indian overseas bank sip report: loans and advances management

1 ICFAI BUSINESS SCHOOL – KOLKATA [email protected]

A REPORT ON

ADVANCES MANAGEMENT

BY

Soniya Sinha

ICFAI BUSINESS SCHOOL


A REPORT ON

ADVANCES MANAGEMENT

BY

Soniya Sinha

INDIAN OVERSEAS BANK

Date of Submission: 17th MAY, 2009


AUTHORISATION

The report is submitted as partial fulfillment of the Masters in Business Administration (MBA)

Program of ICFAI Business School, Kolkata.


ACKNOWLEDGEMENT

I would like to thank Indian Overseas Bank for providing me an opportunity to work with them

and giving necessary guidance in completing the project to the best of my abilities.

I am obliged to Mr. Pal Basnotra, Chief Manager, Indian Overseas Bank, New Alipore, Kolkata,

who provided me the essential information and extended his best support.

I would like to extend special gratitude to Mr. Rakesh Kumar Niraj, Assistant Manager, Loans

and Advances Department, Indian Overseas Bank, New Alipore, Kolkata, for being my company

guide and providing me an insight into various issues pertaining to cases mentioned in the report.

This is his sincere support and consistent guidance that led to the completion of the project.

I am highly indebted to Prof. Dipanker Dey, for his mentorship and valuable suggestions that

gave an entirely new dimension to the project under consideration. His guidance gave immense

confidence and encouragement that helped me to put in my best.

Lastly, I would like to thank my colleague, Varun Vij for helping me with the project work.


LIST OF ILLUSTRATIONS

The illustrations are enlisted below along with their area of concern to bring forth an elucidate

understanding of the topics studied during the training period.

i) XYZ INFOTECH: Financial Analysis of Lending

ii) LIBERTY MARINE SYNDICATE LTD.: Financial Analysis, Packing Credit

iii) PRATIBHA CONSTRUCTIONS: Non Performing Asset, Legal Procedure

iv) Mr. NEAL RAJPUT: Education Loan, Non Performing Asset


TABLE OF CONTENTS

Authorization …………………………………………………………………………... i

Acknowledgement …………………………………………………………………...... ii

List of Illustrations ……………………………………………………………………. iii

1. Abstract ……………………………………………………………................... 8

2. Introduction …………………………………………………………………..... 10

2.1 Indian Banking History

2.2 Indian Overseas Bank

2.3 Scope of Study

2.4 Objective

2.5 Methodology

2.6 Outline of work

3. Main Text ………………………………………………………………………. 20

3.1 General Principles of Loans and Advances

3.2 Principles of Lending

3.3 BASEL II ACCORD: A Measure of Risk Adequacy

3.4 Lending and….

3.5 Types of Advances

3.6 What does a Transaction look like?

3.7 Financial Analysis of Lending

3.8 Method of Credit Rating

3.9 Method of Assigning Credit Limit and Drawing Power

3.10 Securities Used Against Lending

3.11 Calculation of EMI

3.12 Documentation

4. Case Analysis (XYZ Infotech) …………………………………………………. . 43


5. Export Credit ……………………………………………………………………. 60

6. Case Study (Liberty Marine Syndicate Ltd.) …………………………………… 61

7. Non Performing Assets …………………………………………………………. 70

8. Case Analysis …………………………………………………………………… 72

(i) Miscellaneous Cash Credit

(ii) Educational Loan

9. Some Problems related to Pre & Post Advances ……………………………….. 81

10. Conclusion ……………………………………………………………………… 82

11. Attachments …………………………………………………………………...... 83

12. References ………………………………………………………………………. 84

13. Glossary …………………………………………………………………………. 85


ABSTRACT

Financial sector reform in India has progressed rapidly on aspects like interest rate deregulation,

reduction in reserve requirements, prudential norms and supervision of risk. Though the progress

on the structural institutional aspects have been comparatively slower, major changes required to

take the Loans and Advances problem has gained importance.

Chennai based Indian Overseas Bank is one of the nationalized bank in India, that has a

substantive history since 1937. The bank not only deals in retail banking providing utility

services to its customers but has also expanded its area of operation in multidimensional services

like merchant banking, agri business consultancy and e-banking. It recently registered a core

profit of Rs. 1325 crores in the financial year March‟08-March‟09.

The report deals with a clear understanding of the lending procedures followed by Indian

Overseas Bank. It not only explains the basic concepts and the terminologies used in the banking

sector but also gives an insight into the legal aspects and the paper work required for final

sanction of a loan proposal.

Different types of advances, method of assigning credit limit and drawing power to individuals

and business units has been a part of the study during the internship period. The credit rating

methods applied by the banks to rate the credibility of the prospective clients, securities accepted

against lending and calculation of Equated Monthly Installments have also been discussed to

give an overview of the lending concept of the bank.

The most important part of the study includes case analysis of XYZ Infotech. This explains the

significance of financial ratios and credit rating of the client in a precise manner. The forecasting

of pecuniary status of the prospective borrower is shown by the study of balance sheets sand

other financial details furnished by the borrower and the bank.

Later, the report includes the final sanction of the loans, their regular monitoring and conversion

of accounts into standard or bad debts. The treatment of those Non Performing Assets and the

recovery of the same along with the legal procedure followed by the bank are discussed in great

detail.


A compendious note on NPAs brings about a clear understanding of the issues associated with

the recovery procedure of such assets and final treatment. The same has been explained lucidly

with the help of two cases that were witnessed during the Summer Internship Program.

Problems observed while rendering financial assistance to prospective borrowers are also

mentioned in brief. Finally, conclusion and recommendation as per the analysis during the

training period winds up the report.


INTRODUCTION

2.1 INDIAN BANKING INDUSTRY

Banks are the financial backbone of any country‟s economy. Without a sound banking system a

country cannot have a healthy economy. A bank is a financial institution which deals with money

and credit. It accepts deposits from individuals, firms and companies at a lower rate of interest

and gives it at a higher rate of interest to those who need them. The difference between the terms

at which it borrows and which it lends forms the source of profit, thus bank being a profit

earning institute. For the past three decades India‟s banking system has several outstanding

achievements to its credit. The most striking is its extensive reach to customers. It is no longer

confined to only metropolitans or cosmopolitans in India. In fact the Indian banking system has

reached even to the remote corners of the country. This is one of the main reasons for the India‟s

growth process.

The first bank in India though conservative, was established in 1786. From 1786 till today, the

journey of Indian banking system can be segregated into three distinct phases. They are:

PHASE 1: early phase from 1786 to 1969 of Indian banks.

PHASE 2: nationalization of Indian banks and up to 1991 prior to Indian banking sector reforms.

PHASE 3: new phase of Indian banking system with the advent of Indian banking and financial

reforms after 1991.

The Indian banking can be broadly categorized into nationalized (government owned), private

banks and specialized banking institutions. The RBI acts as a centralized body monitoring any

discrepancies and shortcomings of the system. It is the foremost monitoring body in the Indian

financial sector. Since the nationalization of banks in 1969, the public sector banks have realized

the need to become highly customer centric that forced the slow moving public sector banks to

adopt a fast track approach.


The Indian Banking market is growing at an astonishing rate, with assets expected to reach US$

1 trillion by 2010. An expanding economy, middle class and technological innovations are all

contributing to this growth. The country‟s middle class accounts for over 330 million people. In

correlation with the growth of the economy, rising income levels, increased standard of living

and affordability of banking products are promising factors of continued expansion.

GROWTH OF INDIAN BANKING ASSETS (US$ billion)

The unleashing of products and services through the net has galvanized players at all levels of

the banking and financial institutions market grid to look new at their existing portfolio offering.

The Indian banking system has finally worked up to the competitive dynamics of the „new‟

Indian market and is addressing relevant issues to take on the multifarious challenges

nationalized banks have acquired a place of prominence.

Banking in India is highly fragmented with 30 banking units contributing to almost 50% of the

deposits and 60% of the advances. The nationalized banks (i.e. government owned banks)

continue to dominate the Indian banking arena. They continue to be the major lenders in the

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economy due to their share size and penetrative networks which assures them high deposit

mobilization. Industry estimates indicate that out of 274 commercial banks operating in India,

223 banks are in public sector and 51 are in private sector. The private sector bank grid also

includes 24 foreign banks that have started their operations in India.

2.2 INDIAN OVERSEAS BANK

Indian Overseas Bank (IOB) was founded on 10th

February 1937 and had distinction of three

branches at Chennai, Kasaikudi and Rangoon simultaneously commencing business on the

inaugural day. The founder Chairman was M.Ct.Chidambaram Chettiyar. It was started with a

vision to specialize in foreign exchange and overseas banking business in India. Before 1969, it

had ventured into consumer credit, had begun with computerization and had 195 branches in

India. In 1969, when it was nationalized, the bank had 208 branches and business mix of Rs 156

crores. IOB has gained AA rating by CRISIL for its primary issue and a rating of P1+ for its

term deposits.

IOB is currently one of the major banks based in Chennai, with 1845 domestic branches and 12

branches overseas. IOB also has an ISO certified in house information technology department,

which has developed the software that most of its branches use to provide online banking to

customers. IOB has a network of more than 500 ATMs all over India and IOB‟s international

visa debit card is accepted at all the ATMs. IOB offers internet banking (E-see banking) and is

one of the banks that the government of India has approved for online payment of taxes. IOB

provides various banking services, including saving bank, current account, credit facilities and

other services. IOB also provides non-residential Indian (NRI) services, personal banking,

foreign exchange reserves (FOREX) collections services, agri-business consultancy, credit card

and e-banking services. The bank is also engaged in merchant banking. IOB is the first public

sector bank in the country to introduce mobile banking services using wireless application

protocol (WAP). It was also the first public sector bank to introduce anywhere banking at its 129

branches in the four metros and is extending the connectivity to 100 other branches in

Hyderabad, Bangalore, Ahmadabad and Ludhiana.


In year 2000, it came out with a public issue of 11,12,00,000 shares of Rs 10 each for cash at par

aggregating Rs 111.20 crores. It also raised Rs 125 crores through bonds issue in year 2001. It

gained the rating of AA for the issue. Being ranked as the best public sector bank in India in

2007, it‟s key trade centers now include Singapore, Seoul, Hong Kong, Bangkok and Germany.

The Balance Sheet of the bank (Attachment -I) distinctly indicates the increase in both the

advances and deposits.

TOTAL ADVANCES AND DEPOSITS OF THE BANK

In 2006, total business of the bank crossed Rs. 100,000 crores where as the total net profit

exceeded the same figure in 2007. As of September 2008, there were 1424 branches under Core

Banking Solution, 522 branches under Total Branch Automation and a number of branches

linked under services like NEFT and RTGS. IOB has been upgraded to „BBB‟ (long term)

rating by Standard and Poor‟s, third bank in India after SBI and ICICI.

The bank has a very strong foundation with a high profit margin and a low risk. The efficiency in

their management of funds is reflected in their past records where the balance sheets of last five

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ADVANCES 26274 35759 47923 61748

DEPOSITS 44241 50529 68746 83204

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year‟s show that the net Non Performing Assets has been decreasing. The rate of deposits is not

as high as provided by the industry‟s giant State bank of India but by at the same time the loans

sanctioned by the bank have proved to be secured and successful. This in turn has led to a further

increase in total profit of the organization thereby fulfilling its prime objective of being a profit

earning enterprise. The latest audited reports reveal that the bank registered a net profit of Rs.

1325 crores in the financial year that ended on March, 2009 with an increase of almost 21% in its

total business.

2.3 SCOPE AND PURPOSE OF STUDY

The purpose of preparation of this report is to focus on the Lending function of banks with

specific reference to Indian Overseas Bank. The report states the following points:

The study gives an insight into the procedure followed by the Bank as per the norms of

the Reserve Bank of India and the Authority that governs the functioning of Indian

Overseas Bank. It also explains certain terminologies commonly used in the banking

industry.

The report states the different types of advances that are financed by the bank and their

classification as fund and non fund based advances.

The financial analysis of lending i.e. the study of balance sheets and other financial

accounts, to judge the credibility and repaying capacity of the prospective borrower is

done in great detail. The same is illustrated with the help of a practical case analysis

(XYZ Infotech) to build a better understanding of the importance and the procedure of

such a financial analysis.

It also helps us infer the risk involved in sanctioning of advances by imputing the

bankruptcy chances of the proposed borrower in quantitative terms applying Multiple

Discriminant Analysis. It also helps us understand the whole process of financial analysis

involved in appraising a loan.

This brings forth the method to assess the credit worthiness of the borrowers and estimate

the net worth of the assets owned by him, which assists the bank to ascertain the amount


that can be sanctioned to them. The extent to which the credit limit can be sanctioned and

drawing power be enhanced are also mentioned.

Other than this, the project deals with the securities that can be used against lending and

the calculation of Equated monthly Installments (EMI). Moreover procedure of follow

up, the repayment of loan in form of EMIs and credit monitoring lie under the realm of

scope of the study.

Further the documentation of the proposed advances and their final sanction forms

another major area that is taken into consideration.

Credit monitoring, identification of Non Performing Assets (NPA) and legal procedure

adopted by the bank in recovery of those advances forms the most significant part of the

study. The same is exhibited in various case studies that are included in the project to

give a better view, comprising of an integral part of the report.

The last topic discussed as per the schedule of the project involves an in depth study of

the problems related to pre and post sanction of advances and their possible solutions.

Certain conclusions and recommendations are made as per the analysis of the cases.

2.4 OBJECTIVE

The objective of the proposed project is to understand the entire process involved in successful

lending by the bank beginning from the financial analysis of lending of, identification of reliable

potential customer, legal sanction to monitoring of those accounts and their final recovery

procedure through scheduled EMI structure. This aims at analyzing the ways in which the bank

manages its Non Performing Assets (NPA). It includes identification of the problems associated

with pre and post advances and simultaneously finding out viable solutions and alternatives to

address those issues.

The project is likely to help organization understand the various issues related to the advances,

giving it certain solutions to reduce the loses due to non recovery of loans and maintain a


healthy trend line of decreasing net NPA thereby helping it to maintain a balance between its

deposits and advances and an increase in its percentage yield.

2.5 METHODOLOGY AND SOURCES OF DATA

The proposed methodology for fulfilling the objectives of the project is as follows:

The study of guidelines laid by the Reserve Bank of India and the governing authorities

of Indian Overseas Bank to be adhered to (pertaining to advances) as published in the

journals issued by these authorities from time to time.

The secondary data is deduced from the books of accounts maintained by the bank

(without disclosure of any personal details of the borrower).

The data from the official books as maintained by the bank, reference books, news letters

published by financial institutions and websites have been utilized for the analytical study

of advances made by bank.

The methodology includes a detailed study of the data collected from the bank, pre and

post requisites of lending, calculation of interest on loans and equated monthly

installments and documentation of the same.

The observation of advances sanctioned by the bank in the past few years that resulted

successful lending constitutes the most substantial part of the project work.

It also involves active participation in banking transactions and internal functioning of the

Advances Department of the branch. An elaborate study of loans and advances granted

by the branch and analysis of the same has been the most significant component of the

project.

Information mentioned in the cases are deduced from the books of accounts as maintained by the

bank branch, the figures and facts given being realistic in nature.

Finally, identification of the problems associated with advances by bank and the solution of the

same with certain recommendations is to be provided after analyzing certain loans (stated as

illustrations in the project) to help the advances department of the bank.


2.6 LIMITATIONS OF THE STUDY

The study of Advances Management pertaining to Indian Overseas Bank is subject to certain

limitations that are identified as follows:

As far as the illustrations and the case analysis included in the report are concerned, the

scope of study is limited to Indian Overseas Bank, New Alipore Branch, Kolkata.

The personal details related to the borrowers (cases under study that have also been

incorporated in the report) have intentionally not been revealed as per the norms of the

bank. Specific crucial financial details of the clients have also not been disclosed.

The secondary data collected and taken into consideration in order to fulfill the objectives

of the project includes published data from the journals, magazines and data available

from the website of the bank and other companies for general public.

It also includes the data gathered and observed during the daily functioning of the

Advances Department of above mentioned bank (excluding the data marked as critical

and confidential by the bank).

The data used for analysis includes the facts and figures from March,2004-March,2009

and at the same time the latest guidelines as laid down by the Reserve Bank of India are

strictly followed.

The scope is limited to the types of advances funded by bank branch and not all types of

advances. So Agricultural advances and advances against Shares and Unit Trust of India

(UTI) do not fall in the ambit of the study, therefore they have been excluded.

Further, the study serves the Advances Department of the bank branch to identify the issues

related to advances, maintain a decreasing trend in the net value of the Non Performing

Assets in future and minimize the formation of the same. All Summer Internship Program

(SIP) regulations laid down by the bank have been duly complied with.

LITERATURE SURVEY


2.6 OUTLINE OF THE WORK

The project proposed deals in Advances Management of Indian Overseas Bank, New Alipore,

Kolkata. The project is completed and discussed in detail as per the schedule stated in the project

proposal.

In the first phase, the project highlights the general concepts of loans and advances, which

familiarizes us with the terms used in this context. It then covers principles and practices of

lending as per the instructions laid down by the Reserve Bank of India and as received by the

bank from its governing authority.

The types of advances are classified as fund based and non fund based are described, giving an

overview of the various categories of advances. This section describes the term deposits, demand

loans, secured and unsecured loans including letter of credit and bank guarantee.

Later, it explains the financial analysis of different types of advances considering both the

business concerns and the advances to the individuals. The overdraft facility provided by the

bank, cash credit and estimation of drawing power along with the way it is to be calculated is

mentioned.

The financial analysis of lending forms an integral section of the report where an attempt is made

to explain the evaluation procedure of any proposal in hand. This analysis is distinctly illustrated

with the help of a case study where the financials of a company (that had requested for the

enhancement of its credit limit) are assessed to forecast its financial health and its capacity to

repay to in near future.

The credit rating method followed by the bank to ascertain the credit worthiness in case of both

individuals and business enterprises is discussed. The different parameters of judging the same

are mentioned along with the format used by the bank to rate any business concern and assess its

financial position.


As far as the short term credits are concerned the project incorporates the methods and concepts

applied by the bank to find credit rating of the customer, assigning of the credit limits and

calculation of drawing power. The credit worthiness of the potential customer and his repayment

capacity is estimated.

Calculation of Equated Monthly Installments (EMI) based on the amount of loan to be

sanctioned and the time duration required for repayment, including the prevailing interest rates as

per the norms of the RBI are expounded.

The securities accepted against lending, the collateral that the customer offers the bank, modes

of charging securities (lien, hypothecation, pledge, assignment, mortgage) and bank guarantee

required for particular credits is also studied under the project.

Credit documentation and sanction forms another major area of the study where all the

documents pertaining to the advances are enlisted along with their legal significance and the final

advance proposal is approved by the sanctioning authority.

Categorization of advance accounts as Non Performance Assets, factors leading to such a

consequence, its provision and treatment of such accounts are studied. The legal procedure of

their recovery through SARFESI Act 2002 and ultimately their management has been included

to give a more comprehensive idea of the subject matter.


MAIN TEXT

3.1 GENERAL CONCEPTS OF LOANS AND ADVANCES

BORROWER: A borrower being a party in the loan agreement that receives money and

promises to repay it. He may bring a very attractive lending proposition. The banker needs to

know about the character, capacity and capital of the prospect. The borrower may comprise of an

individual, a firm, a company, an HUF or any other business concern.

PURPOSE: The purpose for which a borrower seeks finance should not be anti social and anti

national. The finance required should be proposed to be used for a good cause, the objective

being legal in the eyes of law.

BORROWER’S STAKE OR MARGIN: The term margin refers to that portion of the loan that

needs to be contributed by the borrower. This is most likely to sustain commitment of the

borrower throughout the life of the venture. The percentage of margin is fixed by considering

certain factors like borrower‟s capacity to bring in capital, nature of business, level of risk,

guidelines of RBI, etc.

INTEREST: Interest income refers to the profit that any lending would generate. It is the return

on the advances granted by the bank. The interest amount should be sufficient enough to cover

the cost of lending i.e. it should cover the estimated risk involved and simultaneously generate

enough revenue to fulfill banks prime objective of being profitable.

SECURITY: The banker advances loan keeping certain security which may either be collateral

in nature or in the form of personal guarantee. Each lending is backed by adequate security that

creates a binding on the part of the borrower to repay. Security acts as an assurance, an

alternative to recover the amount by liquidation but the bank‟s basic motto remains recovery of

advances from the income of the borrower. The security must qualify the parameter of being


marketable, ascertainable, transferrable and stable. This means that the security should be easy

enough to sell without incurring much cost in selling. The assets must be easy to identify and

must not result in much loss of value. It should be stable over a significant period of time and

easily transferrable.

3.2 PRINCIPLES OF LENDING

According to general principles of lending, all mortgage originators should act in "good faith and

with fair dealings" in any transaction. A reliable customer forms the basis of a successful

lending. The following principles act as the foundation of a judicious lending:

Safety of funds ensures that the bank, although being a profit generating unit,

continues to build and retain the trust of the public at large.

Security accepted from the borrower as an alternative for recovery of advances in

case of default must be of significant value.

Purpose or the objective of advances should remain in favor of nation‟s security. It

should not be anti- social or illegal.

Profitability and yield on advances should be in line with the banks objective, so the

advances made must be successful.

Liquidity of advances made by the bank indicates its ability to meet its deposit

liabilities, so the advances made should be adequately liquid.

Integrity of borrower is very vital to consider the loan proposal envisaged by him for

further sanction.

Adequacy of bank finance is of prime importance for a borrower to accomplish his

project so both under and over financing should be avoided by the bank.

Timely availability of funds to the borrowers helps the bank grow in the current

scenario.

These principles strengthen the bank finance eventually leading to safe advances.


3.3 BASEL II ACCORD: A MEASURE OF RISK

ADEQUACY

Basel II, also called The New Accord (correct full name is the International Convergence of

Capital Measurement and Capital Standards - A Revised Framework) is the second Basel Accord

and represents recommendations by bank supervisors and central bankers from the 13 countries

making up the Basel Committee on Banking Supervision (BCBS) to revise the international

standards for measuring the adequacy of a bank's capital. It was created to promote greater

consistency in the way banks and banking regulators approach risk management across national

borders.

Basel II is a type of recommendations on banking laws and regulations issued by the Basel

Committee on Banking Supervision that was initially published in June 2004.The objective of

Basel II is to create an international standard that banking regulators can use when creating

regulations about how much capital banks need to put aside to guard against the types of

financial and operational risks bank face.

THE ACCORD IN OPERATION:

Basel II uses a “three pillars” concept-

Minimum Capital Requirements

Supervisory review

Market Discipline


1st Pillar-Minimum Capital Requirements

The first pillar provides improved risk sensitivity in the way that capital requirements are

calculated for three major components of risk that a bank faces: credit risk, operational risk and

market risk. Under the Basel II Norms, banks should maintain a minimum capital adequacy

requirement of 8% of risk assets. For India, the Reserve Bank of India has mandated maintaining

of 9% minimum capital adequacy requirement. This requirement is popularly called as Capital

Adequacy Ratio (CAR) or Capital to Risk Weighted Assets Ratio (CRAR).


2nd

Pillar-Supervisory Review

The second pillar deals with the regulatory response to the first pillar, giving regulators much

improved 'tools' over those available to them under Basel I. It also provides a framework for

dealing with all the other risks a bank may face, such as name risk, liquidity risk and legal risk,

which the accord combines under the title of residual risk.

3rd Pillar-Market Discipline and Disclosure

The third pillar greatly increases the disclosures that the bank must make. This is designed to

allow the market to have a better picture of the overall risk position of the bank and to allow the

counterparties of the bank to price and deal appropriately.

3.4 LENDING AND ADVANCES

Banking system in India has gone through enormous changes. In addition banks are constrained

from optimally diversifying their activities, thereby increasing the opportunity to reduce

operating risk faced by industry, but the primary activity remains lending. Lending is the

provision of monetary resources by the banker where the other party reimburses in installments

or any other form of deferred payment, thereby by generating a debt.

Loans and advances portfolio being the most significant asset of the bank has direct impact on its

profitability. Increase in competition and emergence of new types of risks in the banking sector

has lead to efficient loans and advances management. In order to ensure a strong portfolio banks

need to implement necessary policies aiming at strengthening of pre sanction appraisal and post

sanction monitoring system.

In order to cope up with the changing scenario, banks in India are strengthening their

organizational setup through specialized departments to meet the credit requirements of the

borrowers and continuous analysis of the potential credit growth.


The ideal advance is one that is granted to a „reliable‟ customer for a legal purpose where he has

enough experience for efficient utilization of the amount and repays the amount within a given

time frame as per the agreement.

3.6 What is the loan sanction procedure?

Banks extend loan facilities in form of fund based and non fund based facilities. The banks

provide fund based facility by way of term loans, demand loans, bill discounted, cash credit,

overdraft, etc. whereas the non fund based facilities include letter s of credit and bank guarantee.

Indian Overseas Bank offers a wide range of services in the loans and advances segment some of

which are indexed here:

i) Personal loan

ii) Educational loans

iii) loans on bank term deposits

iv) loans against National Saving Certificates (NSC)

• comes up with a loan proposal

• collateral security• financial details

BORROWER

• verifies the purpose of loan

• assess the credibility of borrower

LENDER (BANK)• verifies the

proposal • either approves

(final sanction) or rejects

REGIONAL OFFICE


v) loans against Insurance Policies

vi) loans against Gold Jewels

vii) loans against Collateral Security, stocks and debtors

viii) loans against Shares

3.5 TYPES OF ADVANCES

CLASSIFICATION OF ADVANCES

The "term" of the loan refers to the length of time you have to repay the debt. Debt financing can

be either long-term or short-term.

Long term loan financing is commonly used to purchase, improve, or expand fixed assets such

as your plant, facilities, major equipment, and real estate. If you are acquiring an asset with the

loan proceeds, you (and your lender) will ordinarily want to match the length of the loan with the

FUND BASED

•Term Loan

•Cash credit

•Bill discounted

•Demand loans

•Overdraft

NON FUND BASED

• Letter of Credit

• Letter of Guarantee

TYPES OF

ADVANCES


useful life of the asset. Short term loan is often used to raise cash for cyclical inventory needs,

accounts payable, and working capital.

In the current lending climate, interest rates on long-term financing tend to be higher than on

short-term borrowing, and long-term financing usually requires more substantial collateral as

security against the extended duration of the lender's risk.

SECURED AND UNSECURED DEBT: Debt financing can also be secured or unsecured. A

secured loan is a promise to pay a debt, where the promise is "secured" by granting the creditor

an interest in specific property (collateral) of the debtor. If the debtor defaults on the loan, the

creditor can recoup the money by seizing and liquidating the specific property used for collateral

on the debt. For startup small businesses, lenders will usually require that both long- and short-

term loans be secured with adequate collateral.

Because the value of pledged collateral is critical to a secured lender, loan conditions and

covenants, such as insurance coverage, are always required of a borrower. You can also expect a

lender to minimize its risk by conservatively valuing your collateral and by loaning only a

percentage of its appraised value. The maximum loan amount, compared to the value of the

collateral, is known as the loan-to-value ratio.

An unsecured loan is also a promise to pay a debt. Unlike a secured loan, the promise is not

supported by granting the creditor an interest in any specific property. The lender is relying upon

the creditworthiness and reputation of the borrower to repay the obligation. An example of an

unsecured loan is a revolving consumer credit card. Sometimes, working capital lines of credit

are also unsecured.

If the borrower defaults on an unsecured loan, the creditor has no priority claim against any

particular property of the borrower. The creditor can try to obtain just a money judgment against

the borrower. Until a small business has an established credit history, it cannot usually get

unsecured loans because of the business's risk.

LETTER OF CREDIT: It is recognized that letters of credit are an important form of collateral

that have been widely used for many years across the securities lending industry. They have

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near-cash characteristics in that their value does not fluctuate with market conditions and they

can be cashed in when presented to the issuing bank. There exists a contract between two parties

subsequent to which the bank guarantees to pay the agreed amount on behalf of his client on the

accepted terms and condition. Letters of credit carry low risk of settlement failure and are

operationally efficient in applying across multiple trades. They are generally used in

international transactions, where two nations differing in legal systems find difficulty in knowing

each party personally. Thus this device facilitates trade.

BANK GUARANTEE: Bank guarantee is a guarantee from a lending institution ensuring that

the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank

will cover it. A bank guarantee enables the customer (debtor) to acquire goods, buy equipment,

or draw down loans, and thereby expand business activity.

A bank guarantee, like a line of credit, guarantees a sum of money to a beneficiary. Unlike a line

of credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations

under the contract. This can be used to essentially insure a buyer or seller from loss or damage

due to nonperformance by the other party in a contract.

A bank guarantee might be used when a buyer obtains goods from a seller, runs into cash flow

difficulties and can't pay the seller. The bank guarantee would pay an agreed-upon sum to the

seller. Similarly, if the supplier was unable to provide the goods, the bank would then pay the

purchaser the agreed amount. Essentially, the bank guarantee acts as a safety measure for the

supposing party in the transaction.

SPECIFIC TYPES OF BANK LOANS: In addition to consumer loans and mortgages, the

most common types of loans given by banks to startup and emerging small businesses are:

working capital lines of credit for the ongoing cash needs of the business

credit cards: higher-interest, unsecured revolving credit

short-term commercial loans for one to three years

longer-term commercial loans: generally secured by real estate or other major assets

equipment leasing for assets you don't want to buy outright

http://www.investopedia.com/terms/c/cashflow.asp


letters of credit for businesses engaged in international trade

3.7 FINANCIAL ANALYSIS OF LENDING

Financial analysis is the systematic examination and interpretation of financial data to evaluate

the past performance of a business, its present conditions and its future prospects. It refers to an

assessment of the viability, stability and profitability of a business, sub-business or a project.

Essentially, financial analysis moves from a preliminary investigation of the client to an in depth

examination of operating performance, as interpreted from historical and projected financial

statements.

With financial analysis, the advances manager assesses the company‟s financial performance to

arrive at a conclusion about the future prospects of the loan repayment.

FINANCIAL ANALYSIS ASSESES THE FIRM’S:

1. Profitability - its ability to earn income and sustain growth in both short-term and long-term.

A company's degree of profitability is usually based on the income statement, which reports on

the company's results of operations;

2. Solvency - its ability to pay its obligation to creditors and other third parties in the long-term;

3. Liquidity - its ability to maintain positive cash flow, while satisfying immediate obligations;

4. Stability- the firm's ability to remain in business in the long run, without having to sustain

significant losses in the conduct of its business. Assessing a company's stability requires the use

of income statement and balance sheet, as well as other financial and non-financial indicators.

STEPS INVOLVED IN FINANCIAL ANALYSIS OF LENDING

Step 1: Company‟s financial statement for at least 3 to 5 years is acquired. The financial

statement must include the following:

Balance sheets

Income statements

Shareholders equity statement


Cash flow statements

Step 2: A quick scanning of all the statements is done to look for large movements in specific

terms from one year to the next. If there is something suspicious, relevant research about the

company is done from the information available to find out the reason. Notes accompanying the

financial statements are also reviewed for additional information that may be significant to

analysis.

Step 3: This stage calls for an exhaustive scrutiny of the balance sheet. While examining, the

advances manager looks for the large changes in overall components of company‟s assets and

liabilities of equity. For example, have fixed assets grown rapidly in one or two years, due to

acquisitions or new facilities? Has the portion of debt grown rapidly, to reflect a new financial

strategy?

Step 4: This level relates to an assessment of the income statement as furnished by the client.

The advances manager looks for the trends overtime. Graphs and growth of the following entries

over the past several years are calculated.

Revenue (sales)

Net income (profit, earnings)

For each key expense components on the income statement, percentage of sales of each year is

calculated. For example, percentage of cost of goods sold over sales, general and administrative

expenses over sales and development over sales are computed. Favorable and unfavorable trends

are highlighted. Manager determines whether the spending trends support the company‟s

strategies.

Step 5: The very phase pertains to an evaluation of the cash flow statement. It gives information

about the cash inflows and outflows from operations, financing and investing. While the income

statement provides information about both cash and non-cash items, the cash flow statement

attempts to reconstruct that information to make it clear how cash is obtained and used by the

business, since that is what investors really care about.


CALCULATION OF FINANCIAL RATIOS

Ratio analysis is a powerful tool of financial analysis. In financial analysis, a ratio is used as a

benchmark for evaluating the financial position and performance of the firm. A ratio in itself has

no meaning. It should be compared with some standard. Standards of comparison may consist of:

Past ratios

Competitors ratios

Industry ratios

Projected ratios

The most frequently used ratios by bank and financial analysts are:

Liquidity Ratio

Degree of financial leverage of debt

Profitability

Efficiency

Value

a) ANALYZING LIQUIDITY: Liquid assets are those that can be converted into cash

quickly. The short-term liquidity ratios show the firm‟s ability to meet its short-term obligations.

Thus a higher ratio (#1 and #2) would indicate a greater liquidity and lower risk for short-term

lenders. The Rules of Thumb for acceptable values are: Current Ratio (2:1), Quick Ratio (1:1).

1. Current Ratio = Total Current Assets / Total Current Liabilities

2. Quick Ratio = (Total Current Assets - Inventories) / Total Current Liabilities

In the quick ratio, we subtract inventories from total current assets, since they are the least liquid

among the current assets.

b) ANALYZING DEBT: Debt ratios show the extent to which a firm is relying on debt to

finance its investments and operations, and how well it can manage the debt obligation, i.e.


repayment of principal and periodic interest. If the company is unable to pay its debt, it will be

forced into bankruptcy. On the positive side, use of debt is beneficial as it provides tax benefits

to the firm, and allows it to exploit business opportunities and grow.

Note that total debt includes short-term debt (bank advances + the current portion of long-term

debt) and long-term debt (bonds, leases, notes payable).

1. Leverage Ratios

1a. Debt to Equity Ratio = Total Debt / Total Equity

This shows the firm‟s degree of leverage or its reliance on external debt for financing.

1b. Debt to Assets Ratio = Total Debt / Total assets

In general, with either of the above ratios, the lower the ratio, the more conservative (and

probably safer) the company is. However, if a company is not using debt, it may be foregoing

investment and growth opportunities. This is a question that can be answered only by further

company and industry research.

2. Interest Coverage (or Times Interest Earned) Ratio = Earnings before Interest and Taxes /

Annual Interest Expense

This shows the firm‟s ability to cover fixed interest charges (on both short-term and long-term

debt) with current earnings. The margin of safety that is acceptable varies within and across

industries, and also depends on the revenue generation history of a firm (especially the

consistency of earnings from period to period and year to year).

3. Cash Flow Coverage = Net Cash Flow / Annual Interest Expense

Net cash flow = Net Income is either subtracted from or added to non-cash items, as applicable

(e.g. -equity income + minority interest in earnings of subsidiary + deferred income taxes +

depreciation + depletion + amortization expenses)


Since depreciation is usually the largest non-cash item in most companies, analysts often

approximate Net cash flow as being equivalent to Net Income + Depreciation.

Cash flow is a “critical variable” in assessing a company. If a company is showing high profits

but has poor cash flow, one should investigate further before passing a favorable opinion on the

company. Analysts prefer ratio #3 to ratio #2.

c) ANALYZING PROFITABILITY: Profitability is a relative term. It is hard to say what

percentage of profits represents a profitable firm, as profits depend on factors such as the

position of the company and its products on the competitive life cycle (for example profits will

be lower in the initial years when investment is high), on competitive conditions in the industry,

and on borrowing costs. For decision-making, bank is mainly concerned with the present value

of expected future profits. Past or current profits are important only as they help us to ascertain

future profits, by identifying historical and forecasted trends of profits and sales.

1. Net Profit Margin = Profit after taxes / Sales

2. Return on Assets (ROA) = Profit after taxes / Total Assets

3. Return on Equity (ROE) = Profit after taxes / Shareholders‟ Equity (book value)

4. Earnings per Common share (EPS) = (Profits after taxes - Preferred Dividend) / (# of

common shares outstanding)

5. Payout Ratio = Cash Dividends / Net Income.

d) ANALYZING EFFECIENY: These ratios reflect how well the firm‟s assets are being

managed.

The inventory ratio shows how fast the inventory is being produced and sold.

1. Inventory Turnover = Cost of Goods Sold / Average Inventory


This ratio shows how quickly the inventory is being turned over (or sold) to generate sales. A

higher ratio implies the firm is more efficient in managing inventories by minimizing the

investment in inventories. Thus a ratio of 12 would mean that the inventory turns over 12 times,

or the average inventory is sold in a month.

2. Total Assets Turnover = Sales / Average Total Assets

This ratio shows how much sales the firm is generating for every dollar of investment in assets.

The higher the ratio, the better is the performance of the bank.

3. Accounts Receivable Turnover = Annual Credit Sales / Average Receivables

4. Average Collection period = Average Accounts Receivable / (Total Sales / 365)

Ratios #3 and #4 show the firm‟s efficiency in collecting cash from its credit sales. While a low

ratio is good, it could also mean that the firm is being very strict in its credit policy, which may

not attract customers.

5. Days in Inventory = Days in a year / Inventory turnover

Ratio #5 is referred to as the “shelf-life” i.e. how quickly the manufactured product is sold off

the shelf. Thus #5 and #1 are related.

e) VALUE RATIOS: Value ratios show the “embedded value” in stocks, and are used by

investors as a screening device before making investments.

1. Price to Earnings Ratio (P/E) = Current Market Price per Share / After-tax Earnings per Share

2. Dividend Yield = Annual Dividends per Share / Current Market Price per Share

f) DEBT SERVICE COVERAGE RATIO:

The debt service coverage ratio (DSCR) is the ratio of cash available for debt servicing to

interest, principal and lease payments. It is a popular benchmark used in the measurement of an

entity's (person or corporation) ability to produce enough cash to cover its debt (including


lease) payments. The higher this ratio is, the easier it is to obtain a loan. The phrase is also used

in commercial banking and may be expressed as a minimum ratio that is acceptable to a lender;

it may be a loan condition or covenant. Breaching a DSCR covenant can, in some

circumstances, be an act of default.

In general, it is calculated by:

A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1 say 0.95 would

mean that there is only enough net operating income to cover 95% of annual debt payments. For

example, in the context of personal finance, this would mean that the borrower would have to

delve into his or her personal funds every month to keep the project afloat. Generally, lenders

frown on a negative cash flow, but some allow it if the borrower has strong outside income.

3.8 METHODS OF CREDIT RATING

Bank uses credit rating methods to judge the credibility and the financial strength of any business

unit that requests for loan. A set format is followed by the organization, where all the parameters

that help in determination of credibility are mentioned. Method of credit rating is explained in

great detail with the help of a case study in the later part of the report.

For all the advance proposals up to Rs. 1 crore, bank relies on internal credit rating system while

any proposal exceeding this amount calls for an authentic credit rating with the recommendation

of CRISIL.

CRISIL is India's leading Ratings, Research, Risk and Policy Advisory Company. CRISIL offers

domestic and international customers a unique combination of local insights and global

perspectives, delivering independent information, opinions and solutions that help them make

better informed business and investment decisions, improve the efficiency of markets and market

participants, and help shape infrastructure policy and projects. Its integrated range of capabilities


includes credit ratings; research on India's economy, industries and companies; investment

research outsourcing; fund services; risk management and infrastructure advisory services

3.9 METHOD OF ASSIGNING CREDIT LIMIT AND

DRAWING POWER

OVERDRAFT FACILITY FOR INDIVIDUALS

Overdraft facility is provided to individual customers. In this case, the credibility of the borrower

is assessed by tracking his past record. The transaction in his account for a minimum of past six

months is checked to judge his credibility and predict his intentions to pay back the amount in

near future. If his past record indicates that he did not default under normal circumstances, then

overdraft facility is allowed. Such a facility up to Rs.2 lacs is provided to him based on the

discretion of the branch manager. Overdraft limit over and above Rs.2,00,000 is provided only

after the approval from the Regional Office is received. The limit is sanctioned against the total

deposits of the individuals keeping 10% as the margin money.

CASH CREDIT FACILITY FOR BUSINESS CONCERN

While assigning the cash credit limit to business units the bank first does an exhaustive analysis

of the particulars furnished by the customer. The documents required include:

Balance sheet of the concern for the past three years ,

Recent stock statement where stock includes raw materials in store, loose tools, work in

progress and finished goods held in warehouse. It should be noted that only paid up

stocks are to be considered and not the stock purchased on credit basis.

Record of debtors: a statement showing the book debts up to 90 days is taken into

account.

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Sales turnover: the sales turnover of the past three years should be clearly shown. In case

where the sales turnover exceeds an amount of Rs 40 lacs, a certification from Chartered

Accountant (CA) is to be obtained.

PAN card details of the client are mandatory.

Asset and liability statement of both the borrower and the guarantor for the preceding

three years is to be verified.

Two years of projected sales and balance sheets need to be procured from the borrower to

comply with all the regulations laid down by the governing authorities.

The details and documents related to stocks, debtors and sales are to be furnished regularly by

the client on a quarterly basis to review his credit limit from time to time. The basic formula

includes for calculation of the drawing power is as follows:

75% of stock + 50% of debtors (stocks and debtors calculated as per the details showed in the

documents procured from the customer)

3.10 SECURITIES USED AGAINST LENDING

The securities are broadly classified as primary security and collateral security. Collateral

securities are the provisional securities accepted by banks that cover the loan amount and can be

legally liquefied in case of default in repayment.

The securities that are included under collateral are mentioned below:

Policies: Endowment policy matures after the death of the policy holder or the

predefined time duration, such as Life Insurance Policy of LIC is acceptable as security.

One of the cheapest ways to borrow small amounts of money is to raise a loan against an

endowment policy. The loans are not common with endowments taken out to back

mortgages, but they are offered against savings policies. The banks usually sanction loan

amount up to 80%-90% of the surrender value of the policy.

National Saving Certificates (NSC) and Kendriya Vikas Patra (KVP): NSCs and

KVPs may be pledged in the bank‟s name along with transfer application to request for


sanction of loans, thus forming another type of bank security. The bank marks lien on the

certificates surrendered by the borrower and informs the same to the issuing authority.

Fixed Deposit Receipts (FDR): The medium term savings of the individuals may act as

a liquid security for all types of loans and advances. The banks willingly sanction

advances against the FDRs of their regular customers keeping 10% as margin.

House property: It is not uncommon for real estate or intellectual property to be

included as part of the calculation of the loans. Under house loan request, the house

property of the borrower is usually taken as security that acts as an insurance against the

loan amount sanctioned. One can avail up to 80% of cost of property as assessed by

authorized official after all legal compliance.

Other assets: Collateral is focused on accounts receivable, inventory and equipment.

Assigning an appropriate possession as security is a common way of making secured

term loans. The possessions may be any machinery, equipment, or business property that

is accepted as collateral. The asset remains with the borrower unless there is default, in

which case the same goes to the bank. Generally, credit against machinery and equipment

is restricted primarily to new or highly serviceable and resalable used items.

MODES OF CHARGING SECURITIES

Charging a security refers to creating a legal RIGHT to payment out of the assets given as

security. It assigns judicial power to the banker to take recourse to the assets given as security in

case of non remittal of the amount on part of the borrower.

Five different modes of creating charge are stated as follows:

i) Lien: Banker‟s lien is the right to retain goods given as securities belonging to the

debtor in order to get the debts discharged. This may either be general lien or specific

in nature. However, to exercise this banker is required to prove his diligence that it

had no notice of defect in the title.

ii) Hypothecation: This is a charge upon any movable property of the debtor without

transfer of its ownership to the creditor. So the goods remain in the possession of the

owner but the borrower is under an obligation to submit regular returns to the bank


indicating any increase or decrease in the value of said goods to help bank determine

his drawing limit.

iii) Pledge: Pledge is just the opposite of hypothecation but the purpose remains same.

Under this the goods that are charged remain in actual possession of the bank and no

withdrawals or additions to the stock are permissible without bank‟s permission.

iv) Mortgage: It is the transfer of interest in specific movable property for the purpose

of securing the payment of money advanced or to be advanced by way of loan, an

existing or future debt, or the performance of an engagement which may give rise to a

pecuniary liability.

3.11 CALCULATION OF EMI

EMI (Equated Monthly Installment) in simple terms means a fixed payment made by a borrower

to a lender at a specified date in each calendar month. Equated monthly installments are used to

pay off both interest and principal each month, so that over a specified number of years, the loan

is paid off in full.

The formula for calculation of EMI given the loan, term and interest rate is:

EMI = (p*r) (1+r)^n

(1+r)^n - 1

p = principal (amount of loan)

r = rate of interest per installment period i.e., if interest is 12% p.a. r = 1

n = no. of installments in the tenure

^ denotes whole to the power.

3.12 DOCUMENTATION

Advances are not reimbursed by the bank until documents are duly filled and properly executed

in compliance with the guidelines of the bank. Documentation in a loan account is of prime

consideration since these documents act as physical evidence in case the bank decides to initiate

any legal proceedings for recovery of its dues.


In all kinds of loans, bank ensures that it has all the pertinent documents from the borrowers to

protect their interests. Banks have predesigned printed forms that are duly filled and kept in their

record for future references.

IMPORTANCE

Document, being a written statement of facts, states certain rights and liabilities of parties

entering into contract (in this case bank and the prospective borrower). It binds the parties to

advance under law. The documents need to be properly executed and adequately stamped for it

to be fit to pass order for a decree.

GENERAL PRECAUIONS IN EXECUTING NECESSARY DOCUMENTS

Documents may be typed or printed. Handwritten documents should be completed in same

handwriting to avoid unnecessary misleading inferences. All documents should be signed in full

signature and in the same font without overwriting or signature in initials. The date and place of

the execution must be mentioned. And the ambiguity in writing the same should be avoided. The

language should be simple enough for the borrower to understand and comprehend.

EXECUTION OF DOCUMENTS

The documents need to be executed in presence of the manager. In case it is to be executed by

any illiterate person, the contents need to be explained ensuring that the executants are not under

undue influence or coercion.

In case of joint borrowers, the borrowers must jointly sign the documents where as in case of

partners, any one (authorized) on behalf of all may sign. The execution in case of a company

requires common seal to be affixed along with the signature of the authorized person as decided

by the Board of Directors. As to the HUF, it is usually signed by the Karta on behalf of all the

family members.

STAMPING OF DOCUMENTS:

According to Indian Stamp Act 1899, the documents that are properly stamped before or at the

time of execution, can only act as the basis of a suit. Stamps are classified under two categories-


judicial and non judicial. Judicial stamps are used in courts for filing suits and appeals while the

non judicial stamps are used by the banks. Adhesive stamps and embossed stamps form part of

the non judicial stamps and are used as applicable. Stamping of documents (wherever required)

provides an identity and legal existence to the document to act as a proof of evidence in case of

any dispute.

RENEWAL OF DOCUMENTS

It is mandatory to renew documents within three years. While reviewing the documents it should

be ensured that all the necessary amendments as per the terms of advances are incorporated in

the renewed document.

SECURITY RECORD AND SAFE CUSTODY OF DOCUMENTS

Document should be adequately examined by the officer-in-charge of advances. All the relevant

particulars related to the original and the renewed document should be recorded in the

Documents Execution Register.

3.13 CREDIT MONITORING

Credit monitoring in a bank is to ensure that the funds are utilized for the sanction purposes and

at the same time complying with all sanction terms and conditions. The purpose of this exercise

is to avoid the time lag and cost over runs, to detect early warning signals and symptoms of

incipient sickness in the units financed by banks and to initiate timely action for recovery or

rehabilitation. Under credit monitoring arrangement bank ensures the following:

a) Borrower should maintain reasonable estimates of current assets, current liabilities and

working capital.

b) Should maintain classification of current assets and current liabilities as per bank guidelines.

c) Should maintain a minimum current ratio of 1.33 except for export industry and for new units.

d) Should submit annual audited accounts in time for annual review bay banks.


e) Ad hoc limits are sanctioned for periods not exceeding three months

f) As far as possible, post sale limits are sanctioned in the form of bill finance.

CREDIT APPRAISAL TECHNEQUIES

Under this process, the decision maker finds the answer to two important questions, one being

whether the entrepreneur requires funds, what are his credentials? If the answer to the question is

positive then the second question being the extent of his requirement and the ways in which it

can be met. Assessment of credit requirement is often difficult because of lack of data. So RBI

suggested that the banks may not insist on submission of audited financial statements up to credit

requirements of Rs 25 lakhs, but beyond this limit, a structured analysis of the financial

statements is a must. Due to increasing non performing assets, credit appraisal techniques are

increasingly focused on the assessments of repayment capacity of the borrower that depends on

his revenue generating ability.

RENEWAL OF DOCUMENTS

At the time of renewal, the bank should obtain a fresh set of documents duly supported by

supplemental deeds if required. A formal letter from the borrower agreeing to continue the credit

facility by bank in future, is obtained. Acknowledgment of the debt and security incorporating

particulars of the original security document duly signed by the borrower are obtained and

attached to form a part of the renewed documents.

43 [email protected] ICFAI Business School

CASE ANALYSIS

XYX INFOTECH: A CASE ON CREDIT APPRAISAL

BORROWER/COMPANY PROFILE

The borrower is banking exclusively with IOB since September 2006. He is successfully running

an NIIT computer training centre at Midnapore for which he is having a cash credit account in

IOB with a limit of Rs 1 lakh. Credit rating of the borrower is „A‟ as in December 2008 and the

worth of the proprietor is Rs 33.77 lakh. He has also taken a term loan of Rs 12.00 lakh from the

bank out of which Rs 9.89 is still outstanding. There are no irregularities in the cash credit and

term loan account till date.

Comments on Operation (Full Last Year & Current Year up-to-date)

A) F 209 period from to Max

(Rs. in Lacs)

Min Turnover Income earned

1) Fund Based`

01.4.07-31.3.08 01.97 00.36 14.57 0.15

03.46 01.18 22.21 0.14

2)‟ Non Fund Based _____________ ______ _______ ___________

3) Obtention of Stocks and Book debts

statements and Quarterly Auditors

certificate on book debts and their

latest dates

Regular


B) Details of Ad-hoc/Excess granted

with period and its adjustment within

the expiry time etc.

(Whether permission of sanctioning

authority obtained)

The excess granted under Br discretion and were

regularized within the commitment period.

PRESENT REQUEST/ PROPOSAL

The borrower is into business since 1992, and his existing branch of NIIT is working

successfully. NIIT has offered him for opening a new unit at Kharagpur and he has paid more

than Rs 10 lakhs as advance for starting the same. The present proposal of the borrower is as

follows:

PRESENT REQUEST/PROPOSAL

LIMIT (Rs. in Lacs)

Nature of Facility Existing Proposed Increase

Term Loan Limit-12.00

DP- 09.89

19.69 07.80

Cash Credit against Stocks/Book

Debts (not exceeding 90 days)

01.00 05.00 04.00

Bills /Others ___________ __________ ____________

Non Fund Based

__________ __________ ____________


COLLATERALS/ GUARANTORS

Collateral RS. In Lacs.

Nature Face Value Present Value Owned/held by

Deposit 01.50 01.73 _____________

NSCs/KVPs ____ ____ ____________

LIC Policy 05.00 ____ _____________

Others 09.85 09.85 _____________

Total 16.35 11.58

Details of Land

and

Building/Flat

Land

Area/Extend in

Acre/Sq. ft.

Constructed Area

Covered Area

(for building)

Forced

Sale

Value

Owned by

(Relationship between

partner / directors)

Details of Collateral Security (Land &

Building)

(Should contain details of ownership,

nature of property, location, extent of

land and building, preliminary

valuation report/Desk- top valuation /

whether Agricultural/Housing

plot/Commercial etc.

Forced Sale Value Rs 9.85


FINANCIAL ANALYSIS

PARTICULARS (1) (2) (3) (4)

31.03.07 31.03.08 31.03.09 31.03.10

Tangible Net Worth (TNW) 07.01 07.57 11.87 16.77

Debt Equity Ratio 02.83 02.70 01.39 01.78

Current Ratio 01.55 01.59 01.42 01.56

Net Working Capital 00.56 01.63 02.69 04.83

TOL/TNW 02.83 02.70 01.39 01.78

Sales (Net Sales) (Less Excise) 0.26 21.00 30.00 40.00

Gross Fixed Assets 10.79 09.06 07.33 06.23

N P A T 00.03 02.34 04.50 07.40

Net Cash Generation (net of

Dividend/drawings

------ 04.07 06.23 08.50

N P A T / Sales 11.54 11.14 15.00 18.50

P B I T / Sales 11.54 11.14 22.40 27.63

Stocks 00.00 02.40 02.40 03.00

Sundry Debtors ------- ------ 03.70 05.00

Sundry Creditors for Goods ------- ------ ------ -------

Unsecured Loan (To be pegged)

(From

Directors/Partners/Friends/

Relatives /Associates)

------- ------- ------- -------


Comments on estimates:

Net worth of the borrower is Rs 33.77 lakhs.

Guarantor in this case is the proprietor‟s

wife. Details of the collateral security are as

follows:

NET WORKING CAPITAL ASSESSMENT

Sales Current year (2008 - 2009)

Estimated Sales current year 2008-09

Projected Sales (next year) 2009-10

Accepted Sales turnover- (2009 - 2010 )

Comments in brief: :

a) Estimated/Projected sales turnover:

b) 25% of projected/estimated sales turnover:

c)Minimum Margin at 5% of Projected/estimated sales

turnover:

c) Available margin (as per Latest Balance Sheet):

d) PBF ((b) –(c ) or (b) – (d) whichever is less):

40

10

,,

2

3

7

P B F (As per Nayak/Vaz Committee/Turnover Method) 07.00 Lacs, Proposed and

sanctioned Rs.05.00 Lacs

Comments on Margin /adequacy NWC for 2007-08 is 1.63 and

for 08-09 is 2.69, we consider

3.00 for arriving MPBF

Structure of limits proposed

Facility Limit Margin

1) Cash Credit 05.00 25%

2) Term Loan 07.80 25%


TERM LOAN ASSESSMENT

Capital Asset to be Purchased / Created

New NIIT centre to be opened at

Kharagpur with rental flat, along with

all furniture, fixtures, machineries, and

stationeries

Margin Proposed:

(As per norms- Minimum of 50% for land 40% for

Building 25% for Machinery / equipment)

05.80

Available from internal generation/fresh/

Infusion of addl. Capital/USL (to be pegged)

15.40

Need for capital asset / machinery / Building

construction ( Justification to be commented)

07.80

Availability of adequate space / power / Man

power (All other requisite infrastructure facilities)

Yes

Calculation of D S C R (values in Rs. lakhs)

PARTICULARS 1 2 3 4 5 6

31.03.08 31.03.09 31.03.10 31.03.11 31.03.12 31.03.13

P A T 2.34 4.50 7.40 9.01 9.78 10.24

Comment on the adequacy of Drawing Power Availability

based on the latest Balance Sheet

Present stocks and

Book debts value are

sufficient to cover

D.P


Depreciation 3.07 1.73 1.10 0.80 0.64 0.54

Interest on term loan –

Existing

1.63 1.60 1.56 1.51 0 0

Proposed 1.05 1.00 0.95 0.91 0.86 0.80

A) Funds Available 8.09 8.83 11.01 12.23 11.28 11.58

Repayment

Term Loan Installment –

Existing

3.62 3.62 3.62 3.62 ______ ______

-

Proposed

2.14 2.14 2.14 2.14 2.14 2.14

Interest on Term Loan -

Existing

NA NA NA NA NA NA

Proposed

NA NA NA NA NA NA

B) Total Obligation 5.76 5.76 5.76 5.76 2.14 2.14

D S C R (A/B) (Range 1.50 to 2.00 is acceptable as bank Norms)

1.40 1.53 1.91 2.12 5.27 5.41

Comments

(Whether the machinery/equipments to be purchased is new or second hand ( Higher

margin to be stipulated), Obtention of authenticated invoices/quotations/comparative

price list on similar brands and satisfactory credit reports on the suppliers to be ensured)

The debt service coverage ratio (DSCR), is the ratio of cash available for debt servicing

to interest, principal and lease payments. It is a popular benchmark used in the

measurement of an entity's (person or corporation) ability to produce enough cash to

cover its debt (including lease) payments. The higher this ratio is, the easier it is to obtain


a loan. The phrase is also used in commercial banking and may be expressed as a

minimum ratio that is acceptable to a lender; it may be a loan condition or covenant.

Breaching a DSCR covenant can, in some circumstances, be an act of default.

The DSCR up to 2011 is considerable as it rounds about the level 2.00. From 2012, since

the existing term loan will be closed their total obligations will be reduced suddenly and

accordingly the DSCR level will also be enhanced. However bank will be revising the

DSCR with every year estimates and projections to compare with the actual achievements

to satisfy our DSCR.

METHOD OF CREDIT RATING NOTES (Specimen given in the case analysis)

Average should be arrived at by dividing the net marks obtained (after deducting the negative

marks) by total number of applicable positive features.

Above 7.5 A +

Above 6.5 A

Above 4.5 B

Below 4.5 C

PARAMETERS

SCORE

1. Sales

If the growth is increasing over the last 3 years 5

@ 20 % and over

@ 10 to 19 %

@ 5 to 9 %

@ less than 5 % or decline in sales in any year during last 3 years

5

4

3

0

2. Net Profit to Above 5 % 5 5


Sales 3 to 4 % 4

1 to 2 % 2

below 1 % 1

3. Sales to Bank 6 times 5

Borrowing 3 to 5 times 3 3

1 to 2 times 1

below 1 0

4. Sales to TNW 5 times 5

3 to 4 times 4

1 to 2 times 2 2

below 1 0

5. Level of Above 80 % 5

utilization 70 to 79 % 3

of limits 50 to 69 % 1

below 50 % 0

6. Documentation

Perfect compliance 5 5

Imperfect but beyond borrower‟s control 4

Not responsive 0

7. Compliance of Terms and Conditions

Prompt compliance 5 5

Delayed or unsatisfactory compliance 3


Not responsive 0

8. Payment of Bills NA

Prompt payment with :

overdue less than 5 % 5




overdue more than 25 % 0

9. DPG /Term Loan Installments and

Periodical interest

Timely repayment 5

Delayed repayment

(1 installment/1 quarter Interest

outstanding)

3 3

Not repaid (2 or more

installments/quarterly Interest outstanding)

0

10. Renewal of Limits

Timely renewal 5

Delayed renewal upto 3 months 3 3

Non-renewal beyond 3 months 0

11. Current Ratio 1.33 and above 20 20

1.25 and above 12

1.15 and above 8


The conduct of the accounts so far is satisfactory. However he is facing some problems in

remitting funds to his account from Midnapore frequently. But ultimately he is sincere towards

the repayment of the loan installments as well as CC A/c operations. SCORING SYSTEM

TRADE CREDIT ACCOUNTS

1.00 and above 4

RATING:

12. Total Liability:

(A) TNW (For Companies other

than HP and Leasing)

Upton 2.0

Upton 2.5

Upton 3.0

Upton 3.5

Upton 4.0

Upton 4.5

Upton 5.0

Above 5.0

25 25

23

20

16

12

8

4

0


(B) For HP and Leasing Companies If public

deposits are : NA

7 to 10 times of NOF 25

6 to 6.9 times of NOF 23

(Ratio of Public Deposits to NOF)





1 to 1.9 4

Less than 1 0


13. Sundry Debtors Level

Actual in line with level assessed 5

(including 20 % deviation)

5

Deviation : 20 to 50 % 3

Deviation : Above 50 % 0

NEGATIVE FEATURES

1. Delayed submission of QIS, CMA and

financial statement :

Delay up to 3 months 2 2

Delay between 3 and 6 months 3

Delay beyond 6 months 5

2. Delay in submission of Stock statements :

Beyond 15 days from due date 3

up to 30 days

3

Beyond 30 days from due date 5

3. Documentation Irregularities :

Not rectified within 30 days from date

of detection or borrower not responsive

5

4. Non fund/ancillary business routed

through other banks/non consortium

members (in case of Consortium advance)

without the concurrence of consortium.

5


5. Merchant Banking Business not

offered to IOB

5

6. Sales-actual at variance with

projections Estimate

Variance between 10 and 15 % 3

Variance exceeding 15 % 5

7. Default in payment of LC obligations

including A & E :

Paid with a delay of 1 to 7 days 2

Paid with a delay of 7 to 15 days 3

Paid with a delay of beyond 15 days 5

8. Current ratio below 1 5

9. Business Mix (for HP and Leasing Cos only) :

Concentration of business within the group

30 to 50 % 3

above 50 % 5

10. Default in payment of installments/

Interest on funded loans beyond

30 days

5

11. Return of Bills - 10 to 25 % 3


TOTAL POSITIVE POINTS------------ 86

TOTAL NEGETIVE POINTS-----------05

NET POINTS = 81

AVG = 81/12 = 6.75

RATING-------------A

MULTIPLE DISCRIMINANT ANALYSIS

The studies above provide for looking at a number of separate clues (ratios to sickness or

failure). It would be more useful to combine the different ratios into single measure of the

more than 25 % 5

12. For HP and Leasing Companies only :

Over dues in HP installments/Lease rentals

10 to 25 % 3

more than 25 % 5

NOTES:

1. For scoring under point No. 7 under „Positive Features‟ viz., compliance with other

terms and conditions, branch should take in to account the following :

Terms and Conditions in sanction letter such as maintenance of margin, obtention of letter of

pegging, no lien letter, power of attorney, non-declaration of dividend etc.

2. In case of guarantees invoked, if payment of invoked amount is not settled within 15 days,

the rating of the borrower should be downgraded to “C”.

3. If LCBR dues are not met even after 15 days from the due date, the rating of the borrower

should be downgraded to “C”.


probability of sickness or failure (bankruptcy). The technique of Multiple Discriminant Analysis

(MDA) helps us to do so. The use of MDA helps to consolidate the effect of all ratios. It is

derived from the following discriminant function:

Z= 0.012X1 + 0.014X2 + 0.033X3 + 0.006X4 + 0.010X5 where

Z = discriminant function score of the firm

X1= net working capital/total assets (%)

X2= retained earnings/total assets (%)

X3= EBIT/total assets (%)

X4= market value of total equity/book value of debt (%)

X5= sales/total assets (times)

According to the established guideline Z score which can be used to classify firms as either

financially sound- a score above 2.675- or headed towards bankruptcy- a score below 2.675. the

lower the score, the greater is the likelihood of bankruptcy and vice versa.

Z SCORE

1.08

2.12

2.73

0

0.5

1

1.5

2

2.5

3

2008 2009 2010


The Z score of XYZ INFOTECH has seen a considerable rise in 2009(2.12) compared to 2008

(1.08), which will further rise to 2.73 in the year 2010 if we consider the projected balance sheet

of the firm. This gives the clear indication that the company is in the sound position as compared

to the previous year and it will very soon cross the acceptable mark of 2.675 in the coming year

which proves numerically that the firm is financially sound.

BANK FINANCE

RECOMMENDATIONS

The captioned party has been enjoying the mentioned limits from September 2006. The

proprietor is an experienced person engaged in business for the last 4-5 years. He started unit at

Midnapore in 2006 and handled successfully. Some of the big names in Pvt. Sectors (like-IBM)

are approaching the institute for campus interview.

NIIT, a brand in itself, had offered him to open another branch at Kharagpur, and has already

issued the license. Their Kharagpur unit‟s future seems quite blooming, since it is an industrial

place strongly supported by IT sector background and basis. The government has also come up

with many new policies and schemes which are favorable for opening new Private Sector biggies

at Kharagpur. So the customer‟s this unit will be unquestionably getting huge opportunities for

their services, i.e. imparting of training for employment.

Limits recommended for sanction BPLR+ RS. LACS.

Nature of Facility Limit Margin Interest Security(PRIME)

1) Cash credit

5.00 Stocks-25%

B.Debts-50%

BPLR+0.50

%

Hypothecation of stocks

and book debts

2) Term loan 7.00 25% BPLR+0.50

%

Hypothecation of

machineries, furniture‟s,

fixtures.etc


EXPORT CREDIT

Pre-shipment finance is also known as packaging credit it refers to any loan or advance granted

or any other credit provided by a bank to an exporter for financing the purchase processing

manufacturing or packaging of goods prior to shipment on the basis of letter of credit opened in

his favor or in favor of some other person.

Post-Shipment finance means any loans or advance granted or any other credit provided by an

institution by an institution to an exporter of goods services from India from the date of

extending the credit after shipments of goods rendering of services to the date realization of

exporter proceeds

Pre Shipment Finance is issued by a financial institution when the seller wants the payment of

the goods before shipment. The principal objective behind pre-shipment finance or pre export

finance is to enable exporter to:

Procure raw materials.

Carry out manufacturing process.

Provide a secure warehouse for goods and raw materials.

Process and pack the goods.

Ship the goods to the buyers.

Meet other financial cost of the business.

The concepts related to export credit and their treatment are more lucidly explained with the help

of a case study (Liberty Marine Syndicate Ltd.) that was witnessed during the SIP period. This

would bring a decipherable picture of the manner in which the export credit is granted to any

party.


CASE STUDY

THE LIBERTY MARINE SYNDICATE LTD.

BACKGROUND

Liberty Marine Syndicate Ltd was established on 22.02.1972. The company was established to

do and undertake contracts for transport and transporting, shipping and clearing and that of ship

chandelling, stevedoring, chipping and painting, multimodal transport operation and international

freight forwarding and all kinds of work and servicing in connection there to.

The company is also engaged as contractors in connection with contracts of loading, unloading

and handling of cargo of any or all description and of preparation of special cribbing and

wedging and packing for wagons and wagon loading.

One of the main areas of activity is charting between India to fast and red sea/Africa lne

specializing in cargos such as iron ore/minerals: agricultural products/fertilizers: bagged cargo:

steel product cement/ clinker/ logs and projects/ heavy lifts. We act as house brokers for SPS

group, glencore, swiss Singapore, IMFA and ISPAT to name a few.

The two directors of the company namely Mr.Rakesh Aggrwal and Mr. Vimal Aggrwal having

the net worth of Rs 32 lacs and Rs 35 lacs respectively are having 16 years of experience in this

business. They are banking with IOB since August 2007.

PROJECT PROPOSAL AND REQUIREMENTS

As the borrower is into the business of exports and imports so the borrower needs packing credit,

letter of credit and letter of guarantee for the successful operation of its business. The specific

requirement of the borrower is as follows:

Type of facility required Amount

Letter of credit Rs 4 crore


Letter of guarantee Rs 2 crore

Packing/Cash Credit Rs 4 crore

TOTAL Rs 10 crore

The primary security given by the borrower was land and building with the market value of Rs 2

crore backed by another security of Rs 2 crore. So the total security given by the borrower was

Rs 4 crore approx.

FINANCIAL ANALYSIS AND RECOMMENDATIONS

PAST PERFORMANCE (In Rs lacs)

YEAR ENDING 2004(AUDITED) 2005(AUDITED) 2006(AUDITED) 2007(AUDITED)

Sales & Servicing 1185.35 2319.60 2431.04 2602.04

Profitability 6.17 10.76 25.13 36.58

Net worth 24.99 45.24 110.37 281.95

It is apparent from the above table that the sales volume of the company is increasing gradually

with the subsequent increase in the profitability and net worth of the company year by year.

SWOT ANALYSIS

Strengths:

1) The company is one of the leading chartering brokers in the country.

2) They are established stevedores and handling agents in the eastern part of the country.

3) They have already started export of iron ore to China which is in high demand and has vast

scope.


4) The company is a professionally managed one with good infrastructure support.

Opportunity

The company has huge opportunity to expand its export business, as there is huge demand from

China.

Weakness and threats

Over dependence on china for export is fraught with risk. Competition from other iron ore

exporting countries is a threat.

KEY FINANCIAL INDICATORS In Rs Lacs

PARTICULARS 31.03.05 31.03.06 31.03.07 31.03.08

Paid up capital 7.34 7.34 42.34 42.34

Net worth 45.24 110.37 281.95 384.25

Long term secured loan ----- ----- ----- -----

Long term unsecured loan ----- ----- ----- -----

Net fixed asset 22.01 67.12 82 72

Intangible asset ----- ----- ----- -----

Deferred tax 0.89 ----- ----- -----

Receivable 426.14 307.50 441.93 650

Other current asset 110.66 168.40 260.44 732

Current liability 513.46 427.98 497.72 1068.08

Bank borrowing ----- ----- ----- -----

Net working capital 22.45 47.92 204.65 316.92

Net sales 2319.60 2431.21 2602.04 3500

Operating profit after interest 29.41 40.71 55.14 155

PBDIT 35.22 49.47 68.51 205

Depreciation 5.35 8.31 10.11 10

Interest .46 .45 3.26 40

Other income .68 5.61 5.29 5

Tax 10.76 15.58 18.56 52.7

PAT 18.65 25.13 36.58 102.3

Cash accruals 24 33.44 46.69 112.30

Increase in net sales 95.69% 4.81% 7.02% 34.51%

% gross profit to net sales 5.60 7.28 7.50 1.42

PAT to net sales (%) 0.8 1.03 1.41 2.92

Return on capital employed% ----- ----- ----- -----

Interest cover(times) 75.56 97.47 19.35 5


Fixed asset to secured term lib ----- ----- ----- -----

Rate of dividend Nil nil Nil Nil

The company is well managed professional group with branches all over the country. From the

above financial statement it is clear that they are growing from strength to strength. Also the

company is undertaking number of new contacts every year. Therefore there is wide variation

between the sales and profitability of the company from year to year.

CALCULATION OF NET WORKING CAPITAL

In Rs Lacs

PARTICULARS 31.03.05 31.03.06 31.03.07 31.03.08

CURRENT ASSETS

Cash and balance 50.12 75.77 145.36 75

Investment other than long term 60.54 ----- 40 40

Receivable 426.15 307.50 441.93 650

Inventory ----- ----- ----- 400

Advance to supplier ----- ----- ----- 165

Advance payment tax ----- 38.02 56.58 52

Other current asset ----- 54.61 58.50 -----

TOTAL CURRENT ASSETS 536.81 475.90 702.37 1382

CURRENT LIABILITIES

Short term borrowing from bank 15.54 ----- 400 400

Short term borrowing from other ----- 26.30 37.87 -----

Sundry creditors 466.38 354.64 388.90 551.69

Provision for taxation ----- 38.63 60.69 113.39

Other statuary liability 30.63 8.41 10.26 -----

TOTAL CURR LIABILITIES 512.55 427.98 497.72 1065.08

NET WORKING CAPITAL 24.25 47.92 204.65 316.92


Working capital is basically the difference between current assets and current liabilities. Positive

working capital means that the company is able to pay off its short-term liabilities. Negative

working capital means that the company currently is unable to meet its short term liabilities with

its current assets.

As the company‟s current assets are exceeding its current liabilities every year (i.e. NWC is

positive), this means that the company is in no trouble of paying back its creditors in the short

term. An increasing working capital along with an increase in net sales is good sign for any

company in both short and long term.

Working capital also gives investors (bank in this case) an idea of the company‟s underlying

operational efficiency. Money that is tied up in the inventory or that customers still owe to the

company cannot be used to pay off any of the company‟s obligation. So even if the company is

not operating in the most efficient manner, it can still show up as a rapid increase in working

capital. Slow collection signals an underlying problem in company‟s operations.

Debtor days ratio actually indicates the number of days of sales that are on the balance sheet of

the company as debtors. The ratio is expressed in number of days. A higher debtor days ratio (as

67.1

46.1

6267.8

73.4

53.24

54.5557.53

0

20

40

60

80

100

120

140

160

2005 2006 2007 2008

DEBTOR AND CREDITOR DAYS

Creditor Days

Debtor Days


in this case) signifies several problems in the collection of funds faced by the company or the

financial position of debtors.

Creditor day ratio indicates the number of days of purchases that are on the balance sheet of the

company as creditors. The ratio is expressed in number of days. A lower creditor days ratio

signifies that the company is liberal in paying its creditors and follow a policy of paying them at

a faster rate.

The company has shown an increasing trend in the debtor days over the past few years. It has

increased about 22% over the period of past 4 years. This indicates that the company is not able

to collect its dues in a short span of time. Comparatively it can be seen that the creditor days of

the company has seen a decreasing trend every year and has come below debtor days in tears

2007 and 2008. This is the negative sign for the company as this means that the company has to

pay to the creditors from the surplus cash every time it makes purchases.

Stocking up of the inventory in 2008 and high debtor days are the two main reasons for the acute

rise in the net working capital of the company in 2008. Though the NWC shows that the

company is financially sound but it also shows the poor debtor management in this case. But still

as per the bank, the NWC projections are at comfortable level as the company has enough

current assets to pay back its current liabilities.

OTHER FINANCIAL INDICATORS

PARTICULARS 31.03.2006 31.03.2007 31.03.2008

Net sales 24.31 26.02 35

NPAT 0.25 0.36 1.02

Cash generation 0.33 0.47 1.12

Current ratio 1.11 1.41 1.30

TNW 1.10 2.82 3.84

TOL/TNW 3.92 1.78 2.78

Quick ratio 1.11 1.41 0.93

Debt equity ratio 0.24 1.55 1.04


Short term solvency or liquidity ratios measure the ability of the firm to meet its current

obligations. There is a short fall in current ratio in 2008 then the acceptable level, though as per

the bank, the current ratio is above the benchmark level in 2007. The quality of current assets has

also decreased in the year 2008 due to the stock up of the inventory worth Rs 400 lacs and

increase in debtor days from 62 to 67.8.

The quick ratio for the years 2006 and 2007 are well above the benchmark level of 1 and highly

acceptable by the bank. The quick ratio in 2008 has decreased largely due to the stocking up of

the inventory but still the level is acceptable as the company has been following a good policy in

regard to inventory in the previous years as it has not allowed the stock to pile up and is also

deemed to follow the same policy in the future years.

2006 2007 2008

Current ratio 1.11 1.41 1.3

Quick ratio 1.11 1.41 0.93

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

SHORT TERM SOLVENCY RATIOS


The company has maintained a very acceptable level of debt equity ratio in 2008. Thought the

D/E ratio saw a sharp rise in 2007 due to rapid increase in short term borrowings of the company

but the company has brought back the ratio at an acceptable level of 1.04 in 2008 as there was a

considerable increase in the net worth of the company.

SALES: During the past three years, the company has shown steady growth of sales and further

going by the past trend, they appear comfortable of achieving the projections comfortably.

NET PROFIT: The company is registering continuous increase in profit with the increase in net

sales. They have also maintained the trend of growth of profit which is acceptable.

TNW: Tangible net worth has been increasing every year due to plowing back of profit. Upon

achieving the projected level of business the TNW will reach the level as projected.

TOL/TNW: It‟s the ratio of total outsider liability by tangible net worth. In year 2007 the ratio is

1.78 which is around the acceptable level of the bank. But the ratio has increased to 2.78 in year

2008 which has crossed the acceptable benchmark. It means that the total outside liability is 2.78

times the tangible net worth of the firm. Though the company showed 2.30 as the projected

ration in 2009, it has to bring down this ratio to the acceptable level.

0.24

1.55

1.04

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2006 2007 2008

DEBT EQUITY RATIO


SECURITY COVERAGE

The company initially offered mortgage of land building, valued at Rs 200 lacs approximately

backed by another security worth Rs 200 lacs. Valuation is done by the approved assessor

appointed by the bank. Further the borrower has promised that they would not avail the

facility/value of letter of credit and letter of guarantee. The only facility they would exercise is

packing credit that is proposed to amount to Rs 400 lacs and equals the security offered by the

borrower.

RECOMMENDATIONS (AS PER BANK)

Keeping in view the satisfactory conditions of the business and taking into account the future

prospects of getting additional business through them and the reference about the background of

the promoters by the SPS group (one of the major account holders in the bank), bank

recommended for the favorable consideration of limits proposed. The same request was sent to

Regional office for consideration for which the Regional office replied in positive.


NON PERFORMING ASSETS

An asset becomes non-performing when it ceases to generate income for the bank. According to

RBI an asset may be termed as NPA if it falls under any of the following category:

Interest or /and installment of principal remains overdue for a period of more than 90

days in case of a term loan

The account remains out of order in respect of an overdraft or cash credit.

The bill remains overdue for a period of more than 90 days in case of bills purchased

and discounted.

The installment or/and principal remains overdue for two crop season for short duration

crops and one crop season for long duration crops.

ASSET CLASSIFICATION ,

Banks are expected to classify nonperforming assets further into three categories based on the

period for which it has remained nonperforming. Thus they are classified into:

Substandard Assets: A substandard asset would be one, which has remained NPA for a

period less than or equal to 12 months. Such an asset will have well defined credit

weakness that jeopardizes the liquidation of the debt and are characterized by the distinct

possibility that the bank will sustain some loss if deficiencies are not covered.

Doubtful Assets: An asset would be classified as doubtful if it has remained in the

substandard category for a period of 12 months. It has all the weakness inherent in the

asset that were classified as standard with added characteristics that the weakness make

collection or liquidation in full, on the basis of currently known facts, conditions and

values, highly questionable and improbable.

Loss Assets: This is an asset that has been identified by the internal auditors or RBI. This

is uncollectible. When account comes under this head it can be written off.


COMPUTATION OF NPA LEVELS

Banks should deduct the following items from the Gross Advances and Gross NPA to arrive at

Net Advances and Net NPA respectively:

ECGC claims received (if any).

Balance in interest suspense account

Part payment received in suspense account

Total provisions held

UPGRADATION OF LOANS ACCOUNTS CLASSIFIED AS NPAs ,

If arrears of interest and principle are paid by the borrower in case of loan accounts classified as

NPAs, the accounts should no longer be treated as non performing and may be classified as

standard accounts.

Advances against NSCs eligible for surrender, KVPs and life policies need not be treated as

NPAs provided adequate margin is available in the accounts. Advances against gold ornaments,

government securities and all other securities are not covered by this exemption.

Writing off of NPA: In case the loan account remains NPA and the borrower does not make any

attempt for its up gradation, the bank may opt for writing off the account with due consent from

regional office. Amounts set aside for making provisions for NPA‟s are not eligible for tax

deductions. Therefore the banks should make either full provisions as per the guidelines of RBI

or write off such advances and claim such tax benefits as are applicable. Recoveries made in

such accounts should be offered for tax purposes as per the rules.

Banks may write off advances at Head Office level, even though the relative advances are still

outstanding in the branch books. However, it is necessary that provision is made as per the

classification accorded to the respective accounts. So, if an asset is a loss advance, 100%

provision will have to be made thereof.


SECURITISATION AND RECONSTRUCTION OF FINANCIAL

ASSETS AND ENFORCEMENT OF SECURITY INTEREST ACT

The act extends to whole of India with effect from July 21, 2002. The act deals with three

aspects:

Enforcement of security interest by secured creditor (banks/financial institution)

Transfer of non-performing assets to Asset Reconstruction Company, which will then

dispose those assets and realize the proceeds.

To provide a legal framework for securitization of assets.

This empowers bank to recover the amount due without the intervention of the court. The

provisions of the act are applicable only for NPA loans with an outstanding amount above Rs.

100,000. NPA accounts where the amount due is less than 20% of the principal and interest, are

not eligible to be dealt under this Act.

If the pre conditions for taking action to enforce security interest are satisfied then the secured

creditor can send a written notice to the borrower to discharge in full his liabilities within 60

days from date of notice failing which the creditor shall be entitled to exercise all his powers.

However, if the borrower fails to pay the amount within specified period the creditor can take

any of the following measures to recover his dues:

Take possession of the secured asset including the right to transfer by way of lease or sale

for realizing the asset.

Takeover the management of the secured asset including all the rights to realize the asset.

Appoint any person as manager to manage the assets, the possession of which has been

taken over by the creditor.


NPA OF BRANCH (in Rs. lacs)

BRANCH ADVANCES (in Rs. lacs)

2005 2006 2007 2008 2009

ADVANCERS 728.85 15922.33 3173.22 6283.79 4504.41

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

2005 2006 2007 2008 2009

NET NPA 41.04 54.4 59.11 38.37 88.39

0

10

20

30

40

50

60

70

80

90

100


CASE STUDY

EDUCATIONAL LOAN

Borrower’s Information

The case under study is related to Education Loan of Mr. Neal Rajput who was pursuing

Bachelor of Business Administration (BBA) from Shantiniketan in 2003. Both, the borrower and

his father had a joint account and were banking with IOB since the year 1998. The prospect had

already completed the first year of his studies and required financial assistance for completion of

second and third year of the course. The father of the prospect, Mr. Dharani Rajput also the

guarantor in this case had total assets sufficient enough to cover the loan amount.

Details/ Requisites of the proposal ,

The total pecuniary support needed to continue the course was Rs.52,000. However, the bank

after a thorough financial analysis of the proposal concluded that it could finance just a part of it

which amounted to Rs. 38,000. The same amount was sanctioned after the completion of all the

legal formalities pertaining to the loan and documentation of the same.

The father signed as a guarantor. The particulars of total net worth of his assets are as follows:

The house property owned by guarantor was valued at Rs.600,000.

The face value of shares held by him amounted to Rs. 8500 where as the market value of

the same as on the date of valuation was Rs. 34,900 approximately.

The endowment policy, Life insurance Policy (worth Rs.6 lacs) proposed to mature in the

year 2029.

As per the guidelines laid down by RBI, bank cannot keep any security for any education loans

sanctioned to an extent of Rs 400,000 while in cases where the advance exceeds this amount,

guarantee of a third party and collateral are mandatory.


Bank Finance and Repayment Schedule ,

After a thorough analysis of the proposal, the bank decided to extend assistance up to Rs. 38,000

at an interest rate of 11.5%. Thirty six equated monthly installments of Rs. 1253 were to be

made.

Endowment policy of the guarantor was in custody of the bank as an assurance, creating an

obligation on the borrower to make prompt payment as per the agreement.

Further the agreement stated that the repayment of the amount mentioned above, would start

either immediately after the joining of the job by the student in any organization or after a period

of six months of completion of the course, whichever is earlier. In the mean time the guarantor

was supposed to make the interest payment monthly.

Default and Reasons ,

Irregular interest payment during the course of study led to accumulation of the amount. Even

after the immediate placement of the student subsequent to completion of his course, the

borrower did not start the repayment of the sanctioned amount. Despite of innumerable notices

sent by the bank no prompt payment was received, either from the borrower or the guarantor.

Later on personal visit by the officials, Mr. Dharani Rajput informed bank about the root cause

of such a default. His son, Mr. Neal Rajput had eloped with his girl friend and married her

without the consent of his parents. The parents did not have any info about his whereabouts. The

guarantor was suffering from a cardio disease and had gone through a major by pass surgery.

Due to this he had also left his job and was under complete bed rest. So, even he was not capable

of repaying the total sum of money due.

Follow up by the bank

The bank incessantly tried communicating the borrower from the date the repayment was due.

Despite of continuous official notices, the bank could not solicit any response from the other end.

On personal visit to the guarantor, the bank got a clear view of the reason of default.


Bank also made an attempt to contact the borrower in person. It communicated the organization

where he was initially inducted. The authorities came to know that he had already left the

organization two months ago. The account was finally slipped to NPA.

The mother of the borrower assured that they would be in a position to repay the outstanding

amount from December, once she started some household business (knitting and weaving).

Since the outstanding amount is nominal and the guarantor‟s financial position is unsound, so the

bank on humanitarian grounds did not take any legal action against the guarantor.

Future Course of Action

After repeated reminders by the bank to the guarantor, the account was classified as NPA as per

the recommendation of the Regional Office (RO). According to the guidelines of the RBI, bank

will not charge further interest on the payment due.

The account may be treated in the following way:

Account may remain as NPA and written off in due course of time depending on the

discretion of the RO.

Other alternative left with the bank is to wait for the endowment policy of the guarantor

that is proposed to mature in 2029 and then adjust the account accordingly thereby

remitting the balance left to his account.

Bank may even try contacting the borrower through his own sources and if found, try to recoup

the amount through legal procedure.

CONCLUSION AND RECOMMENDATION AS PER THE ANALYSIS

Though the borrower was customer of the bank, the interest payments were not regular. The

bank should have sent a written notice instead of verbal reminders. Further, the reimbursement of

the loan should have been stopped on account of breach of such an agreement on the part of the

borrower.


On the other hand, bank may have collaborated with the college authority to know about the

performance of the student in his college. Immediately after receiving the information about his

placement form the college, bank should have communicated to his employer and suggested the

borrower to opt for auto debit. This facility provided by the bank enables the automatic transfer

of the loan installment from his salary account to the loan account on a monthly basis.

As far as the current situation is concerned, bank has taken a more humanistic approach.

MISCELLANEOUS CASH CREDIT

PRATIBHA CONSTRUCTIONS

Borrower’s Information ,

Mr Debojeet Roy initially owned a utility store. He was banking with IOB since the inception of

new alipore branch. The customer ventured into construction business in 2003. He became a

proprietor of a new business enterprise named Pratibha Constructions.

Mr. Debojeet Roy, being the owner of one third of a property valued at Rs. 203.73 lakhs came

up with the proposal of constructing a commercial cum residential apartment.

DETAILS OF THE PROPOSAL

The proprietor required financial assistance of Rs 32 lacs to develop the property owned by him.

After due consideration bank sanctioned a cash credit of Rs 1500,000 at an interest rate of 15%

for the building and construction purpose in September, 2003.

The land that was proposed to be developed was mortgaged as security with the bank. Details of

the property were furnished by the owner. The loan request was sanctioned, keeping 80% as

margin and the proprietor started with his construction work.


Later in April 2004, client requested for a further sanction of two term loans, one of Rs. 250,000

and the other of Rs 500,000. The two term loans were required for lift construction and for

flooring, sanitary and sewage pipes respectively. He also requested for enhancement of cash

credit limit from Rs. 1500,000 to Rs 3000,000 for carrying on the remaining construction work.

The client promised to pay back the term loan by September, 2004 and the cash credit limit

availed by December, 2004. The payment was supposed to be made out of the sale proceeds of

the flats that were being constructed.

PROPOSED PROJECT/ PROJECT PROFILE: Mr. Debojeet Roy

Number of Residential Flats 10

Number of Business Shops 8

Number of Garage 4

Total Investment Rs. 61,50,000

Already Invested Rs. 29,40,000

Loan Required Rs. 32,10,000

BANK FINANCE AND REPAYMENT SCHEDULE

After an in depth analysis bank decided to grant him a cash credit limit of Rs 15 lacs in October

2003. Land and property of the borrower was charged as security. The property was valued at Rs

203.73 lacs where 80% was kept as margin.

In April 2004, as per the request of the client bank sanctioned the following:

Enhancement of credit limit from Rs. 1500,000 to Rs. 2500,000

Approval of a term loan of Rs. 250,000 for construction of lift (costing Rs. 390,000)

Another term loan of Rs 500,000 for flooring, sewage, sanitary etc ( costing Rs 15 lacs).

All loans and limits were sanctioned at an interest rate of BPLR + 3.5%. The repayment

schedule of the term loans as follows:

Twelve EMIs of Rs 20834 against the term loan of Rs 2.5 lacs


Twelve EMIs of Rs 41667 against the term loan of Rs 5 lacs.

Miscellaneous cash credit limits to be adjusted in full latest within 12 months.

The entire property of the client was mortgaged with the bank as security.

DEFAULT

Where the term loans should have been repaid in full, the bank in May 2005 observed that the

account had turned irregular. The total amount outstanding as on May 2005 was as follows:

Rs 2313533 against cash credit account including the interest.

Rs 132665 against term loan of Rs 2.5 lacs.

Rs 219137 against term loan of Rs 5 lacs.

FOLLOW UP BY BANK

As soon as the account was classified as irregular, bank sent a notice to the borrower stating that

the period of repayment has lapsed and the conditions stipulated by regional office had not been

met. No response was received from the borrower either for further extension of credit limit or

request for renewal of the same.

Request from borrower for extension of repayment period was received in July 2005 along with

the reason of non compliance with the terms. He agreed to repay the entire amount with interest

by December 2005. The same was forwarded by the branch to regional office with the

recommendation to exceed the time frame to march 2006 by which he shall be able to clear the

entire amount and renew the limit. The request was considered and sanctioned by the Regional

office.

Despite of extension of repayment period, the borrower was still not able to regularize his

account till March 2006. Since May 2006, the account was always on the verge of slipping into

NPA but each time borrower either credited a part of the amount due or renewed the account by

submission of relevant financial documents. The following steps were taken by the client to save

his account from being NPA:


A payment of Rs 6 lacs was made in September 2006

Renewal of account in March 2007

A sum of Rs 4 lacs paid in November 2007

A part payment of Rs 3 lacs in Mach 2008

The last amount credited to the loan account in October 2008 was Rs 7 lacs.

After October 2008, the borrower neither made any payment to adjust his account nor renewed

it. The bank tried to contact the borrower through notices and in person but failed to solicit any

response. So in March 2009 the account was finally categorized as substandard asset.

COURSE OF ACTION

The bank issued the securitization and reconstruction of financial assets and enforcement of

security interest (SARFAESI) notice. As per the guidelines of SARFAESI, the borrower is given

60 days to clear the amount due else the bank would have all the legal rights to liquidate the

security to realize the unpaid amount. The borrower contacted the bank after receiving the notice

and promised to repay the amount in full before the lapse of the period, through the sale proceeds

of the flats that were unsold.


SOME PROBLEMS OBSERVED DURING

PRE & POST SANCTION OF ADVANCES

Certain issues relating to prior and post advances are identified. These issues may be addressed

to ease the sanction procedure of loans and facilitate the consumers to comply with the legal

formalities. The problems are discussed as under:

Problems associated with pre sanction of loans:

The overall procedure is a lengthy one thereby taking long duration in final sanction. This

not only a time consuming process but also lacks single window service.

This involves too much of paper work, making the process tedious.

A number of verifications are required that discourages the borrower to avail the credit

facility offered by the bank.

The terns of agreement might sound ambiguous to the borrower leading to further

misconception regarding the conditions stated in the loan agreement.

There is a fixed limit on the amount of loans that can be sanctioned by the branch. For

limits exceeding such an amount, the approval of Regional Office needs to be taken. This

again consumes a lot of time.

There are a number of instances where there remain certain discrepancies regarding the

terms and conditions of loans between bank branch and regional office.

Problems associated with post sanction of loans:

Despite of regular monitoring of the accounts, certain accounts result in NPA.

Recovery of NPA is a major cause of concern.


CONCLUSION AND RECOMMENDATION

The conclusion based on the cases that were witnessed in due course of time brings forth certain

recommendations. The suggested recommendations may include the following:

A thorough analysis of any proposal is required in the preliminary stage so that chances

of such a loan account being NPA in future is forecasted well in advance and minimized.

Similarly, as soon as the accounts slip into Special Mentioned Accounts (SMAs), strict

and regular follow ups are essential to save them from turning into loss accounts.

Moreover, incorporation of a Z-score Model to assess the bankruptcy chances of the

prospective borrower in near future would prove to be of great help.


ATTATCHMENT BALANCE SHEET INDIAN OVERSEAS BANK

Mar '04

Mar '05

Mar '06

Mar '07

Mar '08

12 mths 12 mths 12 mths 12 mths 12 mths

Capital and Liabilities:

Total Share Capital 544.80 544.80 544.80 544.80 544.80

Equity Share Capital 544.80 544.80 544.80 544.80 544.80

Share Application Money 0.00 0.00 0.00 0.00 0.00

Preference Share Capital 0.00 0.00 0.00 0.00 0.00

Reserves 1,385.57 1,888.57 2,510.17 3,327.59 4,197.90

Revaluation Reserves 150.72 141.82 122.47 117.97 113.97

Net Worth 2,081.09 2,575.19 3,177.44 3,990.36 4,856.67

Deposits 41,482.58 44,241.24 50,529.32 68,740.41 84,325.58

Borrowings 729.47 590.68 736.63 2,896.23 6,353.65

Total Debt 42,212.05 44,831.92 51,265.95 71,636.64 90,679.23

Other Liabilities & Provisions 3,028.88 3,407.94 4,914.43 6,629.82 6,323.84

Total Liabilities 47,322.02 50,815.05 59,357.82 82,256.82 101,859.74

Mar '04 Mar '05 Mar '06 Mar '07 Mar '08

12 mths 12 mths 12 mths 12 mths 12 mths

Assets

Cash & Balances with RBI 4,332.22 4,175.44 3,077.96 4,686.11 9,124.23

Balance with Banks, Money at Call 912.87 778.52 629.28 4,293.19 1,217.09

Advances 20,294.86 25,205.19 34,756.20 47,060.29 60,423.84

Investments 20,171.64 19,014.72 18,952.28 23,974.47 28,474.71

Gross Block 739.60 819.56 865.33 1,000.13 1,102.80

Accumulated Depreciation 339.28 375.05 419.40 509.20 569.11

Net Block 400.32 444.51 445.93 490.93 533.69

Capital Work In Progress 3.71 7.84 11.80 19.73 24.88

Other Assets 1,206.40 1,188.84 1,484.35 1,732.11 2,061.29

Total Assets 47,322.02 50,815.06 59,357.80 82,256.83 101,859.73

Contingent Liabilities 7,282.71 4,849.95 9,658.91 15,846.11 24,173.83

Bills for collection 5,759.66 5,268.43 6,321.79 8,427.48 10,215.01

Book Value (Rs) 35.43 44.67 56.08 71.08 87.05

BALANCE SHEET ------IN Rs. CRORES------


REFERENCES

Pandey I. M., 2007. Ninth Edition. Financial Management.

Noida: Vikas Publishing House

Indian Overseas Bank, 2008. Introduction Program for Probationary officers

Zacharias K.D. and Ramamurthy G.M., 2008. Legal and Regulatory Aspects of Banking.

New Delhi: Rajiv Beri for Macmillan India Ltd.

Indian Institute of Banking and Finance, 2008. Second Edition. Principles and Practices

of Banking.

New Delhi: Rajiv Beri for Macmillan India ltd.

Iyenegar Vijayaragavan, 2007, First Edition. Introduction to Banking

New Delhi: Excel Books

Valuable insights provided by:

Company Guide- Mr. Rakesh Kumar Niraj

Assistant Manager,

Loans and Advances Department

Indian Overseas Bank

Faculty Guide- Prof. Dipanker Dey


GLOSSARY

Bill Finance: Financial assistance provided by the bank against the bills that includes bills

purchased and bills discounted.

BPLR: Benchmark Prime Lending Rate

Cibil: Credit Information Bureau India Limited

CRISIL:

DPG: Deferred Payment Guarantee, Payment of Bank guarantee on installments.

DPN: where no specification for a fixed period for the repayment of loan is given, the bankers

take a DPN. In DPN, the borrower makes a promise to the banker to repay the loan amount on

demands with agreed rate of interest. This is duly stamped, thus acting as evidence in a court of

law.

KMC: Kolkata Municipal Corporation

MPBF: Maximum Permissible Bank Finance

NEFT: National Electronic Fund Transfer

Overdue: any amount due to the bank under any credit facility is „overdue‟, if it is not paid on the

due date fixed by the bank.

Out of order: if the outstanding balance remains continuously in excess of the sanctioned

limit/drawing power, the accounts are treated as out of order. Similarly if the amount due is less

than the sanctioned amount but there are no credits continuously for more than 90 days and the

amount is not enough to cover the interest debited during the same period, the account is treated

as out of order.

PAT: Profit After Tax

PBF: Permissible Bank Finance


RTGS: Real Time Gross Settlement

SECURED CREDITOR: Any bank or financial institution and includes

TNW: Tangible Net Worth