default - It is defined as the exposure to the borrower at any point of time. Expected Loss It is calculated using the PD, LGD and EAD together. It is the probability weighted loss which is also used for pricing.

Page 30 Credit Risk Management at SBM 5.5.3) Monitor and Manage Risk Rating The job is not over with the credit risk rating process. In fact, it is quintessential to monitor and manage the risk ratings as highlighted below in. Key Tasks Develop Workflow to manage approval of Ratings: The Credit Risk Solution should ensure that the risk ratings and exceptions go through proper approvals by appropriate authorities as laid down by guidelines such as the Banks credit policy. The workflow should also accord traceability to ratings, changes and approvals. Ensure notification on external rating changes: The system should ensure that external ratings changes or other material changes are reflected as early and accurately as possible in the credit risk ratings of an obligor. The system should ensure ratings are reviewed periodically and also based on criteria such as likelihood of credit changes. Interface with Internal Collections: Adequate interface with internal collections is needed so that the system is updated consistently with any default information. Perform Back Testing of Ratings: The system should provide for back testing and calibrating credit risk models within Basel-II guidelines. 5.5.4) Manage portfolio and allocate capital Portfolio Management has become one of the most difficult challenges in the financial world especially from the point of view of credit risk management. Efficient portfolio management and capital allocation is a process which an organization must put on the top of its agenda. Illustrated below in Fig 6 are the steps in this process Page 31 Credit Risk Management Key Tasks Compute and monitor Portfolio risk: The System must be capable of computing and monitoring the credit risk at a portfolio level and also enable drill down based upon criteria such as different lines of businesses etc. The system should provide interface with a risk engine to calculate regulatory and economic capital, allocate capital and calculate RAROC Allow creation of SPVs for transfer of risk: The system must facilitate the creation of SPVs for

the appropriate transfer of credit risk. Reporting on risk: The system must be capable enough to satisfy the reporting requirements of the organization. There are different levels of reporting that are required especially in the case of portfolio management. Stress Testing/ Scenario Analysis: The system should also allow for stress testing of the portfolio under differing conditions specially taking into consideration varying economic circumstances.

5.5.5) Summary of the key priority areas It will be quite safe to assume that any competitive and proactive financial institution must have already started laying down the foundation blocks of a robust credit risk management system. However it would be pertinent to summarize the key priority areas for this process. These areas are highlighted in Fig 7. Page 32 Credit Risk Management at SBM Notification of External Rating changes: It is crucial that an organization effectively uses a combination of internal models with external ratings. Therefore changes in the external inputs should be reflected as soon as possible in the internal ratings. This can be achieved through the use of notifications in the form of real time alerts. Data Architecture: A robust data backbone is crucial to enable credit assessment process. The data backbone should have adequate and accurate data history. Care should be taken to make sure the data design incorporates relevant data fields which are required in current and future models. Back Testing: The models should be properly back tested to improvise them and also for regulatory approvals. Compute & Monitor Portfolio Risk: Measuring and managing individual credit ratings contribute to the management of portfolio risk. This is a crucial phase for the risk department within the organization as credit risk levels have to be maintained within statutory and organizational requirements. Page 33 Credit Risk Management

5.6) Significance of Credit Risk Measurement and Management

Increase in Bankruptcies: Compared to the past, bankruptcies have increased. As a result of this, the permanent, accurate credit risk analysis practices h a v e become more important than in the past. Deregulation: Innovation stimulated by deregulation has led to new entrants into the markets to provide services. The credit risk assessment of the new entrants is very much essential for the well functioning of the market.

Disintermediation: As large institutions with strong credit quality are less dependent on bank funds, banks are left to serve institutions with weaker credit quality. A recent study by Subramanian and Umakrishnan (2004) of 876 corporate in India, the bank debt to total debt ratio for very small firms (sales turnover not more than Rs. 10 crores per annum) was 73% while the ratio for very large firms (sales turnover Rs. 1000 crores and above per annum) was only 41%. A similar fall in the ratio was witnessed as the size measured by sale turnover increased. This disintermediation has led to fall in the overall credit quality of the lending book, increasing the importance of credit risk measurement and management. Shrinking Margins on Loans: Trends in international markets reveal that the interest margins or spreads, i.e. the difference between interest income and interest expenses has been falling. Apart from other factors, the increasing competition in the market is cited as the major reason for this. Growth of off-Balance Sheet Risks: The phenomenal expansion of the Over-the- Counter (OTC) derivative products which carry counterparty risk unlike the exchange traded derivatives has increased the exposure of a number of banks to such products.

Page 34 Credit Risk Management at SBM Volatility in the Value of Collateral: It has been observed that predicting the market value of collateral held against loan is very difficult. This may lead to a situation where the value of collateral may fall below the value of loan granted against it. Falling value of the collateral had been the cause for banking crises in well developed countries such as Switzerland and Japan. Advances in Finance Theory and Computer Technology: These advances have paved the way for banks to test very sophisticated credit risk models that would not have been possible in the absence of finance theory and computer technology. Risk-based Capital Regulations: Apart from the above, the development of risk- based capital requirements pronounced by the Basle Committee has been one of the important drivers of credit risk initiatives. This is more so with the Basle Accord -II which recognizes the differences in credit quality in the form of ratings and availability of collateral unlike the previous accord which is in force till date. Page 35 Overview of Credit Appraisal

Chapter6

Overview Of Credit Appraisal

Credit appraisal means an investigation/assessment done by the banks before providing any loans & advances/project finance & also checks the commercial, financial & technical viability of the project proposed, its funding pattern & further checks the primary & collateral security cover available for recovery of such funds.

6.1) Brief overview of credit

Credit Appraisal is a process to ascertain the risks associated with the extension of the credit facility. It is generally carried by the financial institutions, which are involved in providing financial funding to its customers. Credit risk is a risk related to nonrepayment of the credit obtained by the customer of a bank. Thus it is necessary to appraise the credibility of the customer in order to mitigate the credit risk. Proper evaluation of the customer is performed which measures the financial condition and the ability of the customer to pay back the loan in future. Generally the credit facilities are extended against the security know as collateral. But even though the loans are backed by the collateral, banks are normally interested in the actual loan amount to be repaid along with the interest. Thus, the customer's cash flows are ascertained to ensure the timely payment of principal and the interest. It is the process of appraising the credit worthiness of a loan applicant. Factors like age, income, number of dependents, nature of employment, continuity of employment, repayment capacity, previous loans, credit cards, etc. are taken into account while appraising the credit worthiness of a person. Every bank or lending institution has its own panel of officials for this purpose. There is no guarantee to ensure a loan does not run into problems; however if proper credit evaluation techniques and monitoring are implemented then naturally the loan loss probability / problems will be minimized, which should be the objective of every lending officer.

Page 36 Credit Risk Management at SBM Credit is the provision of resources (such as granting a loan) by one party to another party where that second party does not reimburse the first party immediately, thereby generating a debt, and instead arranges either to repay or return those resources (or material(s) of equal value) at a later date. The first party is called a creditor, also known as a lender, while the second party is called a debtor, also known as a borrower. Credit allows you to commodities now, and use credit to

buy goods or pay for them later. We things with an agreement over a period of time. The avail credit is by the use credit loans, plans vehicle include loans, to repay the loans most common way to of credit cards. Other personal loans, home student loans, small business loans, trade. A credit is a legal contract where one party receives resource or wealth from another party and promises to repay him on a future date along with interest. In simple terms, a credit is an agreement of postponed payments of goods bought or loan. With the issuance of a credit, a debt is formed.

6.2) Basic Types of Credit

There are four basic types of credit. By understanding how each works, you will be able to get the most for your money and avoid paying unnecessary charges. Service credit is monthly payments for utilities such as telephone, gas, electricity, andwater. You often have to pay a deposit, and you may pay a late charge if your payment is not on time. Loans let you borrow cash. Loans can be for small or large amounts and for a few daysor several years. Money can be repaid in one lump sum or in several regular payments until the amount you borrowed and the finance charges are paid in full. Loans can be secured or unsecured. Installment credit may be described as buying on time, financing through the store orthe easy payment plan. The borrower takes the goods home in exchange for a promise to pay later. Cars, major appliances, and furniture are often purchased this way. You usually sign a

Page 37 Overview of Credit Appraisal contract, make a down payment, and agree to pay the balance with a specified number of equal payments called installments. The finance charges are included in the payments. The item you purchase may be used as security for the loan. Credit cards are issued by individual retail stores, banks, or businesses. Using a

creditcard can be the equivalent of an interest-free loan--if you pay for the use of it in full at the end of each month.

6.2.1) Brief Overview of Loans: Loans can be of two types fund base & non-fund base: FUND BASE includes Working Capital Term Loan NON-FUND BASE includes Letter of Credit Bank Guarantee Bill Discounting (A) FUND BASE WORKING CAPITAL: 1. General The objective of running any industry is earning profits. An industry will require funds to acquire fixed assets like land, building, plant, machinery, equipments, vehicles, tools etc., & also to run the business i.e. its day-to-day operations. Funds required for day to-day working will be to finance production & sales. For production, funds are needed for purchase of raw materials/ stores/ fuel, for employment of labor, for power charges etc., for storing finishing goods till they are sold out & for financing the sales by way of sundry debtors/ receivables. Capital or funds required for an industry can therefore be bifurcated as fixed capital & working capital. Working capital in this context is the excess of current assets over current liabilities. The excess of current assets over current liabilities is treated as net working capital or liquid surplus & represents that portion of the working capital, which has been provided from the long-term source. Page 38 Credit Risk Management at SBM 2. Definition Working capital is defined as the funds required to carry the required levels of current assets to enable the unit to carry on its operations at the expected levels uninterruptedly. Thus Working Capital Required is dependent on a) The volume of activity (viz. level of operations i.e. Production & sales) b) The activity carried on viz. mfg process, product, production programme, the materials & marketing mix. 3. Methods & application SEGMENTS SSI SBF LIMITS UPTO 5 CRORES ABOVE 5 CRORES All loans UPTO Rs. 1 CRORE

C&I TRADE & SERVICES ABOVE Rs. 1 CRORE & UPTO Rs. 5 CRORE METHODS Traditional method &Nayak Committee method Projected Balance Sheet Method Traditional/ Turnover Method Traditional method for trade & projected turnover method Projected Balance Sheet Method & Projected Turnover Method. ABOVE Rs. 5 CRORE Projected Balance Sheet Method BELOW Rs. 25 Lacs Above Rs. 25 Lacs C&I INDUSTRIAL UNITS but up to Rs. 5 crores ABOVE Rs. 5 Crores TRADITIONAL METHOS Projected Balance Sheet Method & Projected Turnover Method Projected Balance Sheet Method

Page 39 Overview of Credit Appraisal TERM LOAN:1. A term loan is granted for a fixed term of not less than 3 years intended normally for financing fixed assets acquired with a repayment schedule normally not exceeding 8 years. 2. A term loan is a loan granted for the purpose of capital assets, such as purchase of land, construction of, buildings, purchase of machinery, modernization, renovation or rationalization of plant, & repayable from out of the future earning of the enterprise, in installments, as per a prearranged schedule. From the above definition, the following differences between a term loan & the working capital credit afforded by the Bank are apparent: The purpose of the term loan is for acquisition of capital assets. The term loan is an advance not repayable on demand but only in installments ranging over a period of years. The repayment of term loan is not out of sale proceeds of the goods & commodities per se, whether given as security or not. The repayment should come out of the future cash accruals from the activity of the unit. The security is not the readily saleable goods & commodities but the fixed assets of the units. 3. It may thus be observed that the scope & operation of the term loans are entirely different from those of the conventional working capital advances. The Banks

commitment is for a long period & the risk involved is greater. An element of risk is inherent in any type of loan because of the uncertainty of the repayment. Longer the duration of the credit, greater is the attendant uncertainty of repayment & consequently the risk involved also becomes greater. 4. However, it may be observed that term loans are not so lacking in liquidity as they appear to be. These loans are subject to a definite repayment programme unlike short term loans for working capital (especially the cash credits) which are being renewed year after year. Term loans would be repaid in a regular way from the anticipated income of the industry/ trade.

Page 40 Credit Risk Management at SBM 5. These distinctive characteristics of term loans distinguish them from the short term credit granted by the banks & it becomes necessary therefore, to adopt a different approach in examining the applications of borrowers for such credit & for appraising such proposals. 6. The repayment of a term loan depends on the future income of the borrowing unit. Hence, the primary task of the bank before granting term loans is to assure itself that the anticipated income from the unit would provide the necessary amount for the repayment of the loan. This will involve a detailed scrutiny of the scheme, its financial aspects, economic aspects, technical aspects, a projection of future trends of outputs & sales & estimates of cost, returns, flow of funds & profits. 7. Appraisal of Term Loans Appraisal of term loan for, say, an industrial unit is a process comprising several steps. There are four broad aspects of appraisal, namely Technical Feasibility - To determine the suitability of the technology selected & the adequacy of the technical investigation & design Economic Feasibility - To ascertain the extent of profitability of the project & its sufficiency in relation to the repayment obligations pertaining to term assistance Financial Feasibility - To determine the accuracy of cost estimates, suitability of the envisaged pattern of financing & general soundness of the capital structure and Managerial Competency To ascertain that competent men are behind the project to ensure its successful implementation & efficient management after commencement of commercial production. Technical Feasibility The examination of this item consists of an assessment of the various requirement of the actual production process. It is in short a study of the availability, costs, quality & accessibility of all the goods & services needed. a) The location of the project is highly relevant to its technical feasibility & hence special attention will have to be paid to this feature. Projects whose technical requirements could have been taken care of in one location sometimes fail because they are established in another place where conditions are less favorable. One Page 41 Overview of Credit Appraisal project was located near a river to facilitate easy transportation by barge but lower

water level in certain seasons made essential transportation almost impossible. Too many projects have become uneconomical because sufficient care has not been taken in the location of the project, e.g. a woolen scouring & spinning mill needed large quantities of good water but was located in a place which lacked ordinary supply of water & the limited water supply available also required efficient softening treatment. The accessibility to the various resources has meaning only with reference to location. Inadequate transport facilities or lack of sufficient power or water for instance, can adversely affect an otherwise sound industrial project. b) Size of the plant One of the most important considerations affecting the feasibility of a new industrial enterprise is the right size of the plant. The size of the plant will be such that it will give an economic product, which will be competitive when compared to the alternative product available in the market. A smaller plant than the optimum size may result in increased production costs & may not be able to sell its products at competitive prices. c) Type of technology An important feature of the feasibility relates to the type of technology to be adopted for a project. A new technology will have to be fully examined & tired before it is adopted. It is equally important to avoid adopting equipment or processes which are absolute or likely to become outdated soon. The principle underlying the technological selection is that a developing country cannot afford to be the first to adopt the new nor yet the last to cast the old aside. d) Labour The labour requirements of a project, need to be assessed with special care. Though labour in terms of unemployed persons is abundant in the country, there is shortage of trained personnel. The quality of labour required & the training facilities made available to the unit will have to be taken into account. e) Technical Report A technical report using the Banks Consultancy Cell, external consultants, etc., should be obtained with specific comments on the feasibility of scheme, its profitability, whether machinery proposed to be acquired by the unit under the scheme will be sufficient for all stages of production, the extent of competition prevailing, marketability of the products etc., wherever necessary.

Page 42 Credit Risk Management at SBM Economic Feasibility An economic feasibility appraisal has reference to the earning capacity of the project. Since earnings depend on the volume of sales, it is necessary to determine how much output or the additional production from an established unit the market is likely to absorb at given prices. a) A thorough market analysis is one of the most essential parts of project investigation. This involves getting answers to three questions. 1) How big is the market? 2) How much it is likely to grow? 3) How much of it can the project capture? The first step in this direction is to consider the current situation, taking account of the total output of the product concerned & the existing demand for it with a view to establishing whether there is unsatisfied demand for the product. Care should be taken to see that there is no idle capacity in the existing industries. b) Future possible future changes in the volume & patterns of supply & demand will have to be estimated in order to assess the long term prospects of the industry. Forecasting of demand is a complicated matter but one of the vital importance. It is complicated because a variety of factors affect the demand for product e.g. technological advances could bring substitutes into market while changes in tastes &

consumer preference might cause sizable shifts in demand. c) Intermediate product The demand for Intermediate product will depend upon the demand & supply of the ultimate product (e.g. jute bags, paper for printing, parts for machines, tyres for automobiles). The market analysis in this case should cover the market for the ultimate product.

Page 43 Overview of Credit Appraisal Financial Feasibility The basis data required for the financial feasibility appraisal can be broadly grouped under the following heads i) Cost of the project including working capital ii) Cost of production & estimates of profitability iii) Cash flow estimates & sources of finance. The cash flow estimates will help to decide the disbursal of the term loan. The estimate of profitability & the break even point will enable the banker to draw up the repayment. programme, start-up time etc. The profitability estimates will also give the estimate of the Debt Service Coverage, which is the most important single factor in all the term credit analysis. A study of the projected balance sheet of the concern is essential as it is necessary for the appraisal of a term loan to ensure that the implementation of the proposed scheme. Break-even point: In a manufacturing unit, if at a particular level of production, the totalmanufacturing cost equals the sales revenue, this point of no profit/ no loss is known as the break-even point. Break-even point is expressed as a percentage of full capacity. A good project will have reasonably low break-even point which not be encountered in the projections of future profitability of the unit. Debt/ Service Coverage: The debt service coverage ratio serves as a guide to determining the period of repayment of a loan. This is calculated by dividing cash accruals in a year by amount of annual obligations towards term debt. The cash accruals for this purpose should comprise net profit after taxes with interest, depreciation provision & other non cash expenses added back to it.
Debt Service Coverage Ratio = Cash accruals Maturing annual obligations

Page 44 Credit Risk Management at SBM This ratio is valuable, in that it serves as a measure of the repayment capacity of the project/ unit & is, therefore, appropriately included in the cash flow statements. The ratio may vary from industry to industry but one has to view it with circumspection when it

is lower than the benchmark of 1.75. The repayment programme should be so stipulated that the ratio is comfortable. Managerial Competence In a dynamic environment, the capacity of an enterprise to forge ahead of its competitors depends to a large extent, on the relative strength of its management. Hence, an appraisal of management is the touchstone of term credit analysis. If there is a change in the administration & managerial set up, the success of the project may be put to test. The integrity & credit worthiness of the personnel in charge of the management of the industry as well as their experience in management of industrial concerns should be examined. In high cost schemes, an idea of the units key personnel may also be necessary.

(B) NON-FUND BASE (1) LETTER OF CREDIT The expectation of the seller of any goods or services is that he should get the payment immediately on delivery of the same. This may not materialize if the seller & the buyer are at different places (either within the same country or in different countries). The seller desires to have an assurance for payment by the purchaser. At the same time the purchaser desires that the amount should be paid only when the goods are actually received. Here arises the need of Letter of Credit (LCs). The objective of LC is to provide a means of payment to the seller & the delivery of goods & services to the buyer at the same time. Definition A Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at the request & on the instructions of the customer (the applicant) or on its own behalf, i. is to make a payment to or to the order of a third party (the beneficiary), or is to accept & pay bills of exchange (drafts drawn by the beneficiary); or Page 45 Overview of Credit Appraisal ii. authorizes another bank to effect such payment, or to accept & pay such bills of exchanges (drafts); or iii. authorizes another bank to negotiate against stipulated document(s), provided that the terms & conditions of the credit are complied with. Basic Principle: The basic principle behind an LC is to facilitate orderly movement of trade; it is therefore necessary that the evidence of movement of goods is present. Hence documentary LCs is those which contain documents of title to goods as part of the LC documents. Clean bills which do not have document of title to goods are not normally established by banks. Bankers and all concerned deal only in documents & not in goods. If documents are

in order issuing bank will pay irrespective of whether the goods are of expected quality or not. Banks are also not responsible for the genuineness of the documents & quantity/quality of goods. If importer is your borrower, the bank has to advice him to convert all his requirements in the form of documents to ensure quantity & quality of goods. Parties to the LC 1) Applicant The buyer who applies for opening LC 2) Beneficiary The seller who supplies goods 3) Issuing Bank The Bank which opens the LC 4) Advising Bank The Bank which advises the LC after confirming authenticity 5) Negotiating Bank The Bank which negotiates the documents 6) Confirming Bank The Bank which adds its confirmation to the LC 7) Reimbursing Bank The Bank which reimburses the LC amount to negotiating bank 8) Second beneficiary The additional beneficiary in case of transferable LCs Confirming bank may not be there in a transaction unless the beneficiary demand confirmation by its own bankers & such a request is made part of LC terms. A bank will confirm an LC for his beneficiary if opening bank requests this as part of LC terms. Reimbursing bank is used in an LC transaction by an opening bank when the bank does not have a direct correspondent/branch through whom the negotiating bank can be reimbursed. Here, the opening bank will direct the reimbursing bank to reimburse the negotiating bank with the payment made to the beneficiary. In the case of transferable LC, the LC may be transferred to the second beneficiary & if provided in the LC it can be

Page 46 Credit Risk Management at SBM transferred even more than once. (2) BANK GUARANTEES: A contract of guarantee is defined as a contract to perform the promise or discharge the liability of the third person in case of the default. The parties to the contract of guarantees are: a) Applicant: The principal debtor person at whose request the guarantee is executed b) Beneficiary: Person to whom the guarantee is given & who can enforce it in case of default. c) Guarantee: The person who undertakes to discharge the obligations of theapplicant in case of his default. Thus, guarantee is a collateral contract, consequential to a main contract between the applicant & the beneficiary. Purpose of Bank Guarantees Bank Guarantees are used to for both preventive & remedial purposes. The guarantees executed by banks comprise both performance guarantees & financial guarantees. The guarantees are structured according to the terms of agreement, viz., security, maturity & purpose. Branches may issue guarantees generally for the following purposes:

a) In lieu of security deposit/earnest money deposit for participating in tenders; b) Mobilization advance or advance money before commencement of the project by the contractor & for money to be received in various stages like plant layout, design/drawings in project finance; c) In respect of raw materials supplies or for advances by the buyers; d) In respect of due performance of specific contracts by the borrowers & for obtaining full payment of the bills; e) Performance guarantee for warranty period on completion of contract which would enable the suppliers to realize the proceeds without waiting for warranty period to be over; f) To allow units to draw funds from time to time from the concerned indenters against part execution of contracts, etc.

Page 47 Overview of Credit Appraisal g) Bid bonds on behalf of exporters h) Export performance guarantees on behalf of exporters favoring the Customs Department under EPCG scheme. Appraisal of Bank Guarantee Limit Proposals for guarantees shall be appraised with the same diligence as in the case of fundbase limits. Branches may obtain adequate cover by way of margin & security so as to prevent default on payments when guarantees are invoked. Whenever an application for the issue of bank guarantee is received, branches should examine & satisfy themselves about the following aspects: a) The need of the bank guarantee & whether it is related to the applicants normal trade/business. b) Whether the requirement is one time or on the regular basis c) The nature of bank guarantee i.e., financial or performance d) Applicants financial strength/ capacity to meet the liability/ obligation under the bank guarantee in case of invocation. e) Past record of the applicant in respect of bank guarantees issued earlier; e.g., instances of invocation of bank guarantees, the reasons thereof, the customers response to the invocation, etc. f) Present o/s on account of bank guarantees already issued g) Margin h) Collateral security offered Format of Bank Guarantees Bank guarantees should normally be issued on the format standardized by Indian Banks Association (IBA). When it is required to be issued on a format different from the IBA format, as may be demanded by some of the beneficiary Government departments, it should be ensured that the bank guarantee is a) for a definite period, b) for a definite objective enforceable on the happening of a definite event, c) for a specific amount d) in respect of bona fide trade/ commercial transactions, e) contains the Banks standard limitation clause Page 48 Credit Risk Management at SBM

f) not stipulating any onerous clause, & g) not containing any clause for automatic renewal of the bank guarantee on its expiry

6.3) Credit Risk Assessment (CRA):

Credit is a core activity of banks & an important source of their earnings, which go to pay interest to depositors, salaries to employees & dividend to shareholders In credit, it is not enough that we have sizable growth in quantity/ volume; it is also necessary to ensure that we have only good quality growth. To ensure asset quality, proper risk assessment right at the beginning, that is, at the time of taking an exposure, is extremely important. Moreover, capital has to be allocated for loan assets depending on the risk perception/ rating of respective assets. It is, therefore, extremely important for every bank to have a clear assessment of risks of the loan assets it creates, to become Basle-II compliant. That is why Credit Risk Assessment (CRA) system is an essential ingredient of the Credit Appraisal exercise.

6.3.1) Indian Scenario: In Indian banks, there was no systematic method of Credit Risk Assessment till late 1980s/ early 1990s. Health Code System (1985) / IRAC norms (1993) are Asset (loan) classification systems, not CRA systems. RBI came out with its guidelines on Risk Management Systems in Banks in 1999 & Guidance Note on Management of Credit in October, 2002. 6.3.2) SBM Scenario: However, like in many other fields, in the field of Credit Risk Assessment too, SBM played a proactive & pioneering role. Bank had its Credit Rating System in 1988. Then, the CRA system was introduced in the Bank in 1996. The first CRA model was rolled out in 1996 to take care of exposures to the C & I (Manufacturing) segment. Thereafter, separate models for SSI segments were introduced in 1998, when the C&I (Mfg.) CRA model was developed Page 49 Overview of Credit Appraisal for Non Banking Finance Companies (NBFCs) too. As of now, in SBM, CRA is the most important component of the Credit Appraisal exercise for all exposures > 25 lacs & a very important tool in decision-making (a Decision Support System) as well as in pricing. 6.3.3) Credit Risk Assessment (CRA) Minimum Scores / Hurdle Rates 1. The CRA models adopted by the Bank take into account all possible factors, which go into appraising the risks, associated with a loan. These have been categorized broadly into financial, business, industrial & management risks and are rated separately. To arrive at the overall risk rating, the factors duly weighted are aggregated & calibrated to

arrive at a single point indicator of risk associated with the credit decision. 2. Financial parameters: The assessment of financial risk involves appraisal of the financial strength of the borrower based on performance & financial indicators. The overall financial risk is assessed in terms of static ratios, future prospects & risk mitigation (collateral security / financial standing). 3. Industry parameters: The following characteristics of an industry which pose varying degrees of risk are built into Banks CRA model: Competition Industry outlook Regulatory risk Contemporary issues like WTO etc. 4. Management parameters: The management of an enterprise / group is rated onthe following parameters: Integrity (corporate governance) Track record Managerial competence / commitment Expertise Structure & systems Experience in the industry Credibility: ability to meet sales projections Credibility: ability to meet profit (PAT) projections

Page 50 Credit Risk Management at SBM Length of relationship with the Bank Strategic initiatives Payment record Bank has introduced New Rating Scales for borrower for giving loans. Rating is given on the basis of scores out of 100. Bank gives loans to the borrower as per their rating like SBM gives loans to the borrower up to SB8 rating as it has average risk till SB8 rating. From SB9 rating the risk increases. Thus, SBM do not give loans after SB8 rating. 5. The risk parameters as mentioned above are individually scored to arrive at an aggregate score of 100 (subject to qualitative factors negative parameters). The overall score thus obtained (out of a max. of 100) is rated on a 16 point scale from SB1/SBTL1 to SB 16 /SBTL16. CRA model also stipulates a minimum score under financial, business, industry and management risk parameters for a proposal to be considered acceptable in a given form. The details of such minimum scores are as under: a. Minimum scores General b. Minimum scores under Management Risk : (Integrity/Corporate Governance, Track Record and Managerial Competence/ Commitment) An applicant unit will be required to score minimum 2 marks each (out of 3) in the above three parameters of Management Risk to qualify for Banks assistance. In case of existing accounts if the company scores less than this stipulated minimum marks (02), the Bank would explore all possibilities to exercise exit option. c. Minimum Score under Business Risk: Compliance of Environment Regulations to qualify for financial assistance, an applicant

unit would have to secure full marks (02) under the parameter, Compliance of Environment Regulations. In case, the existing units in the books of the bank do not secure full marks (02), the bank would explore all possibilities for the exercise of exit option.

Page 51 RBI has clarified that Cash Credit Exposures tend to be generally rolled over and also tend to be drawn on an average for a major portion of the sanctioned limits. Hence even though a cash credit exposure may be sanctioned for a period of one year or less, these exposures should be reckoned as Long Term Exposures and accordingly, the Long Term Ratings accorded by the chosen Credit Rating Agencies will be relevant. Page 55 Overview of Credit Appraisal CREDIT APPRAISAL PROCESS (In General) Receipt of application from applicant Receipt of documents (Balance sheet, KYC papers, Different govt. registration no., MOA, AOA, and Properties documents) Pre-sanction visit by bank officers Check for RBI defaulters list, willful defaulters list, CIBIL data, ECGC caution list, etc. Title clearance reports of the properties to be obtained from empanelled advocates Valuation reports of the properties to be obtained from empanelled Valuer/engineers Preparation of financial data Proposal preparation Assessment of proposal Sanction/approval of proposal by appropriate sanctioning authority Documentations, agreements, mortgages Disbursement of loan Post sanction activities such as receiving stock statements, review of accounts, renew of accounts, etc. (On regular basis) Page 56 Credit Risk Management at SBM

7 Risk Management in Banks

Chapter
7.1) Introduction
Risk management is the strategic tool, which helps in identifying, qualifying, monitoring and controlling risks. Risk management protects an organization from dying due to insolvency resulting from the adverse effects of risk. Though universally relevant it is of immense importance to a banking organization or financial institution. The economic scenario has undergone considerable changes as compared that a few decades ago. Some of the changes that we have been witnessed are deregulation of the banking industry, development of financial markets, transition into floating rate of

exchanges, increasing roles of capital markets and global competition, etc. In the past the banking institution functioned in a regulated environment thereby limiting to various types of risks. However, today that legacy no more exists. A banking organization has to constantly strike a balance between risk and reward. A proposal, which may seem very rewarding in the short term, may wipe out the bank completely in the long run due to high risk embedded in it. Risk management helps the bank in striking this balance. Thus risk management systems are not a solution, but a tool to aid decision making.

7.2) Classification of Risks

Risk normally has two dimensions i.e. the quality of risk and the quantity of risk. Quality of risk is essentially the probability of the risk turning into an actual loss. Quantity of risk is the financial effect of the risk turning into loss. Both these dimensions are extremely difficult to measure, primarily because it is an estimation of the future, which is highly uncertain. To understand Risk Management it is extremely important to understand the various types of risks, their characteristics and their interrelationships.

Page 59 Risk Management in Banks Interest rate risk It is the risk of loss of revenue or increase or decrease in cost due to adverse movements in the market interest rates. Risk due to a client exercising its option of pre-payment of a loan due to lower interest rates is known as the optional interest rate risks. Most of the balance sheet items generate revenue or incur costs, which are benched against one or the other interest rate. This has become more significant with the emergence of floating interest rate instruments. The immediate impact of change in interest rate is on banks earnings by changing net interest income. A long term impact of changing interest rate is on banks market value of equity or net worth as the economic value of banks assets, liabilities and off balance sheet items affected due to variation in market interest rate. The interest rate risk when viewed from these two perspectives is known as Earning Perspective and Economic value Perspectives respectively. Liquidity Risk The bank always borrows short-term and lends long term. Due to this nature of banking activities it is vulnerable to an asset-liability mismatch thereby resulting into an inability in meeting its commitments. Liquidity risk is essentially a result of adverse movements of other risks i.e. Credit risk, interest risk, foreign exchange risk. Small information in

the market about the liquidity problems faced by a bank may result into withdrawal of enormous deposits, thereby aggravating the problem. Liquidity risk also includes rising of funds at an abnormal cost to meet its commitments. Management of Interest Rate risk and Liquidity risk is together known, as AssetLiability Management is a subset of the whole gamut of risk management tools. Credit Risk Credit Risk is the most fundamental risk faced by a banking company. Credit Risk is the risk of default by a borrower of funds or decline in the credit standing of a borrower. It is the most difficult to quantify due to the large amount of subjectivity involved in it. Thus credit risk management can assist in decision making; it cannot be a substitute to the judgmental decision of a credit officer.

Page 60 Credit Risk Management at SBM Traditionally credit risk has been managed by setting up limits to the global exposure, industry exposure, country exposure and individual client/group exposure. Credit Risk Management is extremely important as the pricing of a portfolio or a transaction is dependent on the risk factor built in it. However, sometimes a bank may only be an adopter of the prevailing market rate of interest. Nothing the else it is important to judge the rational behind accepting and rejecting a credit proposal. Market Risk It is a risk of loss due to adverse movements in the market rates during the compulsory holding period having an impact on the portfolio held by the bank. Compulsorily holding period denotes the duration during which instrument cannot be sold by an organization. This is normally the time period, which is required in taking delivery of the instrument. Any adverse movements beyond the compulsory holding period are due to the judgmental error and therefore should be analyzed differently. Market risk is also important in constantly determining the true worth of a collateral security provided by the borrower. Foreign exchange risk is often regarded as a part of the market risk, but may be bifurcated for facilitating better analysis. Operational Risk It is the risk faced by an organization, arising due to malfunctioning of internal systems, wrong entering of transaction details, wrong interpretation and judgmental errors made by manpower. Operational risk is difficult to quantify and monitor. However certain critical operations or systems have to be identified, the failure of which would raise survival issues for the company. Close and constant monitoring of these systems is an essential part

of operational risk management. The list above is not exhaustive but only indicative of some of primary risks faced by a banking organization. All the risks are interdependent on each other. For e.g., Default by a borrower (Credit Risk) may affect the liquidity position of the bank (Liquidity Risk)

Page 61 SBM norms for Credit Appraisal & Credit Risk Management

Chapter

SBM Norms for Credit Appraisal & Credit Risk management

Credit appraisal means an investigation/assessment done by the bank prior before providing any loans & advances/project finance & also checks the commercial, financial & technical viability of the project proposed its funding pattern & further checks the primary & collateral security cover available for recovery of such funds.

8.1) Loan Policy An Introduction

1.1 State Bank of Mysores (SBM) Loan Policy is aimed at accomplishing its mission of retaining the banks position as a Premier Financial Services Group, with World class standards & significant global business, committed to excellence in customer, shareholder & employee satisfaction & to play a leading role in the expanding & diversifying financial services sector, while continuing emphasis on its Development Banking role. 1.2 The Loan Policy of the any bank has successfully withstood the test of time and with in-built flexibilities, has been able to meet the challenges in the market place. The policy exits & operates at both formal & informal levels. The formal policy is well documented in the form of circular instructions, periodic guidelines & codified instructions, apart from the Book of Instructions, where procedural aspects are highlighted. 1.3 The policy, at the holistic level, is an embodiment of the Banks approach to sanctioning, managing & monitoring credit risk & aims at making the systems & controls effective. 1.4 The Loan Policy also aims at striking a balance between underwriting assets of high quality, and customer oriented selling. The objective is to maintain Banks undisputed leadership in the Indian Banking scene.

Page 62 Credit Risk Management at SBM 1.5 The Policy aims at continued growth of assets while endeavoring to ensure that these remain performing & standard. To this end, as a matter of policy the Bank does not take over any Non-Performing Asset (NPA) from other banks. 1.6 The Central Board of the Bank is the apex authority in formulating all matters of policy in the bank. The Board has permitted setting up of the Credit Policy & Procedures Committee (CPPC) at the Corporate Centre of the Bank of which the Top Management are members, to deal with issues relating to credit policy & procedures on a Bank-wide basis. The CPPC sets broad policies for managing credit risk including industrial rehabilitation, sets parameters for credit portfolio in terms of exposure limits, reviews credit appraisal systems, approves policies for

compromises, write offs, etc. & general management of NPAs besides dealing with the issues relating to Delegation of Powers. Based on the present indications, following exposure levels are prescribed: Maximum aggregate credit facilities of Rs. 20 Individuals as borrowers crores (Fund based and Non fund based) Non-corporate (E.g. Partnerships, Associations, etc.) Maximum aggregate credit facilities of Rs. 80 crores (Fund based and Non fund based) Maximum aggregate credit facilities as per prudential norms of RBI on exposures Corporate Term Loans (loans with residual maturity of over 3 years) should not in the aggregate exceed 35% of the total advances of SBM. The Bank shall endeavor to restrict fund based exposure to a particular industry to 15% of the Banks total fund based exposure. The Bank shall restrict the term loan exposure to infrastructure projects to 10% of Banks total advances. The Bank shall endeavor to restrict exposure to sensitive sectors (i.e. to capital market, real estate, and sensitive commodities listed by RBI) to 10% of Banks total advances. The Banks aggregate exposure to the capital markets shall not exceed 5% of the

Page 63 SBM norms for Credit Appraisal & Credit Risk Management total outstanding advances (including commercial paper) as on March 31 of the previous year. # Credit Appraisal Standards (A) Qualitative: At the outset, the proposition is examined from the angle of viability & also from the Banks prudential levels of exposure to the borrower, Group & Industry. Thereafter, a view is taken about our past experience with the promoters, if there is a track record to go by. Where it is a new connection for the bank but the entrepreneurs are already in business, opinion reports from existing bankers & published data if available are carefully pursued. In case of a maiden venture, in addition to the drill mentioned heretofore, an element of subjectively has to be perforce introduced as scant historical data weights to be placed on impressions gained out of the serious dialogues with the promoter & his business contacts. (B) Quantitative: (a) Working capital: The basis quantitative parameters underpinning the Banks credit appraisal are as follows:(i) Liquidity: Current Ratio (CR) of 1.33 will generally be considered as a benchmark level of liquidity. However the approach has to be flexible. CR of 1.33 is only indicative & may not be deemed mandatory. In cases where the CR is projected at a lower than the benchmark or a

slippage in the CR is proposed, it alone will not be a reason for rejection for the loan proposal or for the sanction of the loan at a lower level. In such cases, the reason for low CR or slippage should be carefully examined & in deserving cases the CR as projected may be accepted. In cases where projected CR is found acceptable, working capital finance as requested may be sanctioned. In specific cases where warranted, such sanction can be with the condition that the borrower should bring in additional long-term funds to a specific extent by a given future date. Where it is felt that the projected CR is not acceptable but the borrower deserves assistance subject to certain conditions, suitable written commitment should be obtained from the borrower to the effect that he would be bringing in required amounts within a mutually agreed time frame.

Page 64 Credit Risk Management at SBM (ii) Net Working Capital: Although this is a corollary of current ratio, the movements in Net Working Capital are watched to ascertain whether there is a mismatch of long term sources vis--vis long term uses for purposes which may not be readily acceptable to the Bank so that corrective measures can be suggested. (iii) Financial Soundness: This will be dependent upon the owners stake or the leverage. Here again the benchmark will be different for manufacturing, trading, hire-purchase & leasing concerns. For industrial ventures a Total Outside Liability/ Tangible Net worth ratio of 3.0 is reasonable but deviations in selective cases for understandable reasons may be accepted by the sanctioning authority. (iv) Turn-Over: The trend in turnover is carefully gone into both in terms of quantity & value as also market share wherever such data are available. What is more important to establish a steady output if not a rising trend in quantitative terms because sales realization may be varying on account of price fluctuations. (v) Profits: While net profit is ultimate yardstick, cash accruals, i.e., profit before depreciation & taxation conveys the more comparable picture in view of changes in rate of depreciation & taxation, which have taken place in the intervening years. However, for the sake of proper assessment, the non-operating income is excluded, as these are usually one time or extraordinary income. Companies incurring net losses consistently over 2 or more years will be given special attention, their accounts closely monitored, and if necessary, exit options explored.

(vi) Credit Rating: Wherever the company has been rated by a Credit Rating Agency for any instrument such as CP / FD, this will be taken into account while arriving at the final decision. However as the credit rating involves additional expenditure, we would not normally insist on this and only use this tool if such an agency had already looked into the company finances.

Page 65 SBM norms for Credit Appraisal & Credit Risk Management (b) Term Loan (i) In case of term loan & deferred payment guarantees, the project report is obtained from the customer, which may be compiled either in-house or by a firm of consultants/ merchant bankers. The technical feasibility & economic viability is vetted by the bank & wherever it is felt necessary, the Credit Officer would seek the benefit of a second opinion either from the Banks Technical Consultancy cell or from the consultants of the Bank/ SBI Capital Markets Ltd. (ii) Promoters contribution of at least 20% in the total equity is what we normally expect. But promoters contribution may vary largely in mega projects. Therefore there cannot be a definite benchmark. The sanctioning authority will have the necessary discretion to permit deviations. (iii) The other basic parameter would be the net debt service coverage ratio i.e. exclusive of interest payable, which should normally not go below 2. On a gross basis DSCR should not be below 1.75. These ratios are indicative & the sanctioning authority may permit deviations selectively. (iv) As regards margin on security, this will depend on Debt: Equity gearing for the project, which should preferably be near about 1.5: 1 & should not in any case be above 2:1, i.e., Debt should not be more than 2 times the Equity contribution. The sanctioning authority in exceptional cases may permit deviations from the norm very selectively. (v) Other parameters governing working capital facilities would also govern Term Credit facilities to the extent applicable. Page 66 Credit Risk Management at SBM # Required Documents for Process of Loan 1) 2) 3) 4) 5) 6) Application for requirement of loan Copy of Memorandum & Article of Association Copy of incorporation of business Copy of commencement of business Copy of resolution regarding the requirement of credit facilities

Brief history of company, its customers & supplies, previous track records, orders in hand. Also provide some information about the directors of the company 7) Financial statements of last 3 years including the provisional financial statement for the year 2007-08 8) 9) Copy of PAN/TAN number of company Copy of last Electricity bill of company 10) Copy of GST/CST number 11) Copy of Excise number 12) Photo I.D. of all the directors 13) Address proof of all the directors 14) Copies related to the property such as 7/12 & 8A utara, lease/ sales deed, 2R permission, Allotment letter, Possession 15) Bio-data form of all the directors duly filled & notarized 16) Financial statements of associate concern for the last 3 years

Delegation of Powers

1. A scheme of Delegation of Powers comprehensively documented in 1985 and amended from time to time is in operation in the Bank in respect of financial and administrative matters for exercise by the various functionaries. This is based on the premise that an executive is required to exercise only those powers which are related to the responsibilities and duties entrusted to him/her. In exercising the powers, the authorities concerned are required to ensure compliance also with the relevant provisions of the State Bank of India Act and the State Bank of India General Regulations and any rules, regulations, instructions or orders issued from time to time by appropriate controlling authorities. 2. The Scheme of Delegation of Financial powers for advances and allied matters in the Bank has a graded authority structure. The Executive Committee of the Central

Page 67 SBM norms for Credit Appraisal & Credit Risk Management Board (ECCB) has full powers for sanctioning credit facilities. The sanctioning powers have been delegated down the line to Committees of officials at various administrative offices and individual line functionaries.
3.

An appropriate control system is also in operation in tune with the Delegation structure. The powers, exercised by various functionaries, are required to be reported to the next higher authority as laid down in the Scheme of Delegation of Financial Powers.

Page 67 Credit Risk Management at SBM # Pricing (Factors deciding interest rates and other charges) 1. Pricing of loans up to Rs.2 lacs will be as prescribed by RBI. In line with RBI guidelines, he Bank announces from time to time its single Benchmark Prime Lending Rate (BPLR), i.e., reference / indicative rates at which the Bank would lend to its best customers. The BPLR would be referred to as State Bank Advance Rate (SBAR) in our Bank. Interest rate without reference to SBAR could be charged in respect of certain categories of loan / credit like discounting of bills, lending to intermediary agencies etc. Interest rates

below SBAR could be offered to exporters or other credit worthy borrowers including public enterprises on the lines of a transparent and objective policy approved by the Bank's Board. All other loans are to be priced on the basis of Bank's SBAR with the pricing being linked to grade of the risk in the exposure. The maximum spread over SBAR which could be charged by the Bank will be decided by the Bank from time to time. Within such ceiling, the pricing for various credit facilities, schemes, products, credit related services etc. Bank may also price floating rate products by using market benchmarks (e.g. MIBOR etc.) in a transparent manner as per Board approved policies. 2. An internal Credit Risk Rating system covering all advances of Rs.25 lacs and above in C&I, SSI segments have been put in place to facilitate structured assessment of credit risks. The system enables evaluation of the fundamental strength of the borrower so as to charge a graded rate of interest based on different ratings. However, taking into consideration the trends in movement of interest rates and market competition, the Bank has also adopted an appropriate authority structure to facilitate competitive pricing of loan products linked both to risk rating and overall business considerations. 3. Bank has introduced fixed interest rates in respect of certain categories of loans in personal segment, e.g. housing term loans to individuals. Fixed interest rates are also extended for commercial loans, albeit highly selectively. 4. Pricing of Bank's funds and services while being basically market driven is also determined by two important considerations, i.e., minimum desired profitability and risk inherent in the transaction. At the corporate level, the applicable price for a particular advance or service is fixed taking into account the marginal cost of Bank's funds and desired rate of return as calculated from indices like profitability levels and return on capital employed. In case of corporate relationship where the value of connections and overall potential for profitability from a particular account are more

Page 68 SBM norms for Credit Appraisal & Credit Risk Management important than a particular transaction, the price is fine tuned even to level of nolossno-profit in the transaction. For long term exposures, the factors that weigh are the rate charged by the financial institutions, the period of exposure, and the pattern of volatility in the interest rates and the expected movement of the rates in the long term perspective. # Credit Monitoring & Supervision 1. Broadly, the objectives of post-sanction follow up, supervision and monitoring are as under: (a) Follow up function: To ensure the end-use of funds To relate the outstanding to the assets level on a continuous basis To correlate the activity level to the projections made at the time of the sanction / renewal of the credit facilities To detect deviation from terms of sanction. To make periodic assessment of the health of the advances by noting some of the key indicators of performance like profitability, activity level, and management of the unit and ensure that the assets created are effectively utilized for productive purposes and are well maintained. To ensure recovery of the installments of the principal in case of term loans as

per the scheduled repayment programme and all interest. To identify early warning signals, if any, and initiate remedial measures thereby averting the incidence of incipient sickness. To ensure compliance with all internal and external reporting requirements covering the credit area. (b) Supervision function: To ensure that effective follow up of advances is in place and asset quality of good order is maintained. To look for early warning signals, identify incipient sickness and initiate proactive remedial measures.

Page 69 Credit Risk Management at SBM (c) Monitoring function : To ensure that effective supervision is maintained on loans / advances and appropriate responses are initiated wherever early warning signals are seen. To monitor on an ongoing basis the asset portfolio by tracking changes from time to time. Chalking out and arranging for carrying out specific actions to ensure high percentage of Standard Assets. Detailed operative guidelines on the following aspects of effective credit monitoring are in place: Post-sanction responsibilities of different functionaries Reporting for control Security documents, Statement of stocks and book debts Computation of drawing power (DP) on eligible current assets and maintaining of DP register Verification of assets Inspection by branch functionaries frequency, reporting, register etc. Stock Audit Follow up based on information systems Follow up during project implementation stage Follow up post-commercial production Monitoring and control Detection and prevention of diversion of working capital finance Monitoring of large withdrawals Allocation of limit Handling of NPA accounts etc. Page 70 SBM norms for Credit Appraisal & Credit Risk Management

8.2) Loan Administration - Pre-Sanction Process

Appraisal, Assessment and Sanction Functions

8.2.1) Appraisal A. Preliminary Appraisal 1. Sound credit appraisal involves analysis of the viability of operations of a business and the capacity of the promoters to run it profitably and repay the bank the dues as and then they fall 2. Towards this end the preliminary appraisal will examine the following aspects of a proposal. Banks lending policy and other relevant guidelines/RBI guidelines, Prudential Exposure norms, Industry Exposure restrictions, Group Exposure restrictions,

 Industry related risk factors, Credit risk rating, Profile of the promoters/senior management personnel of the project, List of defaulters, Caution lists, Acceptability of the promoters, Compliance regarding transfer of borrower accounts from one bank to another, if applicable; Government regulations/legislation impacting on the industry; e.g., ban on financing of industries producing/ consuming Ozone depleting substances; Applicants status vis--vis other units in the industry, Financial status in broad terms and whether it is acceptable The companys Memorandum and Articles of Association should be scrutinized carefully to ensure (i) that there are no clauses prejudicial to the Banks interests, (ii) no limitations have been placed on the Companys borrowing powers and operations and (iii) the scope of activity of the company.

Page 71 Credit Risk Management at SBM 3. Further, if the proposal is to finance a project, the following aspects have to be examined: Whether project cost is prima facie acceptable Debt/equity gearing proposed and whether acceptable Promoters ability to access capital market for debt/equity support Whether critical aspects of project - demand, cost of production, profitability, etc. are prima facie in order 4. After undertaking the above preliminary examination of the proposal, the branch will arrive at a decision whether to support the request or not. If the branch (a reference to the branch includes a reference to SECC/CPC etc. as the case may be) finds the proposal acceptable, it will call for from the applicant(s), a comprehensive application in the prescribed proforma, along with a copy of the proposal/project report, covering specific credit requirement of the company and other essential data/ information. The information, among other things, should include: Organizational set up with a list of Board of Directors and indicating the qualifications, experience and competence of the key personnel in charge of the main functional areas e.g., purchase, production, marketing and finance; in other words a brief on the managerial resources and whether these are compatible with the size and scope of the proposed activity. Demand and supply projections based on the overall market prospects together with a copy of the market survey report. The report may comment on the geographic spread of the market where the unit proposes to operate, demand and supply gap, the competitors share, competitive advantage of the applicant, proposed marketing arrangement, etc. Current practices for the particular product/service especially relating to terms of credit sales, probability of bad debts, etc. Estimates of sales cost of production and profitability. Projected profit and loss account and balance sheet for the operating years during

the currency of the Bank assistance. If request includes financing of project(s), branch should obtain additionally

Page 72 SBM norms for Credit Appraisal & Credit Risk Management Appraisal report from any other bank/financial institution in case appraisal has been done by them, No Objection Certificate from term lenders if already financed by them and Report from Merchant bankers in case the company plans to access capital market, wherever necessary. 5. In respect of existing concerns, in addition to the above, particulars regarding the history of the concern, its past performance, present financial position, etc. should also be called for. This data/information should be supplemented by the supporting statements such as: Audited profit loss account and balance sheet for the past three years (if the latest audited balance sheet is more than 6 months old, a pro-forma balance sheet as on a recent date should be obtained and analyzed). For non-corporate borrowers, irrespective of market segment, enjoying credit limits of Rs.10 lacs and above from the banking system, audited balance sheet in the IBA approved formats should be submitted by the borrowers. Details of existing borrowing arrangements, if any, Credit information reports from the existing bankers on the applicant Company, and Financial statements and borrowing relationship of Associate firms/Group Companies. B. Detailed Appraisal 1) The viability of a project is examined to ascertain that the company would have the ability to service its loan and interest obligations out of cash accruals from the business. While appraising a project or a loan proposal, all the data/information furnished by the borrower should be counter checked and, wherever possible, inter-firm and interindustry comparisons should be made to establish their veracity. 2) The financial analysis carried out on the basis of the companys audited balance sheets and profit and loss accounts for the last three years should help to establish the current viability. 3) In addition to the financials, the following aspects should also be examined: The method of depreciation followed by the company-whether the company is following straight line method or written down value method and whether the Page 73 Credit Risk Management at SBM company has changed the method of depreciation in the past and, if so, the reason therefore; Whether the company has revalued any of its fixed assets any time in the past and the present status of the revaluation reserve, if any created for the purpose; Record of major defaults, if any, in repayment in the past and history of past sickness, if any; The position regarding the companys tax assessment - whether the provisions made in the balance sheets are adequate to take care of the companys tax liabilities; The nature and purpose of the contingent liabilities, together with comments

thereon; Pending suits by or against the company and their financial implications (e.g. cases relating to customs and excise, sales tax, etc.); Qualifications/adverse remarks, if any, made by the statutory auditors on the companys accounts; Dividend policy; Apart from financial ratios, other ratios relevant to the project; Trends in sales and profitability, past deviations in sales and profit projections, and estimates/projections of sales values; Production capacity & use: past and projected; Estimated requirement of working capital finance with reference to acceptable build up of inventory/ receivables/ other current assets Projected levels: whether acceptable; and Compliance with lending norms and other mandatory guidelines as applicable 4) Project financing: If the proposal involves financing a new project, the commercial, economic and financial viability and other aspects are to be examined as indicated below: Statutory clearances from various Government Depts./ Agencies Licenses/ permits/ approvals/ clearances/ NOCs/ Collaboration agreements, as applicable Details of sourcing of energy requirements, power, fuel etc. Pollution control clearance Cost of project and source of finance Build-up of fixed assets (requirement of funds for investments in fixed assets to be

Page 74 SBM norms for Credit Appraisal & Credit Risk Management critically examined with regard to production factors, improvement in quality of products, economies of scale etc.) Arrangements proposed for raising debt and equity Capital structure (position of Authorized, Issued/ Paid-up Capital, Redeemable Preference Shares, etc.) Debt component i.e., debentures, term Loans, deferred payment facilities, unsecured loans/ deposits. All unsecured loans/ deposits raised by the company for financing a project should be subordinate to the term loans of the banks/ financial institutions and should be permitted to be repaid only with the prior approval of all the banks and the financial institutions concerned. Where central or state sales tax loan or developmental loan is taken as source of financing the project, furnish details of the terms and conditions governing the loan like the rate of interest (if applicable), the manner of repayment, etc. Feasibility of arrangements to access capital market Feasibility of the projections/ estimates of sales, cost of production and profits covering the period of repayment Break Even Point in terms of sales value and percentage of installed capacity under a normal production year Cash flows and fund flows Proposed amortization schedule Whether profitability is adequate to meet stipulated repayments with reference to Debt Service Coverage Ratio, Return on Investment Industry profile & prospects Critical factors of the industry and whether the assessment of these and

management plans in this regard are acceptable Technical feasibility with reference to report of technical consultants, if available Management quality, competence, track record Companys structure & systems Applicants strength on inter-firm comparisons

Page 75 Credit Risk Management at SBM For the purpose of inter-firm comparison and other information, where necessary, source data from Stock Exchange Directory, financial journals/ publications, professional entities like CRIS-INFAC, CMIE, etc. with emphasis on following aspects: Market share of the units under comparison Unique features Profitability factors Financing pattern of the business Inventory/Receivable levels Capacity utilization Production efficiency and costs Bank borrowings patterns Financial ratios & other relevant ratios Capital Market Perceptions Current price 52week high and low of the share price P/E ratio or P/E Multiple Yield (%)- half yearly and yearly Also examine and comment on the status of approvals from other term lenders, market view (if anything adverse), and project implementation schedule. A pre-sanction inspection of the project site or the factory should be carried out in the case of existing units. To ensure a higher degree of commitment from the promoters, the portion of the equity / loans which is proposed to be brought in by the promoters, their family members, friends and relatives will have to be brought upfront. However, relaxation in this regard may be considered on a case to case basis for genuine and acceptable reasons. Under such circumstances, the promoter should furnish a definite plan indicating clearly the sources for meeting his contribution. The balance amount proposed to be raised from other sources, viz., debentures, public equity etc., should also be fully tied up. C. Present relationship with Bank: Compile for existing customers, profile of present exposures: Credit facilities now granted Conduct of the existing account Utilization of limits - FB & NFB Page 76 SBM norms for Credit Appraisal & Credit Risk Management Occurrence of irregularities, if any Frequency of irregularity i.e., number of times and total number of days the account was irregular during the last twelve months Repayment of term commitments

 Compliance with requirements regarding submission of stock statements, Financial Follow-up Reports, renewal data, etc. Stock turnover, realization of book debts Value of account with break-up of income earned Pro-rata share of non-fund and foreign exchange business Concessions extended and value thereof Compliance with other terms and conditions Action taken on Comments/observations contained in RBI Inspection Reports: CO Inspection & Audit Reports Verification Audit Reports Concurrent Audit Reports Stock Audit Reports Spot Audit Reports Long Form Audit Report (statutory audit) D. Credit risk rating: Draw up rating for (i) Working Capital and (ii) Term Finance. E. Opinion Reports: Compile opinion reports on the company, partners/ promoters and the proposed guarantors. F. Existing charges on assets of the unit: If a company, report on search of charges with ROC. G. Structure of facilities and Terms of Sanction: Fix terms and conditions for exposures proposed - facility wise and overall: Limit for each facility sub-limits Security - Primary & Collateral, Guarantee o Margins - For each facility as applicable Rate of interest Rate of commission/exchange/other fees o Concessional facilities and value thereof

Page 77 Credit Risk Management at SBM Repayment terms, where applicable ECGC cover where applicable Other standard covenants H. Review of the proposal: Review of the proposal should be done covering i) Strengths and weaknesses of the exposure proposed ii) Risk factors and steps proposed to mitigate them iii) Deviations, if any, proposed from usual norms of the Bank and the reasons therefor. I. Proposal for sanction: Prepare a draft proposal in prescribed format with required backup details and with recommendations for sanction. J. Assistance to Assessment: Interact with the assessor, provide additional inputs arising from the assessment, incorporate these and required modifications in the draft proposal and generate an integrated final proposal for sanction. 8.2.2) Assessment: Indicative List of Activities Involved in Assessment Function is given below: Review the draft proposal together with the back-up details/notes, and the borrowers application, financial statements and other reports/documents examined by the appraiser. Interact with the borrower and the appraiser.

 Carry out pre-sanction visit to the applicant company and their project/factory site. Peruse the financial analysis (Balance Sheet/ Operating Statement/ Ratio Analysis/ Fund Flow Statement/ Working Capital assessment/Project cost & sources/ Break Even analysis/Debt Service/Security Cover, etc.) to see if this is prima facie in order. If any deficiencies are seen, arrange with the appraiser for the analysis on the correct lines. Examine critically the following aspects of the proposed exposure.

Page 78 SBM norms for Credit Appraisal & Credit Risk Management Banks lending policy and other guidelines issued by the Bank from time to time o RBI guidelines Background of promoters/ senior management o Inter-firm comparison Technology in use in the company o Market conditions Projected performance of the borrower vis--vis past estimates and performance Viability of the project Strengths and Weaknesses of the borrower entity. Proposed structure of facilities. Adequacy/ correctness of limits/ sub limits, margins, moratorium and repayment schedule Adequacy of proposed security cover Credit risk rating Pricing and other charges and concessions, if any, proposed for the facilities o Risk factors of the proposal and steps proposed to mitigate the risk Deviations proposed from the norms of the Bank and justifications therefore To the extent the inputs/comments are inadequate or require modification, arrange for additional inputs/ modifications to be incorporated in the proposal, with any required modification to the initial recommendation by the Appraiser Arrange with the Appraiser to draw up the proposal in the final form. Recommendation for sanction: Recapitulate briefly the conclusions of the appraisal and state whether the proposal is economically viable. Recount briefly the value of the companys (and the Groups) connections. State whether, all considered, the proposal is a fair banking risk. Finally, give recommendations for grant of the requisite fund-based and non-fund based credit facilities. 8.2.3) Sanction: Indicative list of activities involved in the sanction function is given below: Peruse the proposal to see if the report prima facie presents the proposal in a comprehensive manner as required. If any critical information is not provided in the proposal, remit it back to the Assessor for supply of the required data/clarifications. Examine critically the following aspects of the proposed exposure in the light of Page 79 Credit Risk Management at SBM corresponding instructions in force: Banks lending policy and other relevant guidelines o RBI guidelines Borrowers status in the industry o Industry prospects Experience of the Bank with other units in similar industry o Overall strength of the borrower Projected level of operations Risk factors critical to the exposure and adequacy of safeguards proposed there against Value of the existing connection with the borrower Credit risk rating Security, pricing, charges and concessions proposed for the exposure and covenants stipulated vis--vis the risk perception.

 Accord sanction of the proposal on the terms proposed or by stipulating modified or additional conditions/ safeguards, or Defer decision on the proposal and return it for additional data/clarifications, or Reject the proposal, if it is not acceptable, setting out the reasons.

8.2.4) Monitoring Delay in Processing Loan Proposal: Branches have to submit a report on credit proposals pending for more than 30 days in two parts. Part I will comprise proposals requiring sanctions at the Branch/ SECC/ ZCC and Part II will contain sanctions by CCC-II and above. Review reports to CCC-I and later to Group Executive, for information, at prescribed intervals will be coordinated by DGM (CCFO). The consolidated position in this regard in respect of all the Circles will be put up to MD & GE (NB) through GM (SME). Page 80 SBM norms for Credit Appraisal & Credit Risk Management

8.3) Loan Administration - Post Sanction Credit Process

8.3.1) Need Lending decisions are made on sound appraisal and assessment of credit worthiness. Past record of satisfactory performance and integrity are no guarantee for future though they serve as a useful guide to project the trend in performance. Credit assessment is made based on promises and projections. A loan granted on the basis of sound appraisal may go bad because the borrower did not carry out his promises regarding performance. It is for this reason that proper follow up and supervision is essential. A banker cannot take solace in sufficiency of security for his loans. He has to a) make a proper selection of borrower b) Ensure compliance with terms and conditions c) Monitor performance to check continued viability of operations d) Ensure end use of funds e) Ultimately ensure safety of funds lent. 8.3.2) Stages of post sanction process The post-sanction credit process can be broadly classified into three stages viz., follow-up, supervision and monitoring, which together facilitate efficient and effective credit management and maintaining high level of standard assets. The objectives of the three stages of post sanction process are detailed below. Page 81 Credit Risk Management at SBM

8.4) Types of Lending Arrangements

Introduction Business entities can have various types of borrowing arrangements. They are A. One Borrower B. One Borrower C. One Borrower

 One Bank (Sole Banking) Several Banks (with consortium arrangement) Several Banks (Without consortium arrangements Multiple Banking) D. One Borrower Several Banks (Loan Syndication)

A. Sole Banking The most familiar amongst the above for smaller loans is the One Borrower-One Bank arrangement where the borrower confines all his financial dealings with only one bank. Sometimes, units would prefer to have banking arrangements with more than one bank on account of the large financial requirement or the resource constraint of his own banker or due to varying terms & conditions offered by different banks or for sheer administrative convenience. The advantages to the bank in a multiple banking arrangement/ consortium arrangement are that the exposure to an individual customer is limited & risk is proportionate. The bank is also able to spread its portfolio. In the case of borrowing business entity, it is able to meet its funds requirement without being constrained by the limited resource of its own banker. Besides this, consortium arrangement enables participating banks to save manpower & resources through common appraisal & inspection & sharing credit information. The various arrangements under borrowings from more than one bank will differ on account of terms & conditions, method of appraisal, coordination, documentation & supervision & control. B. Consortium Lending When one borrower avails loans from several banks under an arrangement among all the lending bankers, this leads to a consortium lending arrangements. In consortium lending, several banks pool banking resources & expertise in credit management together & finance a single borrower with a common appraisal, common documentation & joint supervision & follow up. The borrower enjoys the advantage similar to single window availing of credit Page 82 SBM norms for Credit Appraisal & Credit Risk Management facilities from several banks. The arrangement continues until any one of the bank moves out of the consortium. The bank taking the highest share of the credit will usually be the leader of consortium. There is no ceiling on the number of banks in a consortium. C. Multiple Banking Arrangement Multiple Banking Arrangement is one, where the rules of consortium do not apply & no inter se agreement among banks exists. The borrower avails credit facility from various banks providing separate securities on different terms & conditions. There is no such arrangement called Multiple Banking Arrangement & the term is used only to denote the

existence of banking arrangement with more than one bank. Multiple Banking Arrangement has come to stay as it has some advantages for the borrower & the banks have the freedom to price their credit products & non-fund based facility according to their commercial judgment. Consortium arrangement occasioned delays in credit decisions & the borrower has found his way around this difficulty by the multiple banking arrangements. Additionally, when units were not doing well, consensus was rarely prevalent among the consortium members. If one bank wanted to call up the advance & protect the security, another bank was interested in continuing the facility on account of group considerations. Points to be noted in case of multiple banking arrangements Though no formal arrangement exists among the financing banks, it is preferable to have informal exchange of information to ensure financial discipline Charges on the security given to the bank should be created with utmost care to guard against dilution in our security offered & to avoid double financing Certificates on the outstanding with the other banks should be obtained on the periodical basis & also verified from the Balance sheet of the unit to avoid excess financing

D. Credit Syndication A syndicated credit is an agreement between two or more lending institutions to provide a borrower a credit facility using common loan documentation. It is a convenient mode of raising long-term funds. The borrower mandates a lead manager of his choice to arrange a loan for him. The mandate spells out the terms of the loan & the mandated banks rights & responsibilities. Page 83 Credit Risk Management at SBM The mandated banker the lead manger prepares an information memorandum & circulates among prospective lender banks soliciting their participation in the loan. On the basis of the memorandum & on their own independent economic & financial evolution the leading banks take a view on the proposal. The mandated bank convenes the meeting to discuss the syndication strategy relating to coordination, communication & control within the syndication process &finalizes deal timing, management fees, cost of credit etc. The loan agreement is signed by all the participating banks. The borrower is required to give prior notice to the lead manger about loan drawal to enable him to tie up disbursements with the other lending banks. Features of syndicated loans Arranger brings together group of banks Borrower is not required to have interface with participating banks, thus easy &

hassle fee Large loans can be raised through syndication by accessing global markets For the borrower, the competition among the lenders leads to finer terms Risk is shared Small banks can also have access to large ticket loans & top class credit appraisal & management Advantages Strict, time-bound delivery schedule & drawals Streamlined process of documentation with clearly laid down roles & responsibilities Market driven pricing linked to the risk perception Competitive pricing but scope for fee-based income is also available Syndicated portions can be sold to another bank, if required Fixed repayment schedule & strict monitoring of default by markets which punish indiscipline

Page 84

Chapter

09 Findings
Credit Risk Management is done to check the commercial, financial & technical viability of the project proposed its funding pattern & further checks the primary or collateral security cover available for the recovery of such funds. Credit & risk go hand in hand. Credit is the core activity of the banks & important source of their earnings. In the business world risk arises out of: Deficiencies / lapses on the part of the management Uncertainties in the business environment Uncertainties in the industrial environment Weakness in the financial position Banks main function is to lend funds/ provide finance but it appears that norms are taken as guidelines not as a decision making. A bankers task is to identify/assess the risk factors/parameters and manage/mitigate them on continuous basis. The CRA models adopted by the bank takes into account all possible risk factors like financial, industrial, business, and management; which are rated separately. After analyzing proposals, we found that in some cases, loan is sanctioned due to strong financial parameters. Where as in some cases, financial performance of the company/firm was poor, even though loan was sanctioned due to some other strong parameters such as the unit has got confirm order, the unit was an existing profit making unit, management was very sound or the company is working in the developmental needs of the society. Thus, we can say that bank considers the subjective matters which generally CRA model

ignores.

Page 85 Credit Risk Management at SBM

Chapter

10 Suggestions
After studying the CRA process and credit policy of bank, we are of the opinion that the Bank is required to have a system for monitoring the over all composition and quality of the various portfolios since credit related problems in banks are concentrated within the credit portfolio. It can take many forms and can arise whenever a significant number of credits have similar risk characteristics. Also the Bank will not necessarily forego booking sound credits solely on the basis of concentration. Bank may use alternatives to reduce or mitigate concentration. Such measure includes: 1) Pricing for additional risk 2) Ask borrower to increase holdings of capital to compensate for the additional risk 3) Making use of loan participation in order to reduce dependency on a particular sector of economy or group of related borrowers 4) Fixing exposure limits for borrowers and for various industrial sectors 5) Collateral security in addition to main securities stipulating asset coverage ratio on case to case basis 6) Personal Guarantees / Corporate Guarantees having reasonable net worth 7) Escrow mechanism for meeting the financial commitments on time

Page 86 Credit Risk Management at SBM

Chapter

11 Conclusion
Credit risk management in todays deregulated market is a challenge. To avoid being blindsided, banks must develop a competitive Early Warning System which combines strategic planning, competitive intelligence and management action. Here in our study, SBM loan policy contains various norms for sanction of different types of loans. These all norms do not apply to each & every case. SBM norms for providing loans are flexible & it may differ from case to case. The CRA models adopted by the bank take into account all possible risk factors to mitigate the risk with a loan. These have been categorized broadly into financial, business, industrial, and management risks. Usually, it is seen that credit appraisal is basically done on the basis of fundamental

soundness. But, after analyzing different types of proposals, our conclusion was such that, in SBM, credit appraisal system is not only looking for financial wealth; other strong parameters also play an important role in analyzing creditworthiness of the firm. Out of the 5 proposals, in one proposal, loan was sanctioned despite of having poor financial records. In another case, even the financial performance was good and loan was defaulted due to management related issues. In all, the viability of the project from every aspect is analyzed, as well as type of business, industry, promoters, past records, experience, projected data and estimates, goals, long term plans also plays crucial role in increasing chances of getting project approved for loan. At last we can say that,

.A banks success lies in its ability to assume and aggregate risk within tolerable and manageable limits.