Project Report on

Credit Rating Procedure of Banks/Financial Institutions

Submitted by

Vrushank Mehta PGDBM Finance, 2005 07

Project Guide

Prof. Mohite

UNIVERSITY OF MUMBAI

N.L.DALMIA INSTITUTE OF MANAGEMENT STUDIES AND RESEARCH, MUMBAI

CERTIFICATE
This is to certify that the project entitled Credit Rating procedure of Banks & Financial Institutions is successfully completed by Mr. Vrushank Mehta during PGDBM Semester IV in partial fulfillment of the course under University Of Mumbai through N. L. Dalmia Institute Of Management Studies & Research.

Prof. P.L.Arya Prof. Mohite Director Project Guide

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ACKNOWLEDGEMENT

I wish to thank and express my gratitude to those who extended their valuable cooperation and contribution towards the project who took out of their busy schedule and provided easy access to the information required. I would also like to thank my project guide Prof. Mohite for timely and unobtrusive guidance given to me. Also thanks to my friends and colleagues for their enduring patience and valuable criticism which shaped the project well.
Vrushank Mehta
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EXECUTIVE SUMMARY
The Reserve Bank of India (RBI), Indias central bank, is responsible for licensing and supervising financial institutions and banks as well as non-banking financial companies. Established in 1934, the RBI is vested with extensive powers under The RBI Act, 1934 and The Banking Regulation Act, 1949 to monitor and regulate all commercial banks and banking activities in India. The RBI has laid down guidelines on the prudential norms with which it expects all commercial banks to comply. The areas covered include capital adequacy, income recognition and asset classification, provisioning for non-performing assets (NPAs), valuation of investments and other related matters. These guidelines are based on the November 1991 recommendations of the Committee on the Financial System (The Narasimham Committee)set up by the RBI and the subsequent 1998 suggestions of the Committee on Banking Sector Reforms (the second Narasimham Committee). In recent years, the RBI has been tightening its prudential norms to bring them into line with best international practice. A basic precept of rating is that one should get to understand the business of the bank in question, the objectives of its management, the environment it operates in and the most likely future development of its business. This assists in arriving at

a rating judgement rooted in an international perspective, which, nevertheless, accommodates the particular circumstances of the bank (whether national, regional or sectoral), preventing hasty pre-judgements based on criteria which are in one way or another inappropriate. There are, however, certain universally applicable attributes of banks asset quality is a good example - for which the rating agency considers it is possible, and desirable, to set standards which have a degree of uniformity.

Table of content Topic Introduction Rating Definition Rating Process & Framework Credit Rating Process Of Bank & Financial Institution Case Report I Case Report II Conclusion Annexure-I Annexure-II Annexure-III Annexure-IV Bibliography Page Number 1 3 11 15 32 54 56 57 65 66 68 69

Introduction

The primary objective of rating is to provide guidance to investors\creditors in determining a credit risk associated with a debt instrument\credit obligation. It does not amount to a recommendation to buy, hold or sell an instrument as it does not take into consideration factors such as market prices, personal risks preferences and other considerations which may influence an investment decision. The rating process is itself based on certain givens. The agency, for instance, does not perform an audit. Instead, it is required to rely on information provided by the issuer and collected by analysts from different sources, including interactions in -person with various entities. Consequently, the agency does not guarantee the completeness or accuracy of the information on which the rating is based. To quote "In determining a rating, both quantitative and qualitative analyses are employed. The judgment is qualitative in nature and the role of the quantitative analysis is to help make the best possible overall qualitative judgment because, ultimately, a rating is an opinion." Standard & Poors Ratings, usually expressed in alphabetical or alphanumeric symbols, are a simple and easily understood tool enabling the investor to differentiate between debt instruments on the basis of their underlying credit quality. The credit rating is thus a symbolic indicator of the current opinion of the relative capability of the issuer to service its debt obligation in a timely fashion, with specific reference to the instrument being rated. It is focused on communicating to the investors, the relative ranking of the default loss probability for a given fixed income investment, in comparison with other rated instruments.

Credit Rating; as elucidated by the leading rating agencies of the world

"A rating is an opinion on the future ability and legal obligation of the issuer to make timely payments of principal and interest on a specific fixed income security. The rating measures the probability that the issuer will default on the security over its life, which depending on the instrument, may be a matter of days to 30 years or more. In addition, long term ratings incorporate an assessment of the expected monetary loss should a default occur." Moodys " Credit ratings help investors by providing an easily recognizable, simple tool that couples a possibly unknown issuer with an informative and meaningful symbol of credit quality." Standard & Poors A rating is specific to a debt instrument and is intended as a grade, an analysis of the credit risk associated with the particular instrument. It is based upon the relative capability and willingness of the issuer of the instrument to service the debt obligations (both principal and interest) as per the terms of the contract. Thus a rating is neither a general purpose evaluation of the issuer, nor an overall assessment of the credit risk likely to be involved in all the debts contracted or to be contracted by such entity.

RATING DEFINITIONS
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Long Term Rating Scales

High Investment Grades
AAA

Debentures rated `AAA' are judged to offer highest safety of timely payment A) of interest and principal. Though the circumstances providing this degree of safety is likely to change, such changes as can be envisaged are most unlikely to affect adversely the fundamentally strong position of such issues. Debentures rated
'AA'

(Triple Highest Safety

AA

are judged to offer high safety of timely payment of

(Double A) interest and principal. They differ in safety from `AAA' issues only High Safety marginally. Investment Grades A Debentures rated `A' are judged to offer adequate safety of timely payment Adequate of interest and principal; however, changes in circumstances can adversely Safety
BBB

affect such issues more than those in the higher rated categories. Debentures rated `BBB' are judged to offer sufficient safety of timely B) payment of interest and principal for the present; however, changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal than for debentures in higher rated categories. Speculative Grades Debentures rated `BB' are judged to carry inadequate safety of timely

(Triple Moderate Safety

BB

(Double B) payment of interest and principal; while they are less susceptible to default Inadequate than other speculative grade debentures in the immediate future, the Safety uncertainties that the issuer faces could lead to inadequate capacity to make
B

timely interest and principal payments Debentures rated `B' are judged to have greater susceptibility to default; while currently interest and principal payments are met, adverse business or economic conditions would lead to lack of ability or willingness to pay interest or principal. Debentures rated `C' are judged to have factors present that make them vulnerable to default; timely payment of interest and principal is possible only if favorable circumstances continue. Debentures rated `D' are in default and in arrears of interest or principal payments or are expected to default on maturity. Such debentures are

High Risk

Substantial Risk
D

In Default

extremely speculative and returns from these debentures may be realized only on reorganization or liquidation. 1) CRISIL may apply "+" (plus) or "-" (minus) signs for ratings from AA to

Note:

D to reflect comparative standing within the category. 2) The contents within parenthesis are a guide to the pronunciation of the rating symbols. 3) Preference share rating symbols are identical to debenture rating symbols except that the letters "pf" are prefixed to the debenture rating symbols, e.g. pfAAA ("pf Triple A"). Fixed Deposit Rating Scales This rating indicates that degree of safety regarding timely payment of interest and principal is very strong.

FAAA

("F Triple A") Highest Safety

FAA

This rating indicates that the degree of safety regarding timely payment of interest and principal is strong. However, the relative degree of safety is not as high as for fixed deposits with "FAAA" rating. This rating indicates inadequate safety of timely payment of interest and principal. Such issues are less susceptible to default than fixed deposits rated below this category, but the uncertainties that the issuer faces could lead to inadequate capacity to make timely interest and principal payments. This rating indicates inadequate safety of timely payment of interest and principal. Such issues are less susceptible to default than fixed deposits rated below this category, but the uncertainties that the issuer faces could lead to inadequate capacity to make timely interest and principal payments. This rating indicates that the degree of safety regarding timely payment of interest and principal is doubtful. Such issues have factors at present that make them vulnerable to default; adverse business or economic conditions would lead to lack of ability or willingness to pay interest or principal. This rating indicates that the issue is either in default or is expected to be in default upon maturity. 1) The rating agency may apply "+" (plus) or "-" (minus) signs for ratings from FAA to FC to indicate the relative position within the rating category

("F Double A") High Safety

FA

Adequate Safety
FB

Inadequate Safety
FC

High Risk

FD

Default Note:

of the company raising fixed deposits. 2) The contents within parenthesis are a guide to the pronunciation of the rating symbols. Rating For Short-Term Instruments (Commercial Paper) This rating indicates that the degree of safety regarding timely payment on the instrument is very strong. This rating indicates that the degree of safety regarding timely payment on the instrument is strong; however, the relative degree of safety is lower than
P-3

P-1

P-2

that for instruments rated "P-1". This rating indicates that the degree of safety regarding timely payment on the instrument is adequate; however, the instrument is more vulnerable to the adverse effects of changing circumstances than an instrument rated in the two higher categories. This rating indicates that the degree of safety regarding timely payment on the instrument is minimal and it is likely to be adversely affected by shortterm adversity or less favorable conditions. This rating indicates that the instrument is expected to be in default on maturity or is in default. CRISIL may apply "+" (plus) sign for ratings from P-1 to P-3 to reflect a comparatively higher standing within the category Rating Scales For Structured Obligations (so) This rating indicates highest degree of certainty regarding timely payment of financial obligations on the instrument. Any adverse changes in circumstances are most unlikely to affect the payments on the instrument. This rating indicates high degree of certainty regarding timely payment of financial obligations on the instrument. This instrument differs in safety from `AAA' instruments only marginally. This rating indicates adequate degree of certainty regarding timely payment of financial obligations on the instrument. Changes in circumstances can adversely affect such instruments more than those in the higher rated categories. This rating indicates a moderate degree of certainty regarding timely payment of financial obligations on the instrument. However, changing 10

P-4

P-5

Note :

AAA(so)

(Triple A SO)
AA(so)

(Double A SO)
A(so)

BBB(so)

(Triple B

SO)
BB(so)

circumstances are more likely to lead to a weakened capacity to meet financial obligations than for instruments in higher rated categories. This rating indicates inadequate degree of certainty regarding timely payment of financial obligations on the instruments. Such instruments are less susceptible to default than instruments rated below this category. This rating indicates high risk and greater susceptibility to default. Any adverse business or economic conditions would lead to lack of capability or willingness to meet financial obligations on time. This rating indicates that the degree of certainty regarding timely payment of financial obligations is doubtful unless circumstances are favorable. This rating indicates that the obligor is in default or expected to default. 1) CRISIL may apply "+" (plus) or "-" (minus) signs for ratings from AA to C to reflect comparative standing within the category. 2) The contents within parenthesis are a guide to the pronunciation of the rating symbols.

(Double B SO)
B(so)

C(so)

D(so) Note :

Foreign Structured Obligations (Fso) Rating Scales The credit rating agency has developed a framework for rating the debt obligations of Indian corporates supported by credit enhancements extended by entities based outside the country. The issues considered inter alia include the credit worthiness of the offshore entity, the nature and structure of the credit enhancement mechanism to ensure timely payments on rated debt obligations an regulatory issues as regards the transfer risk. The credit rating would notch up the standalone credit ratings of these Indian issuers depending on all these factors. CRISIL ratings of Foreign Structured Obligations (fso) factor the credit enhancement extended by an entity based outside the country. The ratings indicate the degree of certainty regarding timely payment of financial obligations on the instrument. These ratings have been assigned in the current regulatory framework as regards the transfer risk and any change therein could impact the ratings. The credit enhancements could be in the form of guarantees, letters of credit, asset backing or other suitable structures. Due to the current regulatory controls on inward remittances, CRISIL would require suitable liquidity mechanisms to be in place for ensuring timely

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payment on due dates. Foreign Structured Obligations ratings are based on the same scale (AAA through D) as CRISIL ratings for long-term instruments. Foreign Structured Obligations ratings symbols are defined below:
AAA(fso) (Triple A)*

High Investment Grades Highest Safety - This rating indicates highest degree of certainty regarding timely payment of financial obligations on the instrument. Any adverse changes in circumstances are most unlikely to affect the payments on the instrument.

AA(fso) (Double A)*

Highest Safety

- This rating indicates high degree of certainty regarding

timely payment of financial obligations on the instrument. This instrument differs in safety, from "AAA(fso)" instruments only marginally. Investment Grades -This rating indicates adequate degree of certainty

A(fso) *

Adequate Safety

regarding timely payment of financial obligations on the instrument. Changes in circumstances can adversely affect such instruments. Changes in circumstances can adversely affect such instruments more than those in
BBB(fso) (Triple B) *

the higher rated categories. Moderate Safety - This rating indicates a moderate degree of certainty regarding timely payment of financial obligations on the instrument. However, changing circumstances are more likely to lead to a weakened capacity to meet financial obligations than for instruments in higher rated categories. Speculative Grades Inadequate Safety - This rating indicates inadequate degree of certainty regarding timely payment of financial obligation on the instrument. Such instruments are less susceptible to default than instruments rated below this category.

BB(fso) (Double B) *

B(fso)

High Risk

- This rating indicates high risk and greater susceptiblity to

default. Any adverse business or economic conditions would lead to lack

C(fso)

of capability or willingness to meet financial obligations on time. Substantial Risk - This rating indicates that the degree of certainty regarding timely payment of financial obligations is doubtful unless circumstances

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D(fso)

are favorable. Default - This rating indicates that the obligation is in default or expected to

default. Note: The contents within Parenthesis are a guide to the pronunciation of the rating symbols. Credit Rating Scale for Financial Strength Ratings (FSR) Ratings are broadly divided into two categories - Secure and Vulnerable. Rating categories from "AAA" to "BBB" are classified as 'secure' ratings and are used to indicate insurance companies whose financial capacity to meet policyholder obligations is sound. Rating categories from "BB" to "D" are classified as vulnerable ratings and are used to indicate insurance companies whose financial capacity to meet policyholder obligations is vulnerable to adverse economic and underwriting conditions. The opinion does not take into account timeliness of payment or the likelihood of the use of a defense such as fraud to deny claims. For insurance companies with cross-border or multi-national operations, including those conducted by branch offices or subsidiaries, ratings do not take into account any potential that may exist for foreign exchange restrictions to prevent policy obligations from being met. Financial strength ratings do not refer to an insurance company's ability to meet non-policy obligations (i.e. debt contracts).The ratings are not recommendations to purchase or discontinue a policy, contract or security issued by an insurance company nor are they guarantees of financial strength.
Secure Ratings AAA Reflects Highest Financial Strength to meet policyholder obligations.

Though the

circumstances providing this strength are likely to change, such changes as can be
AA

envisaged are most unlikely to affect adversely the fundamentally strong position. Reflects High Financial Strength to meet policyholder obligations. Though the circumstances providing this degree of strength are likely to change, such changes as can be envisaged are most unlikely to affect adversely the fundamentally strong position. Companies in this category differ only marginally from the 'AAA' rated insurance companies.

Reflects Adequate Financial Strength to meet policyholder obligations.

However, change

in circumstances can adversely affect such companies more than those in the

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higher rated categories.

BBB Reflects Moderate Financial Strength to meet policyholder obligations.

However,

changing circumstances are more likely to lead to a weakened capacity to meet policyholder obligations than the higher rated categories.
Vulnerable Ratings BB Reflects Inadequate Financial Strength to meet policyholder obligations.

While

companies rated in this category are less susceptible to default than other speculative grade companies in the immediate future, the uncertainties that they
B

face could lead to inadequate capacity to meet their policyholder obligations. Reflects Greater Susceptibility to default on policyholder obligations. While current obligations are met, adverse business or economic conditions would lead to lack of ability or willingness to meet policyholder obligations. Vulnerable to default. Ability to meet policyholder obligations is possible only if favourable circumstances prevail. In default. Current policyholder obligations are in default. Insurance companies rated "D" are extremely speculative and policyholder obligations may be realized

only on reorganization or liquidation. Financial strength ratings from "AA" to "BB" may be modified by use of a plus (+) or (minus
(-)

sign to show the relative standing of the insurance / reinsurance company within the
Bond Fund Rating Scales

rating categories.
AAAf

The funds portfolio holdings provide very strong protection against losses from credit defaults. The funds portfolio holdings provide strong protection against losses from credit defaults. The funds portfolio holdings provide adequate protection against losses from credit defaults. The funds portfolio holdings provide moderate protection against losses from credit defaults. The funds portfolio holdings provide inadequate protection against losses from credit defaults. The funds portfolio holdings have factors present which make them vulnerable to credit defaults.

AAf

Af

BBBf

BBf

Cf

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Rating Process & Framework

Rating is an interactive process with a prospective approach. It involves series of steps. The main points are described as below : ( a ) Rating request : Ratings in India are initiated by a formal request (or mandate ) from the prospective issuer . This mandate spells out the terms of the rating assignment . Important issues that are covered include : binding the credit rating agency to maintain confidentiality , the right to the issuer to accept or not to accept the rating and binds the issuer to provide information required by the credit rating agency for rating and subsequent surveillance. ( b ) Rating team : The team usually comprises two members. The composition of the team is based on the expertise and skills required for evaluating the business of the issuer. ( c ) Information requirements : Issuers are provided a list of information requirements and the broad framework for discussions. These requirements are derived from the experience of the issuers business and broadly conforms to all the aspects which have a bearing on the rating. These factors have been discussed in detail under Rating framework. (d) Secondary information : The credit rating agency also draws on the secondary sources of information including its own research division. The credit rating agency also has a panel of industry experts who provide guidance on specific issues to the rating team. The secondary sources generally provide data and trends including policies about the industry. (e) Management meetings and plant visits : Rating involves assessment of number of qualitative factors with a view to estimate the future earnings of the issuer. This requires

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intensive interactions with the issuers management specifically relating to plans , future outlook , competitive position and funding policies. Plan visits facilitate understanding of the production process , assess the state of equipment and main facilities , evaluate the quality of technical personnel and form an opinion on the key variables that influence level , quality and cost of production. These visits also help in assessing the progress of projects under implementation. (f) Preview meeting: After completing the analysis, the findings are discussed at length in the internal committee, comprising senior analysts of the credit rating agency. All the issues having a bearing on the rating are identified. At this stage , an opinion on the rating is also formed. (g) Rating Committee meeting: This is the final authority for assigning ratings. A brief presentation about the issuers business and the management is made by the rating team. All the issues identified during discussions in the internal committee are discussed. The rating committee also considers the recommendation of the internal committee for the rating. Finally, a rating is assigned and all the issues which influence the rating are clearly spelt out. (h ) Rating communication : The assigned rating along with the key issues is communicated to the issuers top management for acceptance. The ratings which are not accepted are either rejected or reviewed. The rejected ratings are not disclosed and complete confidentiality is maintained. ( I ) Rating Reviews : If the rating is not acceptable to the issuer , he has a right to appeal for a review of the rating . These reviews are usually taken up only if the issuer provides fresh inputs on the issues that were considered for assigning the rating. Issuers response is

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presented to the Rating Committee. If the inputs are convincing, the Committee can revise the initial rating decision. ( j ) Surveillance : It is obligatory on the part of the credit rating agency to monitor the accepted ratings over the tenure of the rated instrument. As has been mentioned earlier, the issuer is bound by the mandate letter to provide information to the credit rating agency. The ratings are generally reviewed every year, unless the circumstances of the case warrant an early review . In a surveillance review the initial rating could be retained or revised (upgrade or downgrade ). How Does the Ratings Process Work? The process of Rating starts with the issue of the Rating Request by the issuer/ signing of the Rating agreement. A detailed flow chart is as under:

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Limitations of Credit Ratings A Credit Rating is an assessment carried out from the limited standpoint of credit risk evaluation. A Credit Rating from rating agency therefore constitutes a current Opinion on the credit quality of a specific issue of debt, in terms of the issuers ability and willingness to meet principal and interest payments on rated debt instruments in a timely manner. Credit Ratings are arrived at based on information obtained in the rating process. In addition to management meetings and information provided by rated entities, the rated entitys audited accounts, regulatory filings, and information provided by trustees form an important source of information. CRISIL does not verify and validate all the information that it uses for its ratings. However, reasonable due diligence is carried out on all information used to the extent feasible to ensure that a meaningful and accurate rating exercise is done (for instance, financial accounts are extensively adjusted to ensure that they present a relevant picture of the financial position of an entity from a debt servicing perspective, to the extent feasible).

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Rating process for Bank/Financial institution

Once we have received a request for a new rating of a bank (this should subsequently be backed by a formal rating agreement), we follow the procedures outlined below:

1. Analyzing the Banks/FIs environment

It is first necessary to collect and analyze data relating to the it system in which the Banks/FIs in question operates and to the place of the Banks/FIs within that system. This process includes analysis of the relevant national Banks/FIs market and of existing and potential competition in that market and also of the degree of concentration within it. It requires examination of the role and functions of the Banks/FIs supervisory authorities in the country in question, of the degree of state control (or decontrol) of that countrys Banks/FIs system, of the requirements of public reporting Banks/FIs and of the accounting practices that lie behind the figures publicly reported by Banks/FIs. On a still wider scale it is necessary to take into account the requirements of the Basle G 10 Agreement on "International convergence of capital measurement and capital standards" and subsequent interpretative statements from the Basle Committee (of international bank supervisors).

2) Bank questionnaire:
Based on our initial analysis of publicly available data, we prepare a questionnaire for presentation to the management of the bank to be rated. A copy of our "prototype" questionnaire is attached as Appendix 1. This is intended to serve as a basis which may be adapted for the particular circumstances of the bank being rated.

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3) Meeting with bank:

As already indicated, the next step is a meeting with senior management of the bank in question to discuss and assess the data provided. Such meetings are usually arranged with the bank's chief financial officer, but many of the more sophisticated banking groups and banks now employ rating agency liaison officers. The length and number of meetings with management depend on the complexity of the entity being rated, but, normally the first time we rate a bank there will be one such meeting, and it will last for half a day to a day.

4) Analysis of the bank :

The Cramel Model comprises the following: I. II. III. IV. V. VI. Capitals adequacy ratio Resource raising ability Asset quality Management & system evaluation Earning potential Liquidity / Asset Liability Management

NO one factor has an overriding importance or is considered in isolation. These entire six factors are viewed in conjunction before assigning rating. In addition to the factors which constitute the CRAMEL, the size of the financial entity is also an important parameter. The size of an entity in the financial sector, imparts it the ability to with stand systematic shock, support that can be expected for the entity.

I CAPITAL ADEQUACY:

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Capital adequacy of an entity provides the necessary capital cushion to with stand credit risks. While assigning a rating, it analyses the capital adequacy level and its sustainability in the medium to long term. The analysis of capital adequacy encompasses the following factors: I.1 Size of capital: The absolute size of a capital imparts flexibility to a bank / FI to withstand shock and thus an entity with higher absolute capital is viewed favorably.

I.2 Quality of Capital (Tier-I Capital): The proportion of Tier I capital or core capital of a bank /FI is the primary indicator of the quality of capital .The level of Tier-I capital is given primary importance when assigning rating for capital adequacy .Although the presence of Tier-II capital does provide some cushion in the short to the medium term , the Tier-II capital needs to be periodically replenished .It also analyses other issues like the presence of hidden reserve and the percentage of the investment portfolio marked to the market. These issues help in streamlining accounting policy differential across various entities and have a bearing on the quality of capital.

I.3 Flexibility to raise Tier I capital: An entity has the flexibility to raise Tier I capital either through internal accruals or through the capital markets. The ability of the entity to access the capital market to meet its Tier I capital needs and its ability to service the increased considered while evaluating the flexibility of a bank /FI to support the capital base is increased asset

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base through earning is an important parameters in assessing capital adequacy .An entity which is able to sustain asset growth generation without impairing capital adequacy is viewed I.4 Growth Plans:

sustainability through

of internal

favorably.

Its factors the future growth plans of a bank/ Fi while analyzing capital adequacy .The capital adequacy of the entity (although at currently high levels) would be regarded as unsustainable , if it pursuing a strategy of high growth .

II Resource raising ability:

It analyses the resource position of the bank /FI in terms of its ability to maintain a low cost , stable resource base .In the domestic context , the resource (funding) composition of bank and FIs is very different .Bank are significantly deposit funded where as the FIs have to depend on wholesale funds . Although some FIs do raise retail funds, they are at a natural disadvantage (in raising retail deposits) as compared to the banking sector in terms of the restrictions on the minimum tenure and interest rates, the absence of a cheque issuing facility and a relatively smaller branch network. Some of the FIs do have access to significant concessional funding from the government if they are playing a role which is of policy importance t the country. However, in general the dependence on wholesale funding attaches a degree of risk t the funding profile of FIs.These risks (especially stability of resource) are partly mitigated by the access that the all India Financial Institutions (AIFIs) have to funds from provident funds and insurance sectors; these funds are of a retail origin .Given this basic distinction in funding profiles between bank/FIs, the funding risk profile of bank / FIs is discussed separately.

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The following issues are considered while analyzing the resources position of a bank. II.1 Size of a deposit base: A large deposit base provides stability to the resource position of a bank. The size of a deposit base provides the bank, a critical mass for effectively managing its cash flows and adds considerably to the diversity (in term of the number of deposits) of the deposit base. Diversity in the deposit base & in term of large numbers of small ticket size deposit, the geographically spread and the optimal rural /urban mix, lend stability to the resources position of a bank. The number of branches and their geographical spread lend diversity to the deposit base of a bank. Thus a bank with large number of branches, dispersed all over India and an optimal rural / urban mix is viewed favorably. II.2 Deposit Mix: The deposit mix of a bank has an impact on the cost of deposits. A high proportion of saving and current deposit, signify a well entrenched deposit base and lead to a stable and low cost resource base. It also analyses the trends in deposit mix to form an opinion on the future stability and costs. II.3 Growth in deposit: Accretion to deposit is the main source of funding asset growth, and managing liquidity risk in bank .It compares the growth in deposit of a bank with industry trends to make relative judgements. II.4 Cost of deposit:

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Cost of deposit is a function of deposit mix of the bank, its region of operation and the bank to attract deposit at lower rates. Bank which have a low cost of resources, not only benefits through higher profitability but also have a higher flexibility to maintain their resources position, in the face of increasing competition. The relevant issues while analyzing the resources position of a FIs: II.5 Diversity of investor base: Given the fact that the FIs are predominantly wholesale funded, the diversity of the investor population (both domestic and international) does mitigate the risk profile to a certain extent .FIs which is dependent on a few investors are viewed less favorably. II.6 Funding mix and cost of funds: Traditionally, all the FIs enjoyed concessional funding from the government in the form of SLR bonds. This facility has been progressively withdrawn from the institutions and they have been increasingly accessing market borrowing over the past few years. The mix of funds between the government and market borrowing over the past few years. The mix of the funds between the government and market borrowed funds is an important determinant of the overall cost of funds for an FI. FIS which still carry a significant proportion of concessional funds on their books will tend to enjoy a cost of funds advantage in the near terms. The funding mix between domestic and foreign currency funding is also examined to determine the overall risk profile .FIs which tend to have a higher proportion of a foreign currency borrower defaulting on payment obligation and thus exposing the FI to currency risk.

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This risk assumes significance in the current context, when the economy is slowing down and there is a greater instance of corporate defaults. In case of FIs which have been significantly dependent on foreign currency multilateral funds, the recently imposed economic sanction would affect their resource raising capabilities. II.7 Retail Penetration: Some of the leading FIs have started tapping the retail market for bonds and deposits. These funds do impart stability to the funding mix and the trends in raising retail resource are factored favorably into its risk evaluation

III ASSET Quality:

Asset quality of bank/FIs is a measure of the ability of the bank to mange credit risks. Its analyses the asset quality on the basis of the following parameters: Geographical diversity and diversity across industries: Geographical diversity of an asset base and diversity across industries, along with single risk concentration limits are important inputs in determining the asset quality of bank/FIs. Industrial development of the states in the western region, like Maharashtra and Gujarat

is relatively higher. Thus, the amount of credit extended in this region is higher concentration of advances in the western region .However , the bank /FIs with all India presence have the additional flexibility due to their widespread branch network , to enhance their exposure to other region , in case of adverse economic development in these states .However , the regional banks with limited operation and branch network have lesser flexibility to diversify their advances portfolio and are thus susceptible t adverse economic condition in a particular region.

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Diversity across industries is largely a function of the geographical presence of the Bank/FIs and Management policy. The industry exposure and single risk concentration is monitored by the central bank through exposure guidelines. However, some bank/FIs show a high degree of exposure t certain industries thus making themselves vulnerable to downturns in those industries. III.1 Client Profile of the corporate asset portfolio: Credit quality of the corporate portfolio of the bank is an important input in the analysis of the asset quality .It analyses the profile of the client in the asset portfolio to make a judgement on portfolio quality. The ability of bank/FIs to attracts better credit quality, especially after the dismantling of consortium lending. The size (of capital) of a financial sector entity lends considerable flexibility to the entity to attract larger and better quality clients given its sheer ability to take on larger exposure in its balance sheet. Also, the ability of the entities to attract and retain good quality clients by providing value added service would enhance asset quality in the future. III.2 Quality of Non-industrial lending: Bank in India have an obligation to lend a proportion of their funds to the priority Sector which primarily encompasses agriculture and small scale industries. To this extent, FIs are better placed than banks because they do not have any such obligation. It analyses the credit quality of this non-industrial portfolio in arriving at a judgement on an overall asset quality of a bank. The credit quality of the asset portfolio is also indicated by the segment wise NPA levels of the portfolio, indicates the performance of the bank in each segment. This help in gauging the

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relative strength of the bank in each of the loan segment. Some of the banks have a higher level of exposure to the trading. These advances provide a comparatively higher yield and also provide diversity due to their small ticket size. The Indian banks have to compulsorily lend 40% of their total advances to the priority sector. The break up of the loan within these sectors in an important indicator of the quality of the portfolio .E.g. An agricultural loan in an agriculturally prosperous state of Punjab would have a better probability of being repaid as compared to other agriculturally weak states. Retail consumers loans (primarily vehicle and housing loans) still do not constitute a major portion of the asset profile of bank/FIs. However, some large bank/FI is strategizing towards a universal bank strategy and proposes to expand significantly in this segment. It looks at the quality of retail consumers credit growth and its final analysis. III.3 NPA LEVEL: The asset quality of a bank depends not only on the credit quality of its but also on the ability of the bank to manage its asset portfolio. The NPA figures at gross and net levels help in benchmarking the bank/Fish ability to manage their portfolio, on a relative scale. While the gross NPA levels are an indicator of the inherent quality of the asset portfolio of the entity and thus the credit appraisal capabilities, the net NPA levels are an indicator of the balance sheet strength of the bank, The NPA levels also indicate the proportion of earning asset of the bank and the potential credit loss of bank. The proportion of earning asset and the

27

potential credit loss would have a bearing on the future earning capability of the bank. Movement of provision and write offs: Some bank/FIs follow a practice of their bad loans, in large portion of their bad loans, in order to clean up their balance sheets. Thus the present NPA numbers are not a true indicator of the banks asset portfolio .Hence, NPA levels alone, cannot be criteria to assess future asset quality of the bank. Average provisioning including write-offs, over a five years an indicator of the levels cleaning up done by the bank, over the reduce its NPA levels. The amount of provisioning done is also inherent credit quality of the asset portfolio. The average movement serve as indicators of the credit risk of the future write-offs and provisioning which would further of a bank. III.4 Growth in advance: High growth rates in the financial sector bring the establishment of collection systems, tracking of asset quality and low seasoning of the lending portfolio. It closely analyses the pattern and nature of growth .It studies the entities with higher growth rates more carefully to look at the nature of growth, reason growth and its implications on the asset quality. An entity which has grown by attracting good quality clients from its competitors would be viewed more favorably as compared to one which has grown by attracting good quality clients from its years, time frame is in order to

an indicator of the

provisioning levels and its portfolio and the expected affect the earning capability

28

competitors would be viewed more favorably as compared to one which has grown just by increasing its geographical presence or diluting credit criteria.

IV Management and system evaluation:

It believes that the quality of management can be an important differentiating factor in the future performance of the bank/FI. The analysis of the management is carried out on the following parameters. IV.1Goals & strategies: The future goals and strategies of the bank are evaluated to take a view in the vision of the bank management. The ability of bank to adapt to the changing environment and their ability to mange credit and market risk , especially in a scenario of increasing deregulation of the financial market assumes critical importance.

IV.2 System & monitoring: It studies the credit appraisal system for managing and controlling credit and market risk at a portfolio levels. Significant emphasis is laid on the risk monitoring system and the periodically and quality of such monitoring. Most Indian banks face the challenges of enhancing their information system and quality of information reporting. The degree of acceptance of new system and the bank, data monitoring systems and the extent of computerization bank is given significant importance .The level of computerization is procedure within in the

gauged on the

29

basis of the extent of the business covered by computerization, the computerization branches and computerization of money market and forex market desks.

in

It attaches significance to the operating system for data capture and MIS reporting in a bank .A bank balance sheet with a large volume of operating system in the bank, and is viewed negatively. IV.3Appetite for risk: A high risk propensity of a management , typically reflect in the higher volatility in earning in both fund based as well as non- fund based business .A management with a higher propensity to take risk is viewed cautiously. IV.4 Motivation level of staff: The motivational level of employees would direct affect the service level of the bank which is a key success factor in a market driven environment.

V Earning Potential:
It analyses on the following basis of the level V.1 Level of earning: It is measured by return on total asset provides the cushion for its debt service, and also increases the ability of the bank to cover its asset risk. The ROTA is a function of interest spread, expenses levels provisioning levels and the non- interest income earned by the bank. The size of net profit is also factored while rating of the entity. Earning of the bank /FIs has been affected due to the volatility in interest rates. Thus, the trend in profitability at gross profit levels is examined over the past levels is examined over the past years to take a view on the sustainability of earning. The various

30

elements leading to the profitability like net interest income, non-interest income , expense levels and the provisioning levels are also analyzed to take and the sustainability of profits in future. V.2 Diversity of income sources: It is an important input in analyzing the stability of earning. Diversity of income sources between various categories of funds based income like industrial portfolio , retail portfolio, etc. lends stability to the income streams through non-interest income like guarantees, service charges from its retail customer, trading income, etc. The non-interest income provides cushion to the profitability, especially which have the capability to provide better value added service would be in a better placed to improve their fee based income. A closer analysis the composition of the revenue streams, help in taking a view regarding the sustainability of the earning.

VI Liquidity/Asset Liability Management:

It assesses the liability maturity profile of the entity to form an opinion on the liquidity risk as well the interest rate risk. VI.1 Liquidity risk: It factors the resources strength of the bank in form of access to call borrowing and the extent of refinance available from RBI. The bank are the primary channel through which retail saving are channeled back into the public sector bank having a wide spread branch network act as conduits for mobilization of retail saving . It views most of the public sector bank favorably on the liquidity support available

31

to the liquidity support available to the bank in the form of call money and RBI refinance. VI.2 Interest rate Risk: The rating factor the volatility of the bank /FIs earning to interest rate changes .It analyses the asset liability maturity profile of an entity to judge the level of interest rate risk carried by the entity. In the Indian banking system, the interest maturity profile of the asset and liabilities have an inherent mismatch. the advances portfolio (linked to prime lending rates ) and the relatively long investment portfolio are funded through short to medium tenure exposes the bank to an element of interest rate risk. FIs do score over bank in this regard due to the whole sale nature of their operation and policies which link the nature of their operation and policies which link the nature of borrowing (fixed/ floating ) with corresponding matched lending .On an overall basis , FIs carry relatively lesser interest rate risk as compared the bank. Parent support: It factors the parentage of the entity in the final rating decision .The extent of support factored is a function of the relative size of the two entities, the credit quality of the parent and the strategic importance of the subsidiary to the parent .It positively factors the system support for specialized entities in the financial sector, which have a policy role in the national economy. to liabilities rate floating and rate

duration which

5. Draft report:

32

Following the meeting with its management and subsequent analysis of the data obtained, the analysts draft a rating report on the bank. Depending on the rating agreement and the particular circumstances, this may be a short-form report (one page of text forming the rating report, plus spread sheets) or a long-form report (one front page of text forming the rating report, plus ca. five pages of text providing our rating analysis, plus spread sheets, plus spread sheet annex, providing explanatory notes to the spread sheets). The analysis in the text of the long-form report is arranged under main and sub- headings which tie in with the topics covered in the bank questionnaire.

6. Presentation of draft report to bank

We send our draft report (without ratings) to the bank being rated, for two reasons: - so that its factual accuracy may be checked; - to allow management to determine whether we have included any information in our draft which was given in confidence and which should be excluded on these grounds.

7. Amendment and subsequent circulation of report to rating committee; composition of the committee
We amend our report in accordance with any comments from the bank which meet the criteria in 6., above, and circulate it together with other, relevant documentation among the members of a rating committee, which normally has a complement of five.There is no single, standing rating committee; rather there is a committee for ach country we cover, or, in some cases, for each peer group of banks in each country. The two analysts who visited the bank, did the analysis and wrote the report are always members of its rating committee.

8. Rating committee meeting; assignment of ratings

33

At the rating committee meeting the two analysts responsible for the work done so far present the rest of the committee with the report they drafted, which has since been seen by the bank and possibly amended, as explained above, to accord with its comments. They also present relevant confidential data, which they have not been able to include in the report, and peer group analyses comparing the bank with its domestic and foreign peers. The ratings implied by the formula are not treated as definitive: they are considered only as further input to the rating decision so that there remains a strong subjective element in our final judgements - a subjectivity tempered, we trust, by several years experience (allowing a reasoned extrapolation of the future), by common sense and by specialized knowledge and research.

9. Dissemination (or non-dissemination) of the ratings

When a bank being rated for the first time has been informed of the decision of the rating committee, it has no recourse to an appeal, but it does have the right to decide whether it wishes our ratings to be made public and the rating report to be sent to our subscribers. However, normally before launching ourselves into the work involved in a new rating, which possibly also involves coverage of a country which is new to us, we would have tried to provide the entity being rated with an "indicative" rating. That is to say, on the basis of a brief analysis of the data available to us we would provide a range of likely ratings within our rating scales so that the bank being rated has from the start an approximate idea of what its ratings will be. In the event that the bank does accept that publication should take place, then the rating report and the ratings will be dispatched to our subscribers who include over 1,200 major institutions worldwide. In addition, our ratings will be made available to the public by means of the "wire" services, press releases,

34

etc. If the bank does not want the ratings published and the report disseminated, then the project will be terminated, and regular subscribers will not be informed that we have done rating work on the bank concerned.

Case I The Federal Bank Limited

National Subordinate Debt A+(ind) Rating Outlook Stable International Individual Support Foreign Currency Short-term Senior Long-term Senior Long-term Rating Outlook Sovereign Risk National AAA(ind) Foreign Currency Long-term BB Senior Local Currency Long-term BB+ Senior

CASE REPORT

5T

Financial Data The Federal Bank Limited Total Assets [US$ mn] Total Assets [INR mn] 31/03/2002 2,104.7 101,446.1 35 31/03/2001 1,891.1 88,200.4

Equity [INR mn] Net Income [INR mn] ROA [%] ROE [%] Equity/Assets [%]

4,487.9 820.1 0.86 18.98 4.42

4,154.7 610.4 0.74 15.70 4.71

Rating Rationale Assessment The ratings of The Federal Bank Limited (FBL) reflect its relatively small size, average

financial profile and long operating history. With a large proportion of its branches and business concentrated in its home state of Kerala, the Bank enjoys a strong franchise among depositors in the state and the expatriate Keralite community. FBLs pursuit of rapid loan and asset growth since the mid-1990s (its loan book has grown by over three times since FY95) without commensurate credit appraisal and risk management systems, coupled with a slowdown in the economy has resulted in a deterioration of its asset quality. Gross and net NPLs as a proportion of gross and net advances have risen over the years and were at 11.82% and 7.36% for end-September 2002. FBLs loan loss reserve coverage improved to 40% at end-September 2002 from 29.2% at end-FY02. Its net NPLs to equity ratio, although improved, was still high (at over 77%) in comparison to some of its peer banks. Although FBLs total capital ratio of 10.63% (Tier 1 ratio was 6.96%) at end-

March 2002 was above the regulatory minimum of 9%, its low capital base is reflected in its low equity to asset ratio of 4.42%, emphasising the need to bolster the Banks equity base, especially Tier 1, to enable it to better absorb the present and future asset quality shocks and support its planned asset growth. Of FBLs total deposits, NRI deposits form a substantial proportion and these, along with the term deposits, render its funding base stable, but expensive. The Bank is focussing on reducing its funding costs by increasing the share of lowcost savings and current deposits by enhancing its reach through an increased branch and ATM network. As against the general industry trend, FBLs net interest 36

margins have improved in the last couple of years on the back of declining average funding costs and higher average yields from its retail loan portfolio. Net Interest Margin (NIM) at 3.1% was better than its peer group banks. Backed by higher operating income, FBLs cost-to-income ratio improved to 38.5% for end-FY02 from 56.7% in FY00. With its

loan-to-deposit ratio consistently above 55%, FBLs reported liquidity ratios were low. FBL reported some mismatches in its asset-liability maturity in the short term, although these are mitigated by high deposit renewal rates. Support FBL has no identifiable controlling shareholder, and while its existing shareholders are likely to be willing or able to provide support to the Bank as a going concern, it is less clear whether they will be willing or able to provide resources in an extreme situation. Although RBI has a good track record of supporting banks in times of need, FBL is a small player in the banking system. In our opinion, therefore, support is possible, should that be necessary, but it cannot be relied upon. The 'T' suffix to our Support rating indicates certain subinvestment grade features of the Indian economy that could limit support for foreign currency creditors. Background The Federal Bank Limited was established in 1931 as the Travancore Federal Bank Ltd.. The Bank was listed on local bourses after its initial public offering in 1994. The ICICI group is the single largest shareholder, with 21.35% of the Banks equity, while public holding was 61.72% as at end-June 2002. FBL primarily lends to mid-size corporates, small and medium enterprises and individuals, and is now focussing on highly rated large and medium corporates and the retail sector.

37

PROFILE An old private sector bank; operates as a regional bank with high concentration of business in its home state of Kerala. Focus shifting from corporate to retail banking. Established as a private sector bank at Nedupuram in the southern state of Kerala by a small group of local citizens, The Federal Bank Limited changed its headquarters to Alwaye in 1945. The Bank was established to cater to the banking needs of traders and agriculturists. Over time, as a large proportion of the local population migrated to other countries, especially the Middle East, FBL also catered to the local banking needs of these expatriates. In the 1960s, the Bank took over five other small banks and became a scheduled commercial bank in 1970. FBL was listed on domestic bourses after its initial public offering in 1994, and in 1996 held a successful rights issue. Prior to its IPO the Bank had privately placed equity with the IC ICI group, which continues to be the single largest shareholder. The shareholding pattern as on June 30, 2002 is given in Table 1: Shareholding Pattern of FBL Category ICICI Group Mutual Funds and Unit Trust of India Foreign Institutional Investors Banks, FIs, NRIs and OCBs Individual Public Shareholders Source: The Federal Bank Limited, Fitch Apart from providing its customers with traditional retail and commercial services, FBL has an active treasury. In FY2000, the Bank decided to cease the operations of its wholly % of 21.35 4.82 1.50 2.11 61.72

38

owned subsidiary Fedbank Financial Services Limited that was engaged in the business of hire purchase, leasing and merchant banking due to an unfavourable environment affecting non-banking finance companies in general, and the company now exists only as a shell company with a core capital of INR5 million. FBL has links with 13 exchange houses and seven banks in the Middle East for providing foreign currency remittance facilities to its customers, especially in the Middle East. The Bank has an agreement with ICICI Prudential Life Insurance to undertake distribution of life insurance products. FBL also offers Depository Services to its customers. FBL has the largest branch networks amongst the old private sector banks. As of March 31, 2002, the Bank serviced it customers through 416 branches and 62 ATMs. 73% of the Banks branches are located in its home state of Kerala, and given the high concentration of its business in the state, FBL can be viewed as a regional player in the banking sector. The Bank plans to increase both its branch and ATM network to 500 each by FY06. FBL had appointed Accenture, an international management consulting group, to conduct an organisational restructuring study for the Bank. The consultants have submitted their report and recommendations and the Bank is now working on implementation of these. Technology: FBL has automated all of its branches using its in-house banking software FedSoft. At present, 74 of its branches are interconnected through leased lines with plans to switch to a Wide Area Network (WAN). The Bank already offers Internet banking under the brand name FedNet in addition to mobile and telephone banking. FBL has invested INR650m in its IT initiatives and plans to invest an additional INR 1 billion over the next three years for interconnecting its branches, expanding its ATM network, extending its

39

current mobile and telephone banking capabilities and to migrate to a centralised banking solution from the current hub and spoke set-up. PERFORMANCE Weak, but improving, asset quality requiring higher loan loss provisions have constrained FBLs profitability. Improving net interest margins despite high funding costs and declining yields on loans and investments. Post liberalisation in the early 1990s, FBL pursued aggressive loan and asset book expansion, but faced asset quality problems on account of prolonged economic slowdown and its own weak credit appraisal and monitoring systems, requiring increased loan loss provisions. This, coupled with declining interest rates amidst intensifying competition, has adversely impacted the Banks performance. ROA and ROE, which were at 1.3% and 30.73%, respectively, in FY95, have since declined to 0.86% and 18.98%, respectively, in FY02. Net Interest Revenue: Net interest income (NII) continues to the predominant source of revenue for FBL, although its share in total operating income has declined to 55.6% in FY02 compared to 68.75% in FY95. After recording a sharp decline in its NII in FY99 on account of a steep rise in its interest expenses, the Banks NII has grown nearly three times since then. NII growth at 16.6% in FY02 continued to be healthy, though it was below the 34.5% growth recorded in FY01. Interest expenses, which had declined during FY01 and FY00, grew by over 12% during FY02 on the back of substantial deposit growth in last two years, which explains the lower NII growth rate.

40

As against the general industry trend, substantial decline in its NII), and its NIM at 3.1% FBLs net interest margins (NIM) have improved after recording a sharp decline in FY99 (which was due to for FY02 was better compared to its peers old private

sector banks as well as some of the better- performing government banks. Although declining, FBLs average funding costs at 8.9% for FY02 continued to be high, and the bank is focussing on reducing this further by cutting the interest rates on its high cost foreign currency NRI deposits and increasing the share of low cost retail deposits by enhancing its delivery capabilities. Non-interest Income: FBLs non-interest incomes are primarily derived from its treasury money market and foreign exchange and trade finance related activities. The share of non-interest income a fivefold increase in its profits from sale of in total operating income, which had been declining since FY99, grew to 44.4% in FY02 primarily due to investments, mainly Government securities (G- Secs). In the last couple of years, most Indian banks have built up government securities investments in excess of reserve requirements as there has been a dearth of quality lending opportunities and the declining interest rates provided increased arbitrage opportunities on these investments. Profits from trading in G-Secs have continued in H1 FY03, and annual profits in 2003 from this business are projected at the same level as FY02.

41

FBLs total non-interest income grew by over 76% in 0 FY02 compared to a contraction of 5.4% in the previous year. While the growth was fuelled by a 560% rise in its income from G-Sec trading, its other non-interest incomes declined during FY02. A high

proportion of treasury income adds an element of volatility to the Banks revenue profile, and it has entered into a number of areas, including cash management services and distribution of third-party insurance, to augment its non-interest income, in an attempt to ensure a more stable revenue profile and maintain its profitability levels. Operating Expenses: The large infrastructure maintained by Indian banks in terms of branches and employees renders their operating expenses high. FBLs non-interest expenses have grown by over two and a half times since FY95 on account of higher employee costs on the back of two wage revisions during the period. However, its costto-income ratio has improved to 38.52% for FY02 compared to a high of 75.45% in FY99. Employee costs continue to be the major contributor, accounting for over 63% of total operating expenses and 1.36% of

42

average earning assets. Going forward, FBLs operating expenses are expected to rise further in view of the on-going expansion of its branch and ATM network as well as technology related and other operating and marketing expenses. However, given the improving operating income levels, the cost-to-income ratio is not expected to rise significantly. Loan Loss Provisions: The rapid expansion to the banks loan book since the mid-1990s (loans and advances grew by over three times since FY95), coupled with the pronounced slowdown in the Indian economy and progressively tightening prudential norms, have adversely impacted FBLs asset

quality necessitating higher loan loss provisions in recent years. While FBLs total loan loss provisions grew by 54% in FY02, these have grown by over four times since FY98. Loan loss provisions formed 51% of total pre-provision operating profits for FY02. As a proportion of average loans these have grown to 3.1% for FY02 from 0.96% in FY99. FBLs loan loss provisions are expected to remain high in the medium term, in view of its high level of NPLs amidst a weak macro-economic environment, implementation of the 90-day default norm that takes effect from 31 March 2004 and the building up of loan loss coverage by the Bank. Half-Year Performance: As per the audited (limited review) results for the half-year ended September 30, 2002 (H1 FY03), FBLs net income (profit after tax) grew by 1.9%

43

and was supported by 11.9% growth in NII. Operating profits growth at 5% was constrained by a 9.4% increase in total non-interest expenses during H1 FY03. Provisions including loan loss provisions were higher by 3%. For FY03, FBL has projected higher operating profits on account of improved net interest income (NII), while lower provisions are projected to result in substantially higher net incomes (profit after tax). Prospects: FBLs performance, to a large extent, is dependant on the economy of its home state Kerala and its NRI deposits base. Saddled with a high level of NPLs, the Bank is currently focusing on cleansing its balance sheet by reducing its NPLs, further strengthening its credit risk measurement and management systems, reducing reliance on costly NRI deposits and increasing the low cost retail deposits to reduce its funding costs. In the short to medium-term, FBL is expected to benefit from higher treasury income and its sustained recovery efforts resulting in improved asset quality. Given the intensifying competition, amidst a generally declining interest rate environment, the Bank will be required to develop its fee-based incomes for a more balanced revenue profile. Over the long-term, we expect FBL to emerge a stronger player with a solid deposit franchise in Kerala and a geographically diversified asset book. RISK MANAGEMENT Aggressive loan book growth and relatively weak credit appraisal and monitoring in mid-1990s have resulted in weak asset quality. FBL has been strengthening its risk management systems. FBLs Board of Directors is responsible for setting up the Banks risk management policies and has put in place the Risk Management Committee to implement policies and

44

procedures to identify, monitor and manage risks including credit, market, liquidity and operational risks. The Credit Risk Management Committee (CRMC), reporting to the Chairman, measures and monitors the credit risk of the Banks loan portfolio, while the Asset Liability Committee (ALCO) measures and monitors market and liquidity risks and uses Earnings at Risk (EaR) for measuring the risk of its trading and banking book. Recently, the Bank has also set up the Operational Risk Committee (ORCO) to measure and monitor operational risks arising from the failure of people, processes, products, technology, etc. Going ahead, the Bank is strengthening its risk management systems through increased use of technology, training its staff in risk measurement and management and prescribing stringent appraisal and monitoring norms for the risks faced by FBL. Credit Risk: FBL lends to corporates and small and medium-sized enterprises (SMEs) for their working capital requirements and trade financing. Large credits (greater than INR50m) and lending to the SME sector collectively accounted for over 80% of the Banks total loan book, while retail and other loans made up the balance. In FY02, growth in FBLs loan book at 6.9% was lower compared to FY01s 20.3%. Over 80% of the Banks loans are secured by collateral, including inventory, receivables, land or plant and machinery. Additional security by way of shares, as well as corporate or personal guarantees is obtained, wherever necessary.

45

FBLs top four exposures to the industrial sector were to textiles (11.59%), food processing (10.4%), iron & steel (9.8%) and real estate 8.4%. FBL follows a credit rating model for all its credit exposures above INR50m, where they are classified into 10 categories of risk grades from FB-1 to FB-10 (FB-1 being the best and FB-10 being the worst). Borrowers are evaluated on various business an does not qualify for assistance. The loan booked financial parameters and assigned a credit rating, and any proposal failing to attain at least a FB-6 rating composition as per the Banks credit ratings for end-FY02 is given in Table 2. .Table 2: Loan Book Composition by Credit Ratings (%) FB-1 2.03 FB-2 17.88 FB-3 29.38 FB-4 19.94 FB-5 5.94 FB-6 0.0 D 24.81

By end-FY03, FBL intends to assign credit ratings to all loans above INR200, 000, with plans to review the ratings every six months, instead of the annual basis currently followed. The Bank has been linking the pricing of its loans to its self-defined credit rating; however, it maintains some flexibility in pricing, especially for top-rated credit accounts, given the intense competition in this segment. Loan Loss Reserves: FBL follows the RBI norms for classifying NPLs and providing for loan losses, and these are somewhat liberal by international standards. A loan is classified as an NPL when interest and/or principal are outstanding for 180 days. FBLs lending to the real estate sector accounted for nearly 9.3% of the total gross NPLs as of end-FY02. This was followed by loans to the iron & steel sector (5.5%) and non-banking finance companies (3%).

46

(INRm/%) Gross NPLs As % of Gross Loans Loan Loss Reserves (LLR) LLR to NPLs (%) Net NPLs to Equity (%) Net NPLs to Net Loans (%) Grading of Net NPLs (%) Sub-standard Small-Doubtful Bad debts 47.53

FY 02 6,380 11.88 1,864.4 29.21 99.34 8.60

FY 01 6,420 12.84 1486.0 23.14 117.78 10.08

FY 00 4,900 11.75

FY 99 4,790 10.93

1,389.9 1,562.9 28.34 95.31 8.56 32.61 98.61 7.53

52.41 47.53 0.0

63.16 36.84 0.0

Table 3: Trends in FBLs Asset Quality FBL pursued aggressive loan book expansion in the mid-1990s, which was followed by a prolonged economic slowdown, tightening asset classification and provisioning norms. Due to FBLs relatively weak credit appraisal and monitoring mechanisms, this led to a substantial deterioration in its asset quality. Both gross and net NPLs have grown in absolute terms as well as a proportion of gross and net advances.Reported gross and net NPLs as a ratio of gross and net advances, at 11.88% and 8.6% respectively, for end-FY02, continued to be high. Application of the 90-day default norm, to be effective from March 31, 2004, would result in gross NPLs rising to over 17% of gross advances as at end-FY02. However, under the RBIs monitor able action plan on FBL, the Bank has given an

47

undertaking to bring its net NPL ratio below 7% by end-March, 2003. Net NPLs were already down to 7.36% as of September 30, 2002. FBLs NPL composition deteriorated in FY02 as doubtful assets as a proportion of total net NPLs increased to over 47% compared to 37% in FY01 the previous fiscal primarily due to ageing of sub-standard assets, and while this somewhat adds to our asset quality concerns, FBL has been able to contain fresh accretion of NPLs in recent times. FBLs loan loss provisions had failed to keep pace with the deterioration in its asset quality and this is reflected in its low loan loss reserve coverage ratio, which stood at only 29.2% for end-FY02 from a high of 32.6% in FY99. However, the coverage improved to 40% for end-September 2002 on the back of increased provisioning, and if the technical write-offs are added back, the coverage improves further to 57.4% as at end-September 2002. FBL plans to further reduce its NPL levels through aggressive recovery efforts and increased loan loss provisioning. FBLs net NPLs to equity ratio improved to 77.6% for end-September 2002 from 99.34% for end-FY02 and is expected to improve further to about 56% by end-FY03. Market Risk: As for most Indian banks, FBL is exposed to interest rate and liquidity risks on account of a structural maturity mismatch arising from funding the loan and fixedincome investment portfolio through short-term customer deposits. To a large extent these risks are mitigated by high renewal rates and relatively stable nature of the Banks deposits and because the bulk of the Banks loans are contracted on a floating rate basis. Even on fixed-rate loans, the Bank reserves the right to re-price them periodically. In addition, the Banks holds government securities in excess of reserve requirements and the portfolio has witnessed appreciation in value on account of falling interest rates.

48

FUNDING AND CAPITAL Customer deposits, especially NRI deposits, have funded FBLs growth. Low capitalisation levels; capital ratios under pressure due to expanding asset base and high level of NPLs. Funding and Liquidity: FBL, like most Indian banks, is predominantly funded through customer deposits and these accounted for 91.7% of total deposits and money market funding as of end-March 2002. However, the deposit mix has historically been skewed towards relatively stable but costlier term-deposits, especially the foreign currency term deposits on account of expatriation by non-resident Indians (NRI). These NRI deposits form approximately 45% of the total deposit base, and nearly 61% of total deposits from branches in the state of Kerala are NRI deposits. FBL plans to reduce its funding costs through a two-pronged strategy. Firstly, the Bank intends to phase out the premium it pays on its NRI Deposits, and secondly, it plans to increase the share of low-cost retail savings and demand deposits through enhanced delivery capabilities in form of expanding branch, ATM and Internet banking network and improvised retail liability products. Presently, the bank reports high renewal rates of its term-deposits and the accretion to deposits has consistently exceeded the repayments. Historically, FBLs credit to deposit ratio has been relatively high at above 55%, and consequently its liquidity ratios have been somewhat lower. While loans as a proportion to deposits and money market funding declined to 56.2% for end-FY02 compared to 60.6% in the previous year, these were still high compared with most other banks, while its quasi-liquid assets (deposits with banks and G-

49

Secs) comprised 33.1% of the Banks total assets. As FBLs is expected to continue expanding its loan book in the medium-term, its liquidity ratios are expected to remain low in the near future. The maturity profile of FBLs assets and liabilities as on March 31, 2002 over the next five years is shown in Table 4. FBL reports negative gaps in some of the time buckets up to one year and in the one-to-three year time bucket. As most of these negative gaps are on account of maturing customer deposits and given the fact that the Bank reports a high renewal rate in case of term deposits (58% in case of domestic term deposits and 62% for NRI deposits) and high retention in savings and demand deposits, Fitch is of the opinion that liquidity risk is substantially mitigated. Capital: Continued growth in FBLs asset base coupled with tightening prudential norms in recent years has led to decline in its capital adequacy ratio. FBLs reported total capital adequacy ratio at 10.63% for end-FY02 was slightly above the regulatory minimum of 9%, although its Tier 1 ratio at 6.96% was low, and in the absence of any fresh equity raising, the Tier 1 ratio has hovered between 7% and 8% for the last four years. Further, like most Indian banks, FBLs capital adequacy ratios are partly boosted by its holding of low-risk G-Secs that accounted for nearly 26% of its total assets as of end-FY02. Table 5: Trends in FBLs Capital Ratio (%) Tier 1 Tier 2 Total Equity/Asset FY 02 6.96 3.67 10.63 4.42 FY 01 7.72 2.57 10.29 4.71 FY 00 7.72 3.61 11.33 4.76 FY 99 6.48 3.84 10.32 4.00

In the past decade, FBL enhanced its equity base on two occasions first in 1994 through its initial public offering, and then in 1996 through a rights issue; since then its capital

50

ratios have been supported by internal accretions and subordinated debt issuances. FBLs capital ratios are expected to come under pressure as the Bank continues to expand and addresses its asset quality problems through higher provisioning and write-offs over the next few years. The low equity levels are also reflected by the Banks low equity to asset ratio that has ranged between 4% and 5% and stood at 4.42% at end-FY02. This emphasizes the need for the Bank to bolster its Tier 1equity levels going forward.

BALANCE SHEET ANALYSIS

The Federal Bank Limited

31 Mar ch

31 March 2002

As % Of

of Aver age

31 Mar ch

As % Of

31 March 2000

As % Of

31 Mar ch

As % Of

51

2002 (US Dm)

(INRm )

As set s IN R m) 7.0 41. 1 3.1 -

(INR m)

2001 INR m)

As set s

INRm)

As set s

1999 INR m)

Ass ets

A Loans 1.Guaranteedb yBanks/Gov 2. Secured 3. Unsecured 4. (Loan Loss Reserves) TOTAL A B. Other Earning Assets 1. Deposits with Banks 2. Government Securities 3. Other Securities 4. Investments in Subs & Joint Ventures 5. Other Investments TOTAL B C. TOTAL EARNING ASSETSa+b D. FIXED ASSETS
E.NON_EARNIN G ASSETS

147.1 864.8 64.6 n.a 1,076 .6

7,092.3 41,683. 8 3,115.1

7,017 .5 39,79 7.5 3,401 .2 0.0 50,21 6.2

6,942 .6 37,91 1.3 3,687 .3

7.9 43. 0 4.2 -

6,215.3 32,857. 6 1,284.2

8.2 43. 2 1.7 -

9,148 .9 28,56 9.4 4,559 .4

11. 3 35. 4 5.6 -

51,891. 1

51. 2

48,54 1.3

55. 0

40,357. 1

53. 1

42,27 7.7

52. 4

125.1 544.7 234.1 0.1 0.3 904.3 1,980 .9 27.6

6,027.8 26,253. 2 11,284. 7 5.0 15.4 43,586. 1 95,477. 2 1,328.7

5.9 25. 9 11. 1 0.0 0.0 43. 0 94. 1 1.3

5,076 .5 22,53 9.3 11,39 5.5 5.0 16.9 39,03 3.1 89,24 9.3 1,330 .0 704.6
3,539.4

4,125 .1 18,82 5.3 11,50 6.3 5.0 18.3 34,48 0.1 83,02 1.4 1,331 .4 649.1
3,198.6

4.7 21. 3 13. 0 0.0 0.0 39. 1 94. 1 1.5

4,484.9 17,760. 0 8,538.4 150.0 211.7 31,145. 0 71,502. 1 1,449.5

5.9 23. 4 11. 2 0.2 0.3 41. 0 94. 1 1.9

6,631 .8 17,31 5.7 8,405 .7 150.0 145.8 32,64 9.0 74,92 6.7 1,548 .2 571.7
3,697.8

8.2 21. 4 10. 4 0.2 0.2 40. 4 92. 8 1.9

1. Cash 2. Other F. Total Assets The Federal Bank Limited

15.8
80.5

760.1
3,880.2

0.7
3.8

0.7
3.6

605.6
2,468.2

0.8
3.2

0.7
4.6

2,104 .7 31 Mar ch 2002

101,44 6.1 31 March 2002 (INRm

10 0.0 As % Of As

94,82 3.2 of Aver age (INR

88,20 0.4 31 Mar ch 2001

10 0.0 As % Of As

76,025. 5 31 March 2000 INRm)

10 0.0 As % Of As

80,74 4.3 31 Mar ch 1999

100 .0 As % Of Ass

52

(US Dm)

set s IN R m)

m)

INR m)

set s

set s

INR m)

ets

G. Deposits & Money Market Funding

1. Demand 2. Savings 3. Time 4. Inter- bank Deposits 5. Other borrowing Total G H. Other Funding 1. Long- term Borrowing 2. Subordinated Debt 3. Hybrid Capital I. Other (NonInt. Bearing) J. Loan Loss Reserves (See A Above) K. Other Reserves L. Equity M. Total Liabilities & Equity

106.8 278.4 1,372 .4 81. 7 77. 6 1,916 .9 n. a 31. 1 n. a 63. 6 n. a n. a 93. 1 2,104 .7

5,147.2 13,419. 5 66,149. 7 3,936.7 3,741.1 92,394. 1

5.1 13. 2 65. 2 3.9 3.7 91. 1 -

4, 745.2 12,43 9.9 61, 029.3 4, 439.4 3, 588.6 86, 242.3 0.0 1, 500.0 0.0 2, 759.6 0.0 0.0 4, 321.3 94, 823.2

4,343 .2 11,46 0.2 55,90 8.9 4,942 .1 3,436 .2 80,09 0.5

4.9 13. 0 63. 4 5.6 3.9 90. 8 -

3,891.7 9,999.1 45,265. 0 5,478.2 3,796.2 68,430. 0

5. 1 13. 2 59. 5 7. 2 5. 0 90. 0 -

3,392 .1 8,468 .4 41,86 6. 3 14,09 4. 0 4,883 .3 72,70 4. 0

4.2 10. 5 51. 9 17. 5 6.0 90. 0 -

1,500.0

1.5 -

1,500 .0

1.7 -

1,500.0

2. 0 -

1,500 .0

1.9 -

3,064.1

3.0 -

2,455 .1

2.8 -

2,475.6

3. 3 -

3,314 .2

4.1 -

4,487.9 101,44 6.1

4.4 10 0. 0

4,154 .7 88,20 0.

4.7 41 00. 0

3,619.8 76,025. 5

4. 8 10 0. 0

3,226 .1 80,74 4. 3

4.0 100 .0

INCOME STATEMENT ANALYSIS 31 March 02 31March01 31March00 31March99

Incom As Incom As Inco As Incom As

53

e.Expe nses (INRm )

1. Interest Received 2. Interest Paid 3. Net Interest Revenue 4. Other Operating Income 5. Personnel Expenses 6. Other Noninterest Expenses 7. Pre- Provision Operating Profit 8. Provision for Loan Losses 9. Provision for diminution in Investments 10. Other Provisions 11. Operating Profit After Provisions 12. Other Nonoperating Income 13. Exceptional Income 14. Pre- Tax Profit 15. Taxes 16. Net Income

10, 424. 0 7, 661. 5 2, 762. 5 2, 203. 1 1,209.6 703.1 3, 052. 9 1, 555. 0 201.5 34. 1 1,262.3 1. 1 1, 263. 4 443.3 820. 1

% of eExpe Total nses Av (INRm Earn ) ing Asset s 11. 9,191.7 68 8.58 6,821.9 3.10 2.47 1. 36 0. 79 3.42 1.74 0. 23 0.04 1. 41 0.00 1.42 0. 50 0.92 2,369.8 1,252.0 1, 109. 0 641.4 1,871.4 1,009.6 16. 9 7.0 838.0 (1. 0) 837.0 226. 6 610.4

% of me Total Expe Av. nses Earn (INR ing m) Asset s 11. 8,817 90 .9 8. 83 7,014 .5 3. 07 1,803 .4 1. 62 1,323 .8 1. 44 1,181 .2 0. 83 590.3 2. 42 1. 31 0.02 0. 01 1. 08 (0. 00) 1. 08 0.29 0. 79 1,355 .8 811.1 (0. 0) 544.7 (0. 8) 543.9 80. 0 463.9

% of Total Av. Earn ing Asset s 12. 04 9. 58 2. 46 1. 81 1. 61 0. 81 1. 85 1. 11 (0. 00) 0. 74 (0. 00) 0. 74 0.11 0. 63

e Expen ses(IN Rm)

8,594. 4 7,715. 7 878. 7 1,128. 9 926. 4 588. 3 493. 0 392. 9 (232. 2) 307. 8 24. 5 0.9 25. 4 0. 1 25. 3

% of Total Av Earn ing Asset s 11. 96 10. 74 1. 22 1. 57 1. 29 0. 82 0. 69 0. 55 (0. 32) 0. 43 0. 03 0. 00 0. 04 0.00 0. 04

Ratio Analysis
31 Ma rch 02 31Ma rc h0 1 54 31Ma r ch00 31Ma rch9 9

I. Profitability Level 1. Net Income/ Equity (av.) % 2. Net Income/ Total Assets (av.) % 3. Non- int Exp/ Net Interest Rev. +Other Operating Income % 4. Net Interest Rev./ Total Assets (av.) % 5. Pre- Provision Operating Profit/ Total Assets (av.) % 6. Op. Profit After Provisions/ Total Assets (av.) %
II. Capital Adequacy (year end)

18.98 0.86 38. 52

15.70 0.74 48. 33

13. 55 0.59 56. 65

0.73 0.03 75. 45

2.91 3.22

2.89 2.28

2.30 1.73

1.14 0.64

1.33

1.02

0.69

0.03

1. Internal Capital Generation % 2. Equity/ Total Assets % 3. Equity/ Loans %

17. 22 4.42 8.65

13. 75 4.71 8.56

11. 62 4.76 8.97

0. 03 4.00 7.63

4. Capital/ Risks - Tier 1 % 5. Capital/ Risks - Total % 6. Fitch Grade Capital Ratio/ Total Assets % III. Liquidity (year end) 1. Liquid Assets/ Deposits & Money Mkt Funding % 2. Liquid Assets + Marketable Debt Securities/ Deposits & Money Mkt Funding % 3. Loans/

6.96 10. 63

7.72 10. 29

7.72 11. 33

6.48 10. 32

36. 36

30. 23

34. 36

34. 75

56. 16

60. 61

58. 98

58. 15

55

Deposits & Money Mkt Funding % IV. Asset Quality 1. Provision for Loan Losses/ Loans (av.) % 2. Provisions for Loan Losses/ Pre- prov. Op. Profit % 3. Loan Loss Reserves/ Loans % 4. Loan Loss Reserves/ Impaired Loans % 5. Gross NPL's/ Loans % 6. Net NPL's/ Equity %

3.10 50. 93

2.27 53. 95

1.96 59. 83

0.96 79. 70

3.59 29. 21

3.06 23. 14

3.44 28. 34

3.70 32. 61

11. 88 99. 34

12. 84 117. 78

11. 75 95. 31

10. 93 98. 61

CASE II
AAA RATING FOR ICICI BANK LTD
56

The rating agency has reaffirmed the AAA [Triple A] rating assigned to the various outstanding debt instruments of ICICI Bank Ltd (IBL). Instruments carrying this rating are considered to be of the best quality, carrying negligible investment risk. Debt service payments are protected by stable cash flows with good margins. While the underlying assumptions may change, such changes as can be visualized are most unlikely to impair the strong position of such instrument. CARE has also reaffirmed the PR1+ [PR One Plus] rating assigned to the Rs.30 bn Certificate of Deposit programme of IBL and Short term Deposit programme aggregating Rs.76.58 bn. This rating indicates superior capacity for repayment of short-term promissory obligations. The rating factors in IBLs strong market position, its proactive management, the measures taken by it to diversify and reduce its loan portfolio risk as also to adapt to the changing external environment, its resource raising strengths, strong technology infrastructure, its significant retail reach and satisfactory capital adequacy. IBLs importance in the Indian banking sector as also the significant ownership by institutional investors are also factors that have a favourable impact on rating. However, legacy of weak assets inherited from erstwhile ICICI remains a concern and improving asset quality amidst a difficult economic scenario will remain a challenge for the banks management. IBL was promoted in 1994, jointly by ICICI (75% equity stake) and SCICI Ltd. (25%). In March 2000, In March 2001, IBL acquired Bank of Madura (BoM), a south based old private sector bank, in an all-stock deal to improve its retail reach. As on March 31, 2002, IBL operated through 500 outlets and over 1000 ATMs. On March 30, 2002, ICICI Ltd and two of its wholly owned retail finance subsidiaries, viz., ICICI Personal Financial Services Limited and ICICI Capital Services Limited were merged with IBL in an all-stock deal. The merger created Indias first

57

universal bank and the second largest commercial bank in the country in terms of assets, after State Bank of India. The merged entity would combine the advantage of low cost of funds of IBL with the extensive corporate relationships and large retail lending network of erstwhile ICICI. The merged entity would be able to offer the entire range of financial products and services to its customers. IBLs asset base as on March 31, 2002 was Rs.1041 bn including the large asset base taken over from erstwhile ICICI. The asset base declined marginally to Rs.996.8 bn as on September 30, 2002. During the six months ended September 2002, IBL generated a total income of Rs.56.75 bn and earned a profit of Rs.5.90 bn, before tax and extraordinary items. The bank also earned Rs.11.91 bn on the sale of ICICIs stake in IBL (held by a trust) and has made additional accelerated provision of Rs.16.86 bn against the legacy portfolio. IBLs capital adequacy also improved marginally to 12.32% (including Tier I 8.05%) as on September 30, 2002. The legacy of stressed assets inherited from ICICI continues to be a cause of concern. However, the additional provisioning made at the time of merger as also the recent legal changes in the foreclosure laws are expected to help IBL in tackling this problem. IBLs success in managing this weak assets portfolio without making large sacrifices that would affect its profitability and solvency would be a key rating sensitivity. Most of IBLs incremental lending is to the retail sector, across all product categories like auto loans, home loans, personal loans, commercial vehicle finance etc. IBLs ability to maintain high asset quality while targeting high growth in the retail portfolio, in a very competitive environment is another key rating sensitivity.

Conclusion

58

Bank /Financial Institutional rating, in common with most financial analysis, is fertile ground for the growth of jungles of clichs and thickets of impenetrable jargon. Banks being rated almost invariably claim to address the issues, to focus on niche markets or franchises, to target their strategic objectives and to empower their executives with aggressive management structures. Readers of rating reports are invited to compare scenarios, to juggle with parameters, synergies and symbioses, to contemplate future (sic) prospects .The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. It is not engaged in the offer or sale of any security. A report providing a rating is neither a prospectus nor a substitute for the information assembled, verified, and presented to investors by the issuer and its agents in connection with the sale of the securities. It does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security.

ANNEXURE I Information to be submitted by client for rating assignment (Banks)

59

A. 1. 2. 3. 4.

GENERAL Name of the Bank Registered Office Head/Controlling/Administrative Office Dates of incorporation/establishment & commencement of business

5. 6. 7. 8.

Brief history Promoters Pattern of share-holding Details of group companies.

As on recent date. Brief write up subsidiaries and

of

operations

of

group

companies,

extent of banks exposure, shareholding pattern and the latest annual accounts. 9. Particulars of Directors Including shareholding in the bank, occupation and other concerns in which they are interested. 10. Branch details Please give the number of rural, semi urban, urban, metropolitan and overseas 11. branches. Organization Chart & particulars of key Please also furnish brief description of executives the functions of each department and the features of the personnel policies. 12. 13. Staff strength Name(s) of the stock exchanges where bank's shares are listed. Also indicate the high & low prices of the shares traded during the previous 12 months.

60

14.

Rating Information

Has any instrument issued by the Bank been rated by a rating agency in India/abroad in the past? If so, please provide a copy of the rating advice.

15.

Terms and conditions of the issue to be rated

61

B. 1.

AREAS OF BUSINESS Please give detailed break-up of advances indicated in your balance sheet (three years details) giving, inter alia, exposure in various currencies, range of interest rates charged, refinance available, if any and security taken against each type. What are the target segments identified by the bank for lending. We need a breakup of the loans and advances outstanding as on Balance Sheet date for the past three years, in terms of listed companies, partnerships etc. Please give the size wise classification of cash credits sanctioned and term loans given in the past three years. Also indicate what percentage of total lending has been as a part of consortiums in the past four years. What are the terms and conditions of the advances and term loans given. Please classify the secured loans into type of security taken. Please give us details of leasing activity and consumer finance in terms of type of assets, maturity, IRR charged and potential for future growth in this area of business. Please give the total number of correspondent banking arrangements entered into by the bank. Please give a note on the non fund based activities targeted by the bank. Please give details of the derivative products offered by the bank and the major deals in the past two years.

2.

3. 4.

6. 7. 8.

C.

ASSET QUALITY

62

1.

Please elaborate on lending policies, procedures and priorities along with major terms and conditions for various type of assistance; please also furnish information regarding prudential norms followed by the bank for lending and exposure to various industries/borrowers. Please indicate delegation of powers in regard to sanctioning and disbursements of assistance and other matters Please give an industry wise break-up of the total exposure of the bank as on the latest balance sheet date. Please furnish details of 50 largest companies in terms of outstanding exposure. Please furnish details of 50 largest defaulters as on Balance sheet date and on a recent date. What is the credit scoring system used for evaluating the borrowers and the various grades assigned on this basis. What are the premiums charged on PLR for each grade? Please give outstanding loan amounts against each grade, on the balance sheet date for the past three years. Does the bank have a policy regarding the grade wise exposures as a percentage of total assets? Please explain the policies and practices with regard to investments and divestments of securities such as equity and preference shares, debentures and bonds, commercial paper and Certificates of Deposit. Please classify the assets into Standard, Substandard, Doubtful and Loss as per the RBI Guidelines as on the Balance sheet date for the last three years and the provisions required and made against the relevant categories; indicating the priority sector advances separately. What are the inter-bank exposure limits, if any, specified by the bank? What has been the loss write offs in the past three years. How does the bank ensure maximum recovery on loans that have gone bad? Is there a separate recoveries section looking after these details.

2. 3. 4. 5. 6.

7.

8.

9. 10.

D.

RESOURCES PROFILE We wish to obtain an understanding of the principal sources and likely volatility of the funding pattern

63

1. 2. 3.

Please give a breakup of the term deposits on Balance Sheet date into FCNR, NRE, NRNR and NRO deposits and domestic deposits. What is the size wise classification of term deposits e.g. greater than Rs.50 crore, between Rs.10-50 crore, between Rs.1-10 crore and less than Rs.1 crore? Please give the currencies and the interest rates on long term borrowings of the bank.

E. 1.

LIQUIDITY MANAGEMENT Please indicate the maturity profile of assets and liabilities as on the Balance sheet date for the last financial year and on a recent date. Kindly use the draft guidelines of the RBI for classifying assets and liabilities into various time buckets. What is the banks experience on rollover of term deposits on maturity. Please indicate how maturity mismatch is monitored by the bank. What are the policies of the bank regarding acceptable levels of mismatch and the policy on steps to be followed for reducing this, when required. What was the maximum inter bank call and term money borrowed by the bank in the last three years.

2. 3.

4.

F.

INTEREST RATE SENSITIVITY We need an understanding of how sensitive your operations are to interest rate volatility. On the basis of the draft guidelines given by the RBI, please group the rate sensitive assets, liabilities and off balance sheet positions into time buckets according to residual maturity or next repricing period. Kindly give this data for the last five quarters. Please indicate the strategy used to determine the interest rates for various tenures of deposits. What are the interest rates offered for various tenures of deposits.

1.

2.

64

3.

What is the policy regarding the spread between cost of capital and the PLR. How often does the management review the cost of capital? What is the margin to which the bank is prepared to bear increase in interest costs?

G.

EXCHANGE RATE RISK Please indicate the total foreign currency liabilities and assets on the balance sheet date for the past three years. What are the hedging strategies followed by the bank. Please indicate the norms specified by the bank for open positions, overnight limits and gap limits.

H. 1. 2.

MANAGEMENT What are plans regarding diversifications into sectors other than the areas of business currently undertaken? Please indicate whether the bank has opened specialized branches to cater to specific needs of industry and its depositors. Are there any plans of opening more such branches? What are the targets in respect of asset growth and percentage return on assets and equity? Details of automation and the capital expenditure on it in the past three years. Please indicate how the inter office adjustments as on the recent balance sheet date have been reconciled. What are the steps being taken by the management with regard to reducing the inter office adjustments. Give details of frauds occurring and the loss due to them in the past three years. What are the management and internal audit controls in respect of all the trading operations. Also explain the MIS that is followed in the bank. Please indicate the employee unions in the bank and the state of labour relations. Please comment on employee productivity.

3. 4. 5.

6. 7. 8.

I. 1.

FINANCIAL INFORMATION Financial position and working results Please enclose Annual reports for the previous 5 years and statement of accounts as on a recent date, if the latest annual report is more than 6 months old.

65

2.

Capital adequacy

Please give detailed computation of capital adequacy ratio as per RBI norms (two years). Details of the fees and commissions by type Breakup of miscellaneous income. Breakup of the provisions made eg. depreciation on investments, provision for taxes, provisions for doubtful debts and other contingencies etc. Are the separate divisions considered as profit centers? If so what are the profits earned by each of these units. Particulars of existing litigations by/against the company, if any.

3.

Earnings Quality

J. PROJECTIONS 1. Estimates of profit and loss accounts, balance sheets and cash flow for the next 5 2 years with underlying assumptions. Details of the capital restructuring plans if any. Details of rights/public issue, if any, planned during the current financial year. The information given above and in statements attached hereto is, to the best of our knowledge and belief, true and correct in all particulars. Place : Date : (Authorized Signatory) Signature Name Designation : :

66

ANNEXURE II Projected Profit & Loss account for next 5 years For the year ending March 31, Income from operations Interest on loans to companies Other income (Pl. specify) Total Income Expenditure Staff Expenses Establishment Expenses Other Admn. & misc. expenses Total expenses Gross Profit Interest, Commitment Charges etc. Depreciation Preliminary expenses written off Operating profit Taxation Net Profit Dividend (Rate %) Retained Profit Net Cash Accruals Gross Cash Accruals

67

ANNEXURE III Sources & Uses of funds for the next 5 years During the year ending March 31, Sources Increase in Share Capital & Premium Issue of debentures -Convertible -Non-Convertible Increase in deposits from public - Domestic - Foreign Increase in Current Liabilities Decrease in Current Assets Gross Cash Accruals Total Uses Repayment of borrowings - Debentures - Deposits - Loans Investments Increase in Current assets Decrease in Current Liabilities Total Opening Balance Surplus/Deficit Closing Balance

68

ANNEXURE IV Projected Balance sheets for next 5 years As at March 31, Liabilities Share Capital Reserves & Surplus Secured Loans Unsecured Loans Current Liabilities & Provisions Total Assets Gross Block Less Depreciation Net Block Investments Loans to companies Cash and Bank balance Misc. Expenditure not written off Total

69

Bibliography
1) www.rbi.org.in 2) www.crisil.com 3) www.icraindia.com 4) www.fitchindia.com 5) www.careindia.com 6)The Credit Rating Information Services Of India Limited

70