Project Report on

“CREDIT APPRAISAL SYSTEM OF SME SECTOR OF

AXIS BANK”

Submitted to

IN PARTIAL FULFILLMENT OF

DEGREE OF MASTER OF BUSINESS MANAGEMENT

FOR THE ACADEMIC YEAR

Submitted By

Under The Guidance of

1

Acknowledgements

Training Programme is a golden opportunity for learning and self

development. I consider myself very lucky and honored to have so many wonderful people

lead me through completion of this project.

My grateful thanks to Mr. Mrugesh Suthar, Circle head, Axis bank who in spite of being

extraordinarily busy with his duties, took time out to hear, guide and keep me on the correct

path. I do not know where I would have been without him.

I would like to thanks _________________________________________, my project guide

for his efforts and help provided to me to get such an excellent opportunity.

I would also like to thank my family and friends for their support as this project could not be

completed without their support and encouragement. I am very much thankful to them.

Last but not the least there were so many who shared valuable information that helped in the

successful completion of this project.

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PREFACE

There are always two sides of knowledge, practical as well as theoretical. Practical is the path

through which one can reach his destination. But it is essential to have clear ideas to reach

that destination and that is what theoretical knowledge means. In short, theoretical is the

instruments which push back the practical one.

Experience makes man perfect. By facing practical situation, one can get new ideas.

Theoretical studies are something, which came by practically. Management student can make

use of whatever he or she gets from his or her Academic background. Since, the

commencement of business and services importance hiked up day by day.

This project helped me to understand concept of credit appraisal and how credit appraisal

process is done in bank. I have tried to put my best effort to complete this task on the basis of

skill that I have achieved during my study in the institute. I have tried to put my maximum

effort to get the accurate statistical data. However I would appreciate if any mistakes are

brought to me by the reader.

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TABLE OF CONTENT

Chapter No. Content Page No.

Executive Summary

1 Objective and Research Methodology

2 Indian Banking Sector

Introduction

Banking Reforms

Classification of banks

Success path for banker

Challenges facing by Banking Industry in India

Banking Activities

Porter’s Five Force Model

SWOT Analysis

3 Introduction to Axis bank

Business Division

4 Introduction to SME sector

History

Description of SME in the manufacturing sector

5 Overview of Credit Appraisal

Brief overview of credit

Brief overview of loan

Credit appraisal Process

Loan administration pre sanction process

Loan administration post sanction credit process

Types of lending arrangement

6 Credit appraisal model at Axis bank

Scheme of Credit to SME sector

Sanctioning powers for schematic Loans under MSME and Mid

Corporate4

7 Introduction to credit risk management

Definition

Determinants of Credit Risk

Introduction to credit tools

Rating Tool for Small and Medium Enterprises (SME)

Definition of Parameters used in SME tool

Subjective Assessment of Quality of Management

Monitoring Tool

Rating Scale

8 Case Study of Dynamic Products Ltd.

9 Findings

10 Conclusion

11 Bibliography

5

EXECUTIVE SUMMARY

The pace of development for the Indian banking industry has been tremendous over the past

decade. As the world reels from the global financial meltdown, India’s banking sector has

been one of the very few to actually maintain resilience while continuing to provide growth

opportunities, a feat unlikely to be matched by other developed markets around the world.

Growing percentage of Non Performing Assets is a big concern for modern as well as

traditional financial institutions. If credit appraisal system is effective then certainly it will

reflect positively on reducing percentage of NPA’s.

Credit Appraisal is a process to ascertain the risks associated with the extension of the

credit facility. It is generally carried by the financial institutions which are involved in

providing financial funding to its customers. Credit risk is a risk related to non repayment of

the credit obtained by the customer of a bank. Thus it is necessary to appraise the credibility

of the customer in order to mitigate the credit risk. Proper evaluation of the customer is

performed this measures the financial condition and the ability of the customer to repay back

the loan in future. Generally the credit facilities are extended against the security know as

collateral. But even though the loans are backed by the collateral, banks are normally

interested in the actual loan amount to be repaid along with the interest. Thus, the customer's

cash flows are ascertained to ensure the timely payment of principal and the interest.

It is the process of appraising the credit worthiness of a loan applicant. Factors like age,

income, number of dependents, nature of employment, continuity of employment, repayment

capacity, previous loans, credit cards, etc. are taken into account while appraising the credit

worthiness of a person. Every bank or lending institution has its own panel of officials for

this purpose.

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There is no guarantee to ensure a loan does not run into problems; however if proper credit

evaluation techniques and monitoring are implemented then naturally the loan loss

probability / problems will be minimized, which should be the objective of every lending

officer.

Project is about credit appraisal process of SME ( Small Medium Enterprise ) sector of Axis

bank. First chapter deals with research methodology and objective, second chapter deals with

introduction of banking sector and current scenario of banking sector. Third chapter is about

introduction to SME and its history. Fourth chapter deals with overview of credit appraisal,

credit appraisal process, pre and post sanction process. Next chapter depicts credit appraisal

process and schemes at Axis bank. Sixth chapter is about credit risk management and rating

tool. Case study of Dynamic Products Ltd. is done and how credit appraisal is done is stated

in next chapter. Finding and conclusion is made on the basis of research.

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CHAPTER -1

OBJECTIVE AND RESEARCH METHODOLOGY

PROBLEM STATEMENT :

To study the credit appraisal system in SME sector, at AXIS Bank Ahmadabad.

OBJECTIVES:

● To study the Credit Appraisal Methods.

● To understand the commercial, financial & technical viability of the project

proposed & it’s funding pattern.

● To understand the pattern for primary & collateral security cover available for

recovery of such funds.

● To study the credit appraisal process done by Axis Bank.

RESEARCH DESIGN:

A research design is the arrangement of the condition for collection and analysis of data.

Actually it is the blueprint of the research project.

Research design used will be Exploratory type.

DATA COLLECTION :

● Primary data:

It will be collected through Informal interviews with Branch Manager and other staff

members at Axis bank.

● Secondary data:

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It will be collected from Business Newspapers, magazines, internal reports of Axis bank,

books, Journal and websites.

Case Study: To understand how credit appraisal is done, I will be taking cases study of

Dynamic Products. Ltd. which is in manufacturing of Food color product.

LIMITATIONS OF STUDY

● As the credit rating is one of the crucial areas for any bank, some of the technicalities

may not reveal which might cause destruction to the information and exploration of

the problem.

● As some of the information is not revealed, whatever suggestions generated, will be

based on certain assumptions.

● Finding of the study will be based on the assumptions that respondents have given

correct information.

● Information provided by respondents may be biased.

● The study is academic in nature.

CHAPTER - 2

9

INDIAN BANKING SECTOR

Introduction

Without a sound and effective banking system in India it cannot have a healthy economy. The

banking system of India should not only be hassle free but it should be able to meet new

challenges posed by the technology and any other external and internal factors.

For the past three decades India's banking system has several outstanding achievements to its

credit. The most striking is its extensive reach. It is no longer confined to only metropolitans

or cosmopolitans in India. In fact, Indian banking system has reached even to the remote

corners of the country. This is one of the main reasons of India's growth process.

Currently, India has 96 scheduled commercial banks(SCBs) - 27 public sector banks (that is

with the Government of India holding a stake), 31 private banks (these do not have

government stake; they may be publicly listed and traded on stock exchanges) and 38 foreign

banks. They have a combined network of over 53,000 branches and 49,000 ATMs.

According to a report by ICRA (Investment Information and Credit Rating Agency of

India Limited) a rating agency, the public sector banks hold over 75 percent of total assets of

the banking industry, with the private and foreign banks holding 18.2% and 6.5%

respectively.

Not long ago, an account holder had to wait for hours at the bank counters for getting a draft

or for withdrawing his own money. Today, he has a choice. Gone are days when the most

efficient bank transferred money from one branch to other in two days. Now it is simple as

instant messaging or dial a pizza. Money have become the order of the day.

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

the journey of Indian Banking System can be segregated into three distinct phases. They are

as mentioned below:

Early phase from 1786 to 1969 of Indian Banks

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Nationalization of Indian Banks and up to 1991 prior to Indian banking sector

Reforms.

New phase of Indian Banking System with the advent of Indian Financial & Banking

Sector Reforms after 1991.

To make this write-up more explanatory, I prefix the scenario as Phase I, Phase II and Phase

III.

◈ BANKING REFORMS

Phase I

The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and

Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay

(1840) and Bank of Madras (1843) as independent units and called it Presidency Banks.

These three banks were amalgamated in 1920 and Imperial Bank of India was established

which started as private shareholders banks, mostly Europeans shareholders.

In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab

National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913,

Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank

of Mysore were set up. Reserve Bank of India came in 1935.

During the first phase the growth was very slow and banks also experienced periodic failures

between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline

the functioning and activities of commercial banks, the Government of India came up with

The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949

as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with

extensive powers for the supervision of banking in India as the Central Banking Authority.

During those day’s public has lesser confidence in the banks. As an aftermath deposit

mobilization was slow. Abreast of it the savings bank facility provided by the Postal

department was comparatively safer. Moreover, funds were largely given to traders.

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Phase II

Government took major steps in this Indian Banking Sector Reform after independence. In

1955, it nationalized Imperial Bank of India with extensive banking facilities on a large scale

especially in rural and semi-urban areas. It formed State Bank of India to act as the principal

agent of RBI and to handle banking transactions of the Union and State Governments all over

the country.

Seven banks forming subsidiary of State Bank of India was nationalized in 1960 on 19th July,

1969, major process of nationalization was carried out. It was the effort of the then Prime

Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country was

nationalized.

Second phase of nationalization Indian Banking Sector Reform was carried out in 1980 with

seven more banks. This step brought 80% of the banking segment in India under Government

ownership.

The following are the steps taken by the Government of India to Regulate Banking

Institutions in the Country:

1949: Enactment of Banking Regulation Act.

1955: Nationalization of State Bank of India.

1959: Nationalization of SBI subsidiaries.

1961: Insurance cover extended to deposits.

1969: Nationalization of 14 major banks.

1971: Creation of credit guarantee corporation.

1975: Creation of regional rural banks.

1980: Nationalization of seven banks with deposits over 200 crore.

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After the nationalization of banks, the branches of the public sector bank India rose to

approximately 800% in deposits and advances took a huge jump by 11,000%.

Banking in the sunshine of Government ownership gave the public implicit faith and

immense confidence about the sustainability of these institutions.

Phase III

This phase has introduced many more products and facilities in the banking sector in its

reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up

by his name which worked for the liberalization of banking practices.

The country is flooded with foreign banks and their ATM stations. Efforts are being put to

give a satisfactory service to customers. Phone banking and net banking is introduced. The

entire system became more convenient and swift. Time is given more importance than

money.

The financial system of India has shown a great deal of resilience. It is sheltered from any

crisis triggered by any external macroeconomics shock as other East Asian Countries

suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the

capital account is not yet fully convertible, and banks and their customers have limited

foreign exchange exposure.

Classification of Banks:

The Indian banking industry, which is governed by the Banking Regulation Act of India

1949 can be broadly classified into two major categories, non-scheduled banks and

scheduled banks. Scheduled banks comprise commercial banks and the co-operative

banks. In Terms of ownership, commercial banks can be further grouped into nationalized

banks, the State Bank of India and its group banks, regional rural banks and private sector

banks (the old / new domestic and foreign). The Indian banking industry is a mix

of the public sector, private sector and foreign banks. The private sector banks are again

spilt into old banks and new banks.

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Banking System in India

Reserve bank of India (Controlling Authority)

Development Financial institutions Banks

IFCI IDBI ICICI NABARD NHB IRBI EXIM Bank SIDBI

Commercial Regional Rural Land Development Cooperative

Banks Banks Banks Banks

Public Sector Banks Private Sector Banks

SBI Groups Nationalized Banks Indian Banks Foreign Banks

Nationalized /Public sector banks

Dominate the banking system in India.

Nationalization of banks in India took place in 1969 by Mrs. Indira Gandhi.

Private Banks

Made banking more efficient and customer friendly.

Jolted public sector banks out of complacency and forced them to become more

competitive.

Foreign banks

Have brought latest technology and latest banking practices in India.

Have helped made Indian banking system more competitive and efficient.

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Major Banks in India

Axis Bank

ABN-AMRO Bank

Abu Dhabi Commercial Bank

American Express Bank

Andhra Bank

Allahabad Bank

Bank of Baroda

Bank of India

Bank of Maharastra

Bank of Punjab

Bank of Rajasthan

Bank of Ceylon

BNP Paribas Bank

Canara Bank

Catholic Syrian Bank

Central Bank of India

Centurion Bank

China Trust Commercial Bank

Citi Bank

City Union Bank

Corporation Bank

Dena Bank

Deutsche Bank

Development Credit Bank

Dhanalakshmi Bank

Federal Bank

HDFC Bank

HSBC

ICICI Bank

IDBI Bank

Indian Bank

Indian Overseas Bank

IndusInd Bank

ING Vysya Bank

Jammu & Kashmir Bank

JPMorgan Chase Bank

Karnataka Bank

Karur Vysya Bank

Laxmi Vilas Bank

Oriental Bank of Commerce

Punjab National Bank

Punjab & Sind Bank

Scotia Bank

South Indian Bank

Standard Chartered Bank

State Bank of India (SBI)

State Bank of Bikaner & Jaipur

State Bank of Hyderabad

State Bank of Indore

State Bank of Mysore

State Bank of Saurastra

State Bank of Travancore

Syndicate Bank

Taib Bank

UCO Bank

Union Bank of India

United Bank of India

United Bank Of India

United Western Bank

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Success Path for Banker

One of the biggest problems facing senior managers of banks today is attracting customers

and attaining growth, often in an environment where products and prices among competitors

are close substitutes. Traditional bases for differentiation, such as product features or cost, are

becoming less tangible. So the management’s are forced to look for new ways to appear

attractive to its target market and simultaneously retain the existing one. From the annual

survey conduct by FICCI, we found that they rank their business strategies that have helped

them in increased customer acquisition and retention (On a scale of 1 to 8 with 8 being the

most important marketing strategy). The results of the Mode score being accorded by the

Public, Private& Foreign banks are presented below:

Technology has moved from being just a business enabler to being a business driver. Be it

customer service, reducing operational costs, achieving profitability, developing risk

management systems, we turn to technology for providing necessary solution. Technological

up gradation was clearly identified as one of the most successful strategy in Customer

Acquisition and Retention followed by Expansion of ATM Network, Advertisements and

additional sales force.

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Customer Retention and Customer Satisfaction are inexorably interred - linked. While

consumers may be happy to make payments and interact with their bank through convenient

– and cheaper – banking channels, they still expect high standards of service. A consistent

service reflects the bank’s brand and image across all channels. 93.75 per cent of respondent

banks informed that superior service pre and post banking has been one of the essential

factors rated high by their customers. 75 per cent of respondent banks felt that Personal

touch in the dealings has helped them in winning customers.

*

Challenges facing by Banking industry in India

The banking industry in India is undergoing a major transformation due to changes in

economic conditions and continuous deregulation. These multiple changes happening one

after other has a ripple effect on a bank Refer fig. trying to graduate from completely

regulated sellers market to completed deregulated customers market.

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Banking Activities

Over the last three decades, there has been a remarkable increase in the size, spread and scope

of activities of banks in India. The business profile of banks has transformed dramatically to

include non-traditional activities like merchant banking, mutual funds, new financial services

and products and the human resource development.

Now days, the bankers have to deal with a large number of matters. They serve as custodian

of stocks and shares and other valuables, imports into and exports out of the country are

financed by banks, and document relating to the goods so imported and exported, at one time

or another, pass through the hand of bankers. Thus, they have not to deal with bills of

exchange, but also with bills of lading, railway receipts, warehouse warratts and receipts,

marine insurance policies and various other documents. As bankers they advance money on

securities and issue letter of credit, traveller’s cheque, credit cards and circular notes to

customers wishing to travel abroad as also to effect purchase and shipment of goods. They

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assists industrial undertaking by underwriting their debentures and shares, providing them

with working capital finance and to a certain extent, with finance for fixed capital

requirements also. In India, the banking industry is entering several new activities in the areas

of merchant banking, leasing housing finance, venture capital and financial services in

general. The range of services provided by our banks stretches from rural finance at one end

to international banking at the other.

According to survey done by FCCI, Following shows most profitable noninterest income of

bank.

19

Competitive Forces Model

(Porter’s Five Force Model)

20

(2)

Potential Entrants is high as development financial institutions as well as private and Foreign Banks have entered in a big way

(1)

Rivalry among existing firms has increased with liberalization. New products and improved customer services is the focus.

(4)

Bargaining power of buyers is high as corporate can raise funds easily due to highCompetition.

(3)The threat of substitute product is very high like credit unions and investment houses. There are other substitutes as well banks like mutual funds, stocks, government securities, debentures, gold, real estate etc.

(5)

Organizing power of the supplier is high. With the new financial instruments they are asking higher return on the investments

1. Rivalry among existing firms

With the process of liberalization, competition among the existing banks has increased.

Each bank is coming up with new products to attract the customers and tailor made Loans

are provided. The quality of services provided by banks has improved drastically.

2. Potential Entrants

Previously the Development Financial Institutions mainly provided project finance and

development activities. But they now entered into retail banking which has resulted into

stiff competition among the exiting players.

3. Threats from Substitutes

Competition from the non-banking financial sector is increasing rapidly. The threat of

substitute product is very high like credit unions and in investment houses. There are other

substitutes as well banks like mutual funds, stocks, government securities, debentures,

gold, real estate etc.

4. Bargaining Power of Buyers

Corporate can raise their funds through primary market or by issue of GDRs, FCCBs. As

a result they have a higher bargaining power. Even in the case of personal finance, the

buyers have a high bargaining power. This is mainly because of competition.

5. Bargaining Power of Suppliers

With the advent of new financial instruments providing a higher rate of returns to

the investors, the investments in deposits is not growing in a phased manner. The

suppliers demand a higher return for the investments.

6. Overall Analysis

The key issue is how banks can leverage their strengths to have a better future. Since the

availability of funds is more and deployment of funds is less, banks should evolve new

products and services to the customers. There should be a rational thinking in sanctioning

Loans, which will bring down the NPAs. As there is a expected revival in the Indian

economy Banks have a major role to play.

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SWOT Analysis

The banking sector is also taken as a proxy for the economy as a whole. The performance of bank should therefore, reflect “Trends in the Indian Economy”. Due to the reforms in the financial sector, banking industry has changed drastically with the opportunities to the work with, new accounting standards new entrants and information technology. The deregulation of the interest rate, participation of banks in project financing has changed in the environment of banks.

The performance of banking industry is done through SWOT Analysis. It mainly helps to know the strengths and Weakness of the industry and to improve will be known through converting the opportunities into strengths. It also helps for the competitive environment among the banks.

a) STRENGTHS

1. Greater securities of Funds

Compared to other investment options banks since its inception has been a better avenue in terms of securities. Due to satisfactory implementation of RBI’s prudential norms banks have won public confidence over several years.

2. Banking network

After nationalization, banks have expanded their branches in the country, which has helped banks build large networks in the rural and urban areas. Private banks allowed to operate but they mainly concentrate in metropolis.

3. Large Customer Base

This is mainly attributed to the large network of the banking sector. Depositors in ruralareas prefer banks because of the failure of the NBFCs.

4. Low Cost of Capital

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

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b) WEAKNESS

1. Basel Committee

The banks need to comply with the norms of Basel committee but before that it is challenge for banks to implement the Basel committee standard, which are of international standard.

2. Powerful Unions

Nationalization of banks had a positive outcome in helping the Indian Economy as a whole. But this had also proved detrimental in the form of strong unions, which have a major influence in decision-making. They are against automation.

3. Priority Sector Lending

To uplift the society, priority sector lending was brought in during nationalization. This is good for the economy but banks have failed to manage the asset quality and their intensions were more towards fulfilling government norms. As a result lending was done for non-productive purposes.

4. High Non-Performing Assets

Non-Performing Assets (NPAs) have become a matter of concern in the banking industry. This is because reduced to meet the international standardsof change in the total outstanding advances, which has to be reduced to meet the international standards.

c) OPPORTUNITIES

1. Universal Banking

Banks have moved along the value chain to provide their customers more products and services. like home finance, Capital Markets, Bonds etc. Every Indian bank has an opportunity to become universal bank, which provides every financial service under one roof.

2. Differential Interest Rates

As RBI control over bank reduces, they will have greater flexibility to fix their own interest rates which depends on the profitability of the banks.

3. High Household Savings

Household savings has been increasing drastically. Investment in financial assets has also increased. Banks should use this opportunity for raising funds.

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4. Untapped Foreign Markets

Many Indian banks have not sufficiently penetrated in foreign markets to generate satisfactory business therefore, it can be concluded clear opportunity exists in such markets.

5. Interest Banking

The advance in information technology has made banking easier. Business can Effectively carried out through internet banking.

d) THREATS

1. NBFCs, Capital Markets and Mutual funds

There is a huge investment of household savings. The investments in NBFCs deposits, Capital Market Instruments and Mutual Funds are increasing. Normally these instruments offer better return to investors.

2. Changes in the Government Policy

The change in the government policy has proved to be a threat to the banking sector. Due to some major changes in policies related to deposits mobilization credit deployment, interest rates- the whole scenario of banking industry may change.

3. Inflation

The interest rates go down with a fall in inflation. Thus, the investors will shift his investments to the other profitable sectors.

4. Recession

Due to the recession in the business cycle the economy functions poorly and this has proved to be a threat to the banking sector. The market oriented economy and globalization has resulted into competition for market share. The spread in the banking sector is very narrow. To meet the competition the banks has to grow at a faster rates and reduce the overheads. They can introduce the new products and develop the existing services.

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CHAPTER -3

INTRODUCTION TO AXIS BANK

Axis Bank was the first of the new private banks to have begun operations in 1994, after the

Government of India allowed new private banks to be established. The Bank was promoted

jointly by the Administrator of the specified undertaking of the Unit Trust of India (UTI - I),

Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC)

and other four PSU insurance companies, i.e. National Insurance Company Ltd., The New

India Assurance Company Ltd., The Oriental Insurance Company Ltd. and United India

Insurance Company Ltd.

The Bank's Registered Office is at Ahmedabad and its Central Office is located at Mumbai.

The Bank has a very wide network of more than 1281 branches and Extension Counters (as

on 31st March 2011). The Bank has a network of over 7591 ATMs (as on 30 th September

2011) providing 24 hrs a day banking convenience to its customers. This is one of the largest

ATM networks in the country.

The Bank has strengths in both retail and corporate banking and is committed to adopting the

best industry practices internationally in order to achieve excellence.

Business divisions

Treasury management

Treasury is responsible for the maintenance of the statutory requirements such as the cash

reserve ratio (CRR), statutory liquidity ratio (SLR) and the investment of such funds. It also

manages the assets and liabilities of the bank. Primary dealing activities can be classified into

● Money market operations

● Foreign exchange operations

● Derivatives

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Merchant Banking and capital markets

Axis Bank is a registered merchant Banker. The services offered are:

● Private placement/syndication

● Issue management

● Debenture trustees

● Depository services

● Project advisory services, capital market services, advisory on Mergers &

Acquisition

Retail financial services

All branches have a dedicated financial advisory desk, wherein the mutual fund schemes are

marketed. The objective is to provide customers with a larger portfolio of investment avenues

thereby enhancing customer relationship. Other products handled by the department include

sale of Gold Coins as well as marketing of Depository services.

Corporate and institutional banking

● Cash management Services

● Business current Accounts

● Correspondent Banking

● Government Business

Retail Banking

Retail banking is one of the key departments in the bank. It has the largest variety in its

portfolio which consists of retail asset and retail liability products. Retail Banking by

definition implies banking services which are offered to individual customers as opposed to

corporate banking which is meant for companies.

International banking

26

Major functions include

● Handling regulatory issues which include compliance with regulations

of various authorities such as RBI regulations, FEMA etc

● Keeping a track of the business volumes being generated by the

branches and controlling the margins

● Maintaining relationship with correspondent Banks outside India

Advances

The function involves extending fund and non-fund based credit facilities to different clients

in the country, the department aims to maximize the interest spread earned on funds available

with the bank while keeping the risk on the credit portfolio at acceptable limits. The

department also tries to maximize fee-based income from both fund based and non-fund

based activities.

27

CHAPTER – 4

INTRODUCTION TO SME

In the Indian context, the small and medium enterprises (SME) sector is broadly a Term used

for small scale industrial (SSI) units and medium-scale industrial units. Any industrial unit

with a total investment in its fixed assets or leased assets or hire-purchase asset of upto Rs 10

million, can be considered as an SSI unit and any investment of upto Rs 100 million can be

termed as a medium unit. An SSI unit should neither be a subsidiary of any other industrial

unit nor be owned or controlled by any other industrial unit.

An SME is known by different ways across the world. In India, a standard definition surfaced

only in October 2, 2006, when the Ministry of Micro, Small and Medium Enterprises,

Government of India, imposed the Micro, Small and Medium enterprises Development

(MSMED) Act,2006.

This definition, however was changed according to the changing economic scenario and thus

has separate definitions to it. For instance, an SME definition for manufacturing enterprises is

different from what an SME definition for service enterprises has to say.

History

Small and Medium Enterprises or SMEs are vital for the growth and well being of the

country. This sector was recognized and given importance right from independence and is

being encouraged ever since then.

Though, it commenced on a small scale, it gradually gained significance, because it employed

a considerable number of people.

When it started gaining momentum, this sector was defined as an enterprise with investment

in plant and machinery of up to Rs 1 lakh and situated in towns and villages with strength of

less than 50,000 people. The policy statement put in place special legislation to recognize and

28

protect self employed people in cottage and home industries. District industries canters

(DICs) were set up and made the focal point of SSI development, bypassing large cities and

state capitals. Also, the government started providing special services akin to product

standardization, quality control and marketing surveys in order to assist the SSIs in enabling

them to market their products in an underdeveloped market.

The scenario for the small-scale sector changed with the Industrial Policy of July 1991,

which, for the first time in India’s development history spoke of liberalization. What this

meant was that medium and large enterprises would no longer need licenses to run. Export-

oriented enterprises could be wholly foreign owned and foreign equity participation was

selectively allowed. Industries could import capital goods with much fewer restrictions.

1996 saw the government involved in the setting up of a higher level committee, known as

the Abid Hussain Committee, to review policies for small industries and recommend

measures to help formulate a strong and innovative policy package for the rapid development

of SMEs. With liberalization, rapid changes were seen in the Indian economy. Indian

companies were no longer insulated from the global economy. In fact, there was an urgent

need to make them, especially SMEs, more competitive and resilient.

In 1991, the growth rate of SSIs was almost three times that of the total industrial sector at

3.1 percent. From 1991 to 1995, the growth rate of SSIs exceeded that of the total industrial

sector. Yet, in 1995-96, the growth rate of SSIs was slightly lower than the total industrial

sector, however it increased again in 1996 and continued to be higher than the total industrial

growth rate till 1999. till 2006, the SME segment saw a lot more development and support

from the government.

29

Description of SME in the manufacturing sector

The Term enterprise in the manufacturing context stands for an industrial undertaking or a

business concern involved in the production, processing or preservation of goods for the list

of eligible industries in the First Schedule to the Industries (Development and Regulation

Act), 1951.

For the Manufacturing Sector, the MSMED Act 2006 defines micro, small and medium

enterprises (MSMEs) as mentioned below:

A micro enterprise is an enterprise where investment in plant and machinery does not

exceed Rs 25 lakh.

The investment in plant and machinery in a small enterprise is more than Rs 25 lakh,

but does not exceed Rs 5 crore.

A medium enterprise is one where the investment in plant and machinery is more than

Rs 5 crore, but does not exceed Rs 10 crore.

In all these, the cost excludes that of land, building and the items specified by the Ministry of

Small Scale Industries with its notification No SO 1722 (E) dated October 5, 2006.

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CHAPTER - 5

OVERVIEW OF CREDIT APPRAISAL

Credit appraisal means an investigation/assessment done by the banks before providing any

Loans & advances/project finance & also checks the commercial, financial & technical

viability of the project proposed, its funding pattern & further checks the primary & collateral

security cover available for recovery of such funds.

Brief overview of Credit

Credit Appraisal is a process to ascertain the risks associated with the extension of the credit

facility. It is generally carried by the financial institutions, which are involved in providing

financial funding to its customers. Credit risk is a risk related to non-repayment of the credit

obtained by the customer of a bank. Thus it is necessary to appraise the credibility of the

customer in order to mitigate the credit risk. Proper evaluation of the customer is performed

this measures the financial condition and the ability of the customer to repay back the Loan in

future. Generally the credits facilities are extended against the security know as collateral.

But even though the Loans are backed by the collateral, banks are normally interested in the

actual Loan amount to be repaid along with the interest. Thus, the customer's cash flows are

ascertained to ensure the timely payment of principal and the interest.

It is the process of appraising the credit worthiness of a Loan applicant. Factors like age,

income, number of dependents, nature of employment, continuity of employment, repayment

capacity, previous Loans, credit cards, etc. are taken into account while appraising the credit

worthiness of a person. Every bank or lending institution has its own panel of officials for

this purpose.

However the 3 ‘C’ of credit are crucial & relevant to all borrowers/ lending, which must be

kept in mind, at all times.

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Character

Capacity

Collateral

If any one of these are missing in the equation then the lending officer must question the

viability of credit. There is no guarantee to ensure a Loan does not run into problems;

however if proper credit evaluation techniques and monitoring are implemented then

naturally the Loan loss probability / problems will be minimized, which should be the

objective of every lending Officer.

Credit is the provision of resources (such as granting a Loan) by one party to another party

where that second party does not reimburse the first party immediately, thereby generating a

debt, and instead arranges either to repay or return those resources (or material(s) of equal

value) at a later date. The first party is called a creditor, also known as a lender, while the

second party is called a debtor, also known as a borrower.

Credit allows you to buy goods or commodities now, and pay for them later. We use credit to

buy things with an agreement to repay the Loans over a period of time. The most common

way to avail credit is by the use of credit cards. Other credit plans include personal Loans,

home Loans, vehicle Loans, student Loans, small business Loans, trade. A credit is a legal

contract where one party receives resource or wealth from another party and promises to

repay him on a future date along with interest. In simple Terms, a credit is an agreement of

postponed payments of goods bought or Loan. With the issuance of a credit, a debt is formed.

Brief overview of Loans

Loans can be of two types fund base & non-fund base:

A. Fund Base includes:

Working Capital

Term Loan

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B. Non-fund Base includes:

Letter of Credit

Bank Guarantee

Bill Discounting

A. Fund Base:

Working capital

The objective of running any industry is earning profits. An industry will require funds to

acquire “fixed assets” like land, building, plant, machinery, equipments, vehicles, tools etc.,

& also to run the business i.e. its day-to-day operations.

Funds required for day to-day working will be to finance production & sales. For production,

funds are needed for purchase of raw materials/ stores/ fuel, for employment of labor, for

power charges etc. financing the sales by way of sundry debtors/ receivables.

Capital or funds required for an industry can therefore be bifurcated as fixed capital &

working capital. Working capital in this context is the excess of current assets over current

liabilities. The excess of current assets over current liabilities is treated as net, for storing

finishing goods till they are sold out & for working capital or liquid surplus & represents that

portion of the working capital, which has been provided from the long-Term source.

Term Loan

A Term Loan is granted for a fixed Term of not less than 3 years intended normally for

financing fixed assets acquired with a repayment schedule.

A Term Loan is a Loan granted for the purpose of capital assets, such as purchase of land,

construction of, buildings, purchase of machinery, modernization, renovation or

rationalization of plant, & repayable from out of the future earning of the enterprise, in

installments, as per a prearranged schedule.

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From the above definition, the following differences between a Term Loan & the working

capital credit afforded by the Bank are apparent:

o The purpose of the Term Loan is for acquisition of capital assets.

o The Term Loan is an advance not repayable on demand but only in installments

ranging over a period of years.

o The repayment of Term Loan is not out of sale proceeds of the goods & commodities

per se, whether given as security or not. The repayment should come out of the future

cash accruals from the activity of the unit.

o The security is not the readily saleable goods & commodities but the fixed assets of

the units.

It may thus be observed that the scope & operation of the Term Loans are entirely different

from those of the conventional working capital advances. The Bank’s commitment is for a

long period & the risk involved is greater. An element of risk is inherent in any type of Loan

because of the uncertainty of the repayment. Longer the duration of the credit, greater is the

attendant uncertainty of repayment & consequently the risk involved also becomes greater.

However, it may be observed that Term Loans are not so lacking in liquidity as they appear

to be. These Loans are subject to a definite repayment programme unlike short Term Loans

for working capital (especially the cash credits) which are being renewed year after year.

Term Loans would be repaid in a regular way from the anticipated income of the industry/

trade.

These distinctive characteristics of Term Loans distinguish them from the short Term credit

granted by the banks & it becomes necessary therefore, to adopt a different approach in

examining the applications of borrowers for such credit & for appraising such proposals.

The repayment of a Term Loan depends on the future income of the borrowing unit. Hence,

the primary task of the bank before granting Term Loans is to assure itself that the anticipated

income from the unit would provide the necessary amount for the repayment of the Loan.

This will involve a detailed scrutiny of the scheme, its capital assets. Financial aspects,

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economic aspects, technical aspects, a projection of future trends of outputs & sales &

estimates of cost, returns, flow of funds & profits.

B. Non-fund Base:

Letter of credit

The expectation of the seller of any goods or services is that he should get the payment

immediately on delivery of the same. This may not materialize if the seller & the buyer are at

different places (either within the same country or in different countries). The seller desires to

have an assurance for payment by the purchaser. At the same time the purchaser desires that

the amount should be paid only when the goods are actually received. Here arises the need of

Letter of Credit (LCs). The objective of LC is to provide a means of payment to the seller &

the delivery of goods & services to the buyer at the same time.

Definition

A Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at the

request & on the instructions of the customer (the applicant) or on its own behalf,

o Is to make a payment to or to the order of a third party (the beneficiary), or is to

accept & pay bills of exchange (drafts drawn by the beneficiary); or

o Authorizes another bank to effect such payment, or to accept & pay such bills of

exchanges (drafts); or

o Authorizes another bank to negotiate the Terms & conditions of the credit are

complied with. against stipulated document(s), provided that

Bank Guarantees:

A contract of guarantee is defined as ‘a contract to perform the promise or discharge the

liability of the third person in case of the default’. The parties to the contract of guarantees

are:

a) Applicant: The principal debtor – person at whose request the guarantee is executed

b) Beneficiary: Person to whom the guarantee is given & who can enforce it in case of

default.

c) Guarantee: The person who undertakes to discharge the obligations of the applicant

in case of his default.

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Thus, guarantee is a collateral contract, consequential to a main co applicant & the

beneficiary.

Purpose of Bank Guarantees

Bank Guarantees are used to for both both preventive & remedial purposes. The guarantees

executed by banks comprise both performance guarantees & financial guarantees. The

guarantees are structured according to the Terms of agreement, viz., security, maturity &

purpose.

Branches may issue guarantees generally for the following purposes:

a) In lieu of security deposit/earnest money deposit for participating in tenders;

b) Mobilization advance or advance money before commencement of the project by the

contractor & for money to be received in various stages like plant layout,

design/drawings in project finance;

c) In respect of raw materials supplies or for advances by the buyers;

d) In respect of due performance of specific contracts by the borrowers & for obtaining

full payment of the bills;

e) Performance guarantee for warranty period on completion of contract which would

enable the suppliers to period to be over; realize the proceeds without waiting for

warranty) To allow units to draw funds from time to time from the concerned

indenters against part execution of contracts, etc.

f) Bid bonds on behalf of exporters

g) Export performance guarantees on behalf of exporters favoring the Customs

Department under EPCG scheme.

Bill discounting:

Definition:

As per Negotiable Instrument Act, “The bill of exchange is an instrument in writing

containing an unconditional order, signed by the maker, directing a certain person to pay a

certain sum of money only to, or to the order of, a certain person, or to the bearer of that

instrument.”

Discounting of bill of exchange:

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A seller (Drawer) if need cash, may handover the B/E to the Bank, NBFC, a company or a

high Net worth Individual and obtain ready cash this is known as discounting of bill. the

practice in India is that, the financing organization holds the original B/E till the drawee pays

on maturity. For discounting the bill, financiers charge an interest on the bill amount for the

duration of the bill which is called discount charges.normal maturity periods are 30, 60, 90,

120 days.

Types of Bills

1. Demand Bill

2. Usance Bill

3. Documentary Bills

a. Documents against acceptance (D/A) bills

b. Documents against payment (D/P) bills

4. Clean Bills

Advantages

o To Investors

1. Short Term source of finance

2. Outside the purview of Section 370 of Indian Companies Act 1956

3. No tax deducted at source

4. Flexibility

o To Banks

1. Safety of funds

2. Certainty of payment

3. Profitability

37

Credit Appraisal Process

38

Receipt of application from applicant

Receipt of documents(Balance sheet, KYC papers, Different govt. registration no., MOA, AOA, and

properties documents

Pre-sanction visit by bank officers

Check for RBI defaulters list, willful defaulters list, CIBIL data, ECGC, Caution list etc

Title clearance reports of the properties to be obtained from empanelledAdvocates

Proposal preparation

Valuation reports of the properties to be obtained from empanelled valuer/engineers

Preparation of financial data

Assessment of proposal

Sanction/approval of proposal by appropriate sanctioning authority

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Documentations, agreements, mortgages

Disbursement of Loan

Post sanction activities such as receiving stock statements, review of accounts, renew of accounts, etc

(On regular basis)

Loan administration pre- sanction process

Appraisal, Assessment and Sanction functions

1. Appraisal

A. Preliminary appraisal

Sound credit appraisal involves analysis of the viability of operations of a business and

the capacity of the promoters to run it profitably and repay the bank the dues as and when

they fall

Towards this end the preliminary appraisal will examine the following aspects of a

proposal.

Bank’s lending policy and other relevant guidelines/RBI guidelines,

Prudential Exposure norms,

Industry Exposure restrictions,

Group Exposure restrictions,

Industry related risk factors,

Credit risk rating,

Profile of the promoters/senior management personnel of the project,

List of defaulters,

Caution lists,

Acceptability of the promoters,

Compliance regarding transfer of borrower accounts from one bank to another, if

applicable;

Government regulations/legislation impacting on the industry; e.g., ban on financing

of industries producing/ consuming Ozone depleting substances;

Applicant’s status vis-à-vis other units in the industry,

Financial status in broad Terms and whether it is acceptable The Company’s

Memorandum and Articles of Association should be scrutinized carefully to ensure (i)

that there are no clauses prejudicial to the Bank’s interests, (ii) no limitations have

40

been placed on the Company’s borrowing powers and operations and (iii) the scope of

activity of the company.

Further, if the proposal is to finance a project, the following aspects have to be examined:

Whether project cost is prima facie acceptable

Debt/equity gearing proposed and whether acceptable

Promoters’ ability to access capital market for debt/equity support

Whether critical aspects of project - demand, cost of production, profitability, etc. are

prima facie in order

Required Documents for Process of Loan

a) Application for requirement of loan

b) Copy of Memorandum & Article of Association

c) Copy of incorporation of business

d) Copy of commencement of business

e) Copy of resolution regarding the requirement of credit facilities

f) Brief history of company, its customers & supplies, previous track records, orders In

hand. Also provide some information about the directors of the company

g) Financial statements of last 3 years including the provisional financial statement.

h) Copy of PAN/TAN number of company

i) Copy of last Electricity bill of company

j) Copy of GST/CST number

k) Copy of Excise number

l) Photo I.D. of all the directors

m) Address proof of all the directors

n) Copies related to the property such as 7/12 & 8A utara, lease/ sales deed, 2R

Permission, Allotment letter, Possession

o) Bio-data form of all the directors duly filled & notarized

p) Financial statements of associate concern for the last 3 years

After undertaking the above preliminary examination of the proposal, the branch will

arrive at a decision whether to support the request or not. If the branch (a reference to the

branch includes a reference to SECC/CPC etc. as the case may be) finds the proposal

41

acceptable, it will call for from the applicant(s), a comprehensive application in the

prescribed proforma, along with a copy of the proposal/project report, covering specific

credit requirement of the company and other essential data/ information. The information,

among other things, should include:

Organizational set up with a list of Board of Directors and indicating the

qualifications, experience and competence of the key personnel in charge of the main

functional areas

e.g., purchase, production, marketing and finance; in other words a brief on the

managerial resources and whether these are compatible with the size and scope of the

proposed activity.

Demand and supply projections based on the overall market prospects together with a

copy of the market survey report. The report may comment on the geographic spread

of the market where the unit proposes to operate, demand and supply gap, the

competitors’ share, competitive advantage of the applicant, proposed marketing

arrangement, etc.

Current practices for the particular product/service especially relating to Terms of

credit sales, probability of bad debts, etc.

Estimates of sales cost of production and profitability.

Projected profit and loss account and balance sheet for the operating years during the

Currency of the Bank assistance.

If request includes financing of project(s), branch should obtain additionally

a) Appraisal report from any other bank/financial institution in case appraisal has been

done by them.

b) ‘No Objection Certificate’ from Term lenders if already financed by them and

c) Report from Merchant bankers in case the company plans to access capital market,

wherever necessary.

In respect of existing concerns, in addition to the above, particulars regarding the history

of the concern, its past performance, present financial position, etc. should also be called

for. This data/information should be supplemented by the supporting statements

Such as:

a) Audited profit loss account and balance sheet for the past three years (if the latest

audited balance sheet is more than 6 months old, a pro-forma balance sheet as on a

42

recent date should be obtained and analysed). For non-corporate borrowers,

irrespective of market segment, enjoying credit limits of Rs.10 lacs and above from

the banking system, audited balance sheet in the IBA approved formats should be

submitted by the borrowers.

b) Details of existing borrowing arrangements, if any,

c) Credit information reports from the existing bankers on the applicant Company, and

d) Financial statements and borrowing relationship of Associate firms/Group

Companies.

B. Detailed Appraisal

The viability of a project is examined to ascertain that the company would have the

ability to service its Loan and interest obligations out of cash accruals from the

business. While appraising a project or a Loan proposal, all the data/information

furnished by the borrower should be counter checked and, wherever possible, inter-

firm and inter-industry comparisons should be made to establish their veracity.

The financial analysis carried out on the basis of the company’s audited balance

sheets and profit and loss accounts for the last three years should help to establish the

current viability.

In addition to the financials, the following aspects should also be examined:

The method of depreciation followed by the company-whether the company is

following straight line method or written down value method and whether the

company has changed the method of depreciation in the past and, if so, the reason

therefore;

Whether the company has revalued any of its fixed assets any time in the past and the

present status of the revaluation reserve, if any created for the purpose;

Record of major defaults, if any, in repayment in the past and history of past sickness,

If any;

The position regarding the company’s tax assessment - whether the provisions made

in the balance sheets are adequate to take care of the company’s tax liabilities;

The nature and purpose of the contingent liabilities, together with comments thereon;

43

Pending suits by or against the company and their financial implications (e.g. cases

relating to customs and excise, sales tax, etc.);

Qualifications/adverse remarks, if any, made by the statutory auditors on the

company’s accounts;

Dividend policy;

Apart from financial ratios, other ratios relevant to the project;

Trends in sales and profitability, past deviations in sales and profit projections, and

estimates/projections of sales values;

Production capacity & use: past and projected;

o Estimated requirement of working capital finance with reference to acceptable

build up of inventory/ receivables/ other current assets;

Projected levels: whether acceptable; and

Compliance with lending norms and other mandatory guidelines as applicable

Project financing:

If the proposal involves financing a new project, the commercial, economic and

Financial viability and other aspects are to be examined as indicated below:

Statutory clearances from various Government Depts. / Agencies

Licenses/permits/approvals/clearances/NOCs/Collaboration agreements, as applicable

Details of sourcing of energy requirements, power, fuel etc.

Pollution control clearance

Cost of project and source of finance

Build-up of fixed assets (requirement of funds for investments in fixed assets to be

critically examined with regard to production factors, improvement in quality of

products, economies of scale etc.)

Arrangements proposed for raising debt and equity

Capital structure (position of Authorized, Issued/ Paid-up Capital, Redeemable

Preference Shares, etc.)

Debt component i.e., debentures, Term Loans, deferred payment facilities, unsecured

Loans/ deposits. All unsecured Loans/ deposits raised by the company for financing a

project should be subordinate to the Term Loans of the banks/ financial institutions

and should be permitted to be repaid only with the prior approval of all the banks and

the financial institutions concerned. Where central or state sales tax Loan or

44

developmental Loan is taken as source of financing the project, furnish details of the

Terms and conditions governing the Loan like the rate of interest (if applicable), the

manner of repayment, etc.

Feasibility of arrangements to access capital market

Feasibility of the projections/ estimates of sales, cost of production and profits

covering the period of repayment

Break Even Point in Terms of sales value and percentage of installed capacity under a

Normal production year

Cash flows and fund flows

Proposed amortization schedule

Whether profitability is adequate to meet stipulated repayments with reference to

Debt Service Coverage Ratio, Return on Investment

Industry profile & prospects

Critical factors of the industry and whether the assessment of these and management

plans in this regard are acceptable

Technical feasibility with reference to report of technical consultants, if available

Management quality, competence, track record

Company’s structure & systems

Applicant’s strength on inter-firm comparisons

For the purpose of inter-firm comparison and other information, where necessary, source data

from Stock Exchange Directory, financial journals/ publications, professional entities like

CRIS-INFAC, CMIE, etc. with emphasis on following aspects:

o Market share of the units under comparison

o Unique features

o Profitability factors

o Financing pattern of the business

o Inventory/Receivable levels

o Capacity utilization

o Production efficiency and costs

o Bank borrowings patterns

o Financial ratios & other relevant ratios

45

o Capital Market Perceptions

o Current price

o 52week high and low of the share price

o P/E ratio or P/E Multiple

o Yield (%)- half yearly and yearly

Also examine and comment on the status of approvals from other Term lenders, market view

(if anything adverse), and project implementation schedule. A pre-sanction inspection of the

project site or the factory should be carried out in the case of existing units. To ensure a

higher degree of commitment from the promoters, the portion of the equity / Loans which is

proposed to be brought in by the promoters, their family members, friends and relatives will

have to be brought upfront. However, relaxation in this regard may be considered on a case to

case basis for genuine and acceptable reasons. Under such circumstances, the promoter

should furnish a definite plan indicating clearly the sources for meeting his contribution. The

balance amount proposed to be raised from other sources, viz., debentures, public equity etc.,

should also be fully tied up.

C. Present relationship with Bank:

Compile for existing customers, profile of present exposures:

Credit facilities now granted

Conduct of the existing account

Utilization of limits - FB & NFB

Occurrence of irregularities, if any

Frequency of irregularity i.e., number of times and total number of days the account

was irregular during the last twelve months

Repayment of Term commitments

Compliance with requirements regarding submission of stock statements, Financial

Follow-up Reports, renewal data, etc.

Stock turnover, realization of book debts

Value of account with break-up of income earned

Pro-rata share of non-fund and foreign exchange business

Concessions extended and value thereof

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Compliance with other Terms and conditions

Action taken on Comments/observations contained in RBI Inspection Reports: CO

Inspection & Audit Reports

D. Credit risk rating: Draw up rating for (i) Working Capital and (ii) Term Finance.

E. Opinion Reports: Compile opinion reports on the company, partners/ promoters and

The proposed guarantors.

F. Existing charges on assets of the unit: If a company, report on search of charges with

ROC.

G. Structure of facilities and Terms of Sanction:

Fix Terms and conditions for exposures proposed - facility wise and overall:

Limit for each facility – sub-limits

Security - Primary & Collateral, Guarantee

Margins - For each facility as applicable

Rate of interest

Rate of commission/exchange/other fees

Concessional facilities and value thereof

Repayment Terms, where applicable

ECGC cover where applicable

Other standard covenants

H. Review of the proposal:

Review of the proposal should be done covering (i) strengths and weaknesses of the exposure

proposed (ii) risk factors and steps proposed to mitigate them

(ii) Deviations, if any, proposed from usual norms of the Bank and the reasons therefore

I. Proposal for sanction:

Prepare a draft proposal in prescribed format with required backup details and with

recommendations for sanction.

J. Assistance to Assessment:

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Interact with the assessor, provide additional inputs arising from the assessment, incorporate

these and required modifications in the draft proposal and generate an integrated final

proposal for sanction.

2. Assessment :

Indicative List of Activities Involved in Assessment Function is given below:

Review the draft proposal together with the back-up details/notes, and the borrower’s

application, financial statements and other reports/documents examined by the

appraiser.

Interact with the borrower and the appraiser.

Carry out pre-sanction visit to the applicant company and their project/factory site.

Peruse the financial analysis (Balance Sheet/ Operating Statement/ Ratio Analysis/

Fund Flow Statement/ Working Capital assessment/Project cost & sources/ Break

Even analysis/Debt Service/Security Cover, etc.) to see if this is prima facie in order.

If any deficiencies are seen, arrange with the appraiser for the analysis on the correct

lines.

Examine critically the following aspects of the proposed exposure.

o Bank’s lending policy and other guidelines issued by the Bank from time to time

o RBI guidelines

o Background of promoters/ senior management

o Inter-firm comparison

o Technology in use in the company

o Market conditions

o Projected performance of the borrower vis-à-vis past estimates and performance

o Viability of the project

o Strengths and Weaknesses of the borrower entity.

o Proposed structure of facilities.

o Adequacy/ correctness of limits/ sub limits, margins, moratorium and repayment

schedule

o Adequacy of proposed security cover o Credit risk rating

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o Pricing and other charges and concessions, if any, proposed for the facilities

o Risk factors of the proposal and steps proposed to mitigate the risk

o Deviations proposed from the norms of the Bank and justifications therefor

To the extent the inputs/comments are inadequate or require modification, arrange for

additional inputs/ modifications to be incorporated in the proposal, with any required

modification to the initial recommendation by the Appraiser

Arrange with the Appraiser to draw up the proposal in the final form.

Recommendation for sanction: Recapitulate briefly the conclusions of the appraisal

and state whether the proposal is economically viable. Recount briefly the value of the

company’s (and the Group’s) connections. State whether, all considered, the proposal

is a fair banking risk. Finally, give recommendations for grant of the requisite fund-

based and non-fund based credit facilities.

3. Sanction:

Indicative list of activities involved in the sanction function is given below:

Peruse the proposal to see if the report prima facie presents the proposal in a

comprehensive manner as required. If any critical information is not provided in the

proposal, remit it back to the Assessor for supply of the required data/clarifications.

Examine critically the following aspects of the proposed exposure in the light of

corresponding instructions in force:

Bank’s lending policy and other relevant guidelines

RBI guidelines

Borrower’s status in the industry

Industry prospects

Experience of the Bank with other units in similar industry

Overall strength of the borrower

Projected level of operations

Risk factors critical to the exposure and adequacy of safeguards proposed

49

Value of the existing connection with the borrower

Credit risk rating

Security, pricing, charges and concessions proposed for the exposure and covenants

o Stipulated vis-à-vis the risk perception.

Accord sanction of the proposal on the Terms proposed or by stipulating modified or

additional conditions/ safeguards, or Defer decision on the proposal and return it for

additional data/clarifications, or Reject the proposal, if it is not acceptable, setting out

the reasons.

Loan administration - Post sanction Credit process.

Need

Lending decisions are made on sound appraisal and assessment of credit worthiness.

Past record of satisfactory performance and integrity are no guarantee for future

though they serve as a useful guide to project the trend in performance. Credit

assessment is made based on promises and projections. A loan granted on the basis of

sound appraisal may go bad because the borrower did not carry out his promises

regarding performance. It is for this reason that proper follow up and supervision is

essential. A banker cannot take solace in sufficiency of security for his loans. He has

to -

a) Make a proper selection of borrower

b) Ensure compliance with terms and conditions

c) Monitor performance to check continued viability of operations

d) Ensure end use of funds.

e) Ultimately ensure safety of funds lent.

Stages of post sanction process

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The post-sanction credit process can be broadly classified into three stages viz., follow-up,

supervision and monitoring, which together facilitate efficient and effective credit

management and maintaining high level of standard assets. The objectives of the three stages

of post sanction process are detailed below.

Types of Lending Arrangements

Introduction

Business entities can have various types of borrowing arrangements. They are

One Borrower – One Bank

One Borrower – Several Banks (with consortium arrangement)

One Borrower – Several Banks (without consortium arrangements – Multiple

Banking

One Borrower – Several Banks (Loan Syndication)

One Bank

The most familiar amongst the above for smaller loans is the One Borrower-One Bank

arrangement where the borrower confines all his financial dealings with only one bank.

Sometimes, units would prefer to have banking arrangements with more than one bank on

account of the large financial requirement or the resource constraint of his own banker or due

to varying terms & conditions offered by different banks or for sheer administrative

convenience. The advantages to the bank in a multiple banking arrangement/ consortium

51

arrangement are that the exposure to an individual customer is limited & risk is proportionate.

The bank is also able to spread its portfolio. In the case of borrowing business entity, it is able

to meet its funds requirement without being constrained by the limited resource of its own

banker. Besides this, consortium arrangement enables participating banks to save manpower

& resources through common appraisal & inspection & sharing credit information.

The various arrangements under borrowings from more than one bank will differ on account

of terms & conditions, method of appraisal, coordination, documentation & supervision &

control.

Consortium Lending

When one borrower avails loans from several banks under an arrangement among all the

lending bankers, this leads to a consortium lending arrangements. In consortium lending,

several banks pool banking recourses & expertise in credit management together & finance a

single borrower with a common appraisal, common documentation & joint supervision &

follow up. The borrower enjoys the advantage similar to single window availing of credit

facilities from several banks. The arrangement continues until any one of the bank moves out

of the consortium. The bank taking the highest share of the credit will usually be the leader of

consortium. There is no ceiling on the number of banks in a consortium.

Multiple Banking Arrangement

Multiple Banking Arrangement is one where the rules of consortium do not apply & no inter

se agreement among banks exists. The borrower avails credit facility from various banks

providing separate securities on different terms & conditions. There is no such arrangement

called ‘Multiple Banking Arrangement’ & the term is used only to denote the existence of

banking arrangement with more than one bank. Banking Arrangement has come to stay as it

has some advantages for the borrower & the banks have the freedom to price their credit

products & non-fund based facility according to their commercial judgment. Consortium

arrangement occasioned delays in credit decisions & the borrower has found his way around

this difficulty by the multiple banking arrangement. Additionally, when units were not doing

well, consensus was rarely prevalent among the consortium members. If one bank wanted to

call up the advance & protect the security, another bank was interested in continuing the

facility on account of group considerations.

Points to be noted in case of multiple banking arrangements

52

Though no formal arrangement exists among the financing banks, it is preferable to

have informal exchange of information to ensure financial discipline

Charges on the security given to the bank should be created with utmost care to guard

against dilution in our security offered & to avoid double financing

Certificates on the outstanding with the other banks should be obtained on the

periodical basis & also verified from the Balance sheet of the unit to avoid excess

financing

Credit Syndication

A syndicated credit is an agreement between two or more lending institutions to provide a

borrower a credit facility using common loan documentation. It is a convenient mode of

raising long-term funds.

The borrower mandates a lead manager of his choice to arrange a loan for him. The mandate

spells out the terms of the loan & the mandated bank’s rights & responsibilities.

The mandated banker – the lead manger – prepares an information memorandum &

Circulates among prospective lender banks soliciting their participation in the loan. On the

basis of the memorandum & on their own independent economic & financial evolution the

leading banks take a view on the proposal. The mandated bank convenes the meeting to

discuss the syndication strategy relating to coordination, communication & control within the

syndication process & finalizes deal timing, management fees, cost of credit etc. The loan

agreement is signed by all the participating banks. The borrower is required to give prior

notice to the lead manger about loan drawal to enable him to tie up disbursements with the

other lending banks.

Features of syndicated loans

Arranger brings together group of banks

Borrower is not required to have interface with participating banks, thus easy & hassle

fee

Large loans can be raised through syndication by accessing global markets

For the borrower, the competition among the lenders leads to finer terms

Risk is shared

Small banks can also have access to large ticket loans & top class credit appraisal

& management

53

Advantages

Strict, time-bound delivery schedule & drawals

Streamlined process of documentation with clearly laid down roles & responsibilities

Market driven pricing linked to the risk perception

Competitive pricing but scope for fee-based income is also available

Syndicated portions can be sold to another bank, if required

Fixed repayment schedule & strict monitoring of default by markets which punish

indiscipline

54

CHAPTER - 6

CREDIT APPRAISAL MODEL AT AXIS BANK

Scheme of Credit to SME Sector

AXIS bank provides credit to SME sector under following Schemes

A. SME – Schematic (Fast Track)

It includes structured products basically to provide fast services to clients. It includes various

products like:

Mpower OD and Mpower Term Loan

Business Loan for Property

Power Rent

Power Trade

Zero Collateral Loans (ZCL) to MSE under CGS

Card Power

Enterprise Power

Business Power

Mpower OD and Mpower Term Loan:

The product aims at to provide both Working capital and Term finance

requirements of a trade enterprise. The facility is in the form of a Cash Credit (for

Working Capital requirements) and Term Loan (Financing Capital expenditure).

The facility is secured by hypothecation of Working Capital assets and further

collateralized by charge over an immovable property/ financial asset. Non-Fund

based facilities can also be granted under the product. The maximum Loan

amount under the product is Rs. 2.50 Crs.

Business Loan for Property:

The product is aimed at providing finance to business enterprises for acquition of

an immovable property. The facility is in the form of a Term Loan repayable by

EMIs. The maximum Loan amount under the product is Rs. 5 crores.

55

Power Rent:

The product generally known in market parlance as “Lease Rental Discounting” is

aimed at providing a Term Loan to owners of properties against their lease rental

receivables. The Loan amount is assessed on the basis of the net present value of

the rental receivables over the lease period (after deducting margin and taxes).

The lease rentals are hypothecated in bank’s favor and the Loan is further

collateralized by charge over the property. The product specifies a minimum-

security coverage of 1.5 times. Maximum Loan amount under the product is Rs.

20 crores.

Power Trade:

The product aims to provide both working capital and Term finance requirements

of a trade enterprise. The facility is in the form of a cash credit (for working

capital requirements) and Term Loan (financing capital expenditure). The facility

is secured by hypothecation of working capital assets and further collateralized by

charge over an immovable property/ financial asset. Non- fund based facilities can

also be granted under the product. The maximum Loan amount under the product

is Rs. 2.5 crores.

Zero Collateral Loans (ZCL) to MSE under CGS:

This product facilitates the MSEs and software/IT related services to avail both

working capital and term finance from bank. The facility is secured by guarantee

cover of credit guarantee fund trust for micro and small enterprises (CGTMSE)

and there is no collateral security to be taken in such cases. Maximum loan

amount under the product is Rs. 1.00 crore.

Card Power:

This is a scheme for financing credit/debit card receivables of units installing pour

EDC machines. Both demand loan & term loan facilities are offered to the

borrowers, subject to a maximum of Rs. 2.5 crores. All trading/ retailing activities

(with a few exceptions like liquor, tobacco, seasonal business etc.), where credit/

debit cards are used are eligible for the loans.

56

Enterprise Power:

This product has been developed to meet the credit needs of the Micro and small

enterprises covering both manufacturing and the service sectors. The facilities

offered include CC Rupee export credit; pre & post shipment credit & non-fund

based facilities like LC & BG. The maximum limit is restricted to Rs. 1.00 Crore.

Busness Power:

Business Power is an unsecured Term Loan (Maximum loan amount under the

product is Rs. 35 lacs) to be repaid by way of EMI’s over a maximum period of 4

years.

B. SME- Non Schematic (Standard)

For a business on the growth phase with a wide range of opportunities to explore, timely

availability of credit is an integral ingredient needed to scale new heights. Axis Bank

understands this and endeavor to be not just a bank but also financing partner, so that

focus on business needs becomes possible whereas Bank cater to meet financing needs.

Their services ranging from Funded to Non-Funded, from Short Term to Long Term and

from Credit to Trade Services ensures to get finance the way it is best suited for business.

Services:

Cash Credit

Working Capital Demand Loan

Export Finance

Short Term Loan

Term Loan

Clean Bill Discounting

LC Backed Bill Discounting

Co-Acceptance of Bills

Credit Facilities against Guarantee or Stand By Letter of Credit issued by Foreign

Banks

Letter of Credit

Bank Guarantee

Solvency Certificates

57

Cash Credit:

Bank offer Cash Credit facilities to meet day-to-day working capital needs. Cash

Credit is provided against the primary security of stock, debtors, other current

assets, etc., and/or collateral security of movable fixed assets, immovable

property, personal or corporate guarantee, etc. Interest is charged not on the

sanctioned amount but on the utilized amount

Working Capital Demand Loan:

Bank also provides working capital facilities in the form of Working Capital

Demand Loan instead of cash credit facility. The primary or collateral security

will be as mentioned in cash credit facility. Here also interest is levied on the

amount drawn rather than on the amount utilized.

Export Finance:

Bank provides finance for export activities in the form of Pre-Shipment Credit

against firm order and or Letter of Credit and Post shipment credit. Credit is

available for procuring raw materials, manufacturing the goods, processing and

packaging the goods and shipping the goods. Finance is provided in Indian or

foreign currency depending upon the need of the borrower.

Short Term Loan:

Bank provides Working Capital facilities to meet day-to-day working capital

needs and Term Loan for capex. However there may be occasions where there is

need of ad hoc or short-Term finance for general corporate purposes, meeting

temporary mismatches in working capital or for meeting contingent expenses. In

such situations it provides Short Term Loans for tenure up to a year to ensure that

business runs smoothly.

Term Loan:

When there is need of long-Term funds for capex or capacity expansions or plant

modernization and so on. Keeping these requirements in mind Bank provides

58

Term Loans up to acceptable tenor with suitable moratorium, if required, and

repayment options structured on the basis of customer’s estimated cash flows.

These Loans are primarily secured by a first charge on the fixed assets acquired

through the Loan amount. Suitable collateral security is also taken whenever

required.

Clean Bill Discounting:

Bank provides clean bill discounting facilities to fund receivables. Bank discount

bills or receivables and provide credit against that. This facility is provided for a

period of 3-6 months depending upon the tenor of the bill.

LC Backed Bill Discounting:

Bank discount trade bills drawn under Letters of Credit issued by reputed banks

to fund receivables. This facility is provided for a period of 3-6 months

depending upon the tenor of the bill or Letter of Credit.

Co-Acceptance of Bills:

Bank also provides co-acceptance of trade bills depending upon the need of the

borrower.

Credit Facilities against Guarantee or Stand By Letter of Credit issued by

Foreign Banks:

Various foreign companies set up subsidiary in India. Bank provides funding to

such companies against guarantees or SBLCs of acceptable foreign banks.

Letter of Credit:

Apart from fund based working capital facilities Bank provides a range of Non-

Fund Based facilities such as Letter of credit, Bank Guarantees, Solvency

certificates, etc. Letter of Credit is provided to meet trade purchases. These are

generally provided for 3-6 months depending upon Trade cycle. Apart from this

it provides Import Letter of Credit for importing machinery or capital goods.

Such LCs are for tenure ranging from 1-3 years depending upon the need of the

borrower.

59

Bank Guarantee:

Bank provides Bank Guarantee on behalf of its client to various other entities

such as Government, quasi govt bodies, corporate and so on. it provides a range

of guarantee such as Performance guarantee, financial guarantee, EPCG etc. The

tenure of Bank Guarantee range from 1 year to 10 years depending upon the

purpose of the guarantee.

Solvency Certificates:

Bank also provides solvency certificate depending upon the need of the borrower.

Sanctioning powers for schematic Loans under MSME

and Mid Corporate

In order to have better control over the portfolio, it is felt that the budget for schematic

advances should be allotted only to select branches, where the potential and manpower

support exist for such business.

Accordingly, the budget has been restricted to select branches, to be decided by Advances

Cells. The Branch Heads of branches located at centers where Advances Cells have been set

up will not have any sanctioning powers. Branch Heads of stand-alone branches where

budgets have been allocated will have sanctioning powers as per delegation of powers given

below. The Branch Heads of other stand-alone branches where budgets have not been

allocated will not have any sanctioning powers. These branches would, however, continue to

source business and such proposals would be processed / sanctioned at the respective

Advances Cells. Review / renewal of existing Loans at such branches would also be done at

the Advances Cells.

Branches would continue to be responsible for all post sanction formalities, maintaining

quality of assets held in their books, periodic updating of drawing power, obtention of stock

statements and periodical inspection of borrowal units.

60

The sanctioning powers, to be exercised by various officials would be as under.

Sanctioning Authority Exposure Limits

(in Rs. Lacs)

Interest rates

Concessions

Reviewing Authority

Senior Manager50 NIL

AVP / VP-Advances at

the Advances Cell

AVP 250 NIL DVP/VP-Advances

DVP / VP 1000 Upto 100 bps SVP – Advances

SVP (Advances) at ZO 2000 Upto 100 bps Zonal Head

All requests for interest rate concessions are to be forwarded to the Advances Cells.

The proposals sanctioned at Advances Cells / Zonal Offices during a particular month are to

be submitted for review by the next higher authority through a monthly control return, latest

by the 5th of the succeeding month, in the prescribed format and not on a case-by-case basis.

Similarly, the proposals sanctioned by the Branch Heads /Advances Cells (headed by

AVPs/Managers) during a particular month are to be submitted for review by the appropriate

authority at Zonal Office or Advances Cells as the case may be through a monthly control

return, latest by the 5th of the succeeding month, in the prescribed format and not on a case-

by-case basis. The concessions in rates of interest / variations authorised by the VP

(Advances) and SVP (Advances) during a particular month are to be submitted for review by

the SVP(Advances)/ Zonal Head respectively through a monthly control return, in the

prescribed format by the 5th of the succeeding month.

If a combination of schematic Loan products is to be offered, the combined exposure should

be the criterion while sanctioning the limits

61

CHAPTER - 7

Introduction to Credit Risk Management

Definition

Of all different types of risks that a bank is subject to, credit risk can be defined as the risk of

failure on the part of the borrower to meet obligations towards the bank in accordance with

the Terms and conditions that have been agreed upon. Inability and/or unwillingness of the

borrower to repay debts may be the cause of such default.

The bank aims at minimizing this risk that could arise from individual borrowers or the entire

portfolio. The former can be addressed by having well-developed systems to appraise the

borrowers; the latter, on the other hand, can be minimized by avoiding concentration of credit

exposure with a few borrowers who have similar risk profiles. Credit risk management

becomes even more relevant in the light of the changes that have been brought about in the

economic environment, including increasing competition and thinning spreads on both the

sides of Balance sheet

Determinants of Credit Risk

Factors determining credit risk of a bank’s portfolio can be divided into external and internal

factors. The banks do not have control on external factors. These include factors across a

wide spectrum ranging from the state of the economy to the correlation among different

segments of industry. The risk arising out of external factors can be mitigated via

diversification of the credit portfolio across industries especially in light of any expectations

of adverse developments in the existing portfolio.

Given that the banks have very little control over such external factors, the bank can

minimize the credit risk that it faces mainly by managing the internal factors.

These include the internal policies and processes of the bank like Loan policies, appraisal

processes, monitoring systems etc. These internal factors can be taken care of, partly, via

effective rating and monitoring systems, entry level criteria etc. These processes would

enable improvement in the quality of credit decisions.

62

This would effectively improve the quality (and hence profitability) of the portfolio. While

monitoring systems are useful tool at post-sanction stage, rating systems act as important aid

at the pre-sanction stage.

Introduction to Credit Tools

The Bank has developed tools for better credit risk management. These focus on the areas of

rating of corporate (pre-sanctioning of Loans) and monitoring of Loans (post-sanctioning).

The focus of this manual is to familiarize the user with the credit rating tool.

Credit Rating: Definition

Credit rating is the process of assigning a letter rating to borrowers indicating the

creditworthiness of the borrower. Rating is assigned based on the ability of the borrower

(company) to repay the debt and his willingness to do so. The higher the rating of a company,

the lower the probability of its default. The companies assigned with the same credit rating

have similar probability of default.

Use in decision-making

Credit rating helps the bank in making several key decisions regarding credit including:

• Whether to lend to a particular borrower or not; What price to charge

• What are the products to be offered to the borrower and for what tenor

• At what level should sanctioning be done

• What should be the frequency of renewal and monitoring

It should, however, be noted that credit rating is one of the inputs used in taking credit

decisions. There are various other factors that need to be considered in taking the decision

(e.g., adequacy of borrower’s cash flow, collateral provided, relationship with the borrower).

The rating allows the bank to ascertain a probability of the borrower’s default based on past

data.

63

Main features of the rating tool:

i) Comprehensive coverage of parameters.

ii) Extensive data requirement.

iii) Mix of subjective and objective parameters.

iv) Includes trend analysis.

v) 13 parameters are benchmarked against other players in the segment. The tool contains the

latest available audited data/ratios of other players in the segment. The data is updated at

intervals.

vi) Captures industry outlook.

vii) Eight grade ratings broadly mapped with external credit rating agency’s ratings prevalent

in India.

Special features of the web based credit rating tool

i) Centralised data base.

ii) Easy accessibility and faster computation of scores.

iii) Selective access to users based on the area of operation. Branches have access to the data

pertaining to their branch only, Zonal offices have access to the data pertaining to all the

branches under their control and the Credit Department and Risk Department at Central

Office have access to all accounts.

iv) Adequate security system and provision of audit trails for confidentiality.

v) Maintaining of past rating records in the system for collection of empirical data on rating

migrations. This will enable the bank to arrive at PDs (Probability of Default) factor.

Rating Tool for Small and Medium Enterprises (SME)

The SME rating tool has been developed for the purpose of assigning a credit rating to the

SME borrower of the Bank. The aim of the tool is to provide a standardised system for the

bank to evaluate the credit risk of different borrowers. It should, however, be noted that this

tool is not the standalone exercise for the purpose of sanctioning of Loan to a SME borrower.

It should be supplemented with other inputs important in the sanctioning process.

64

The following broad areas have been considered for determining the rating of

Borrowers’ in the SME category:

Financial performance

Business performance

Industry outlook

Quality of management

Conduct of account (after roll out of the Monitoring tool)

Within each of these broad areas, various parameters have been used for obtaining an overall

rating of the borrower. In the following sections, we shall discuss in greater detail the

structure of the tool and the methodology of using it.

Parameters used in credit rating of SME:

The rating tool for SME borrowers assigns the following weightings to each one of the four

main categories

i) Scenario (I) without monitoring

Parameter Weight age (%)

Financial performance 40

Operating performance of business 22.5

Quality of management 22.5

Industry outlook 15

ii) Scenario (II) with monitoring tool: The weightages would be conveyed separately on roll

out of the tool.

65

Parameters:

Financial performance

The tool in its current form uses various parameters for rating a borrower on its

financial strength. These various sub-parameters give us an idea of the different

sources of risk being faced by a company in different areas.

Operating performance of business

Operational efficiency of a borrower is important in deTermining the generation of

cash for repayment of its debt obligations. The parameters in this category assess the

borrower’s competence in its primary activities.

Quality of management

Quality of the management of a borrowal unit has a direct impact on the performance

of the unit. Also, it would have a direct impact on the integrity of the borrower

especially in Terms of its willingness to repay its debt.

Industry

In order to undertake the credit rating of any borrower, it is important to assess the

riskiness of the industry to which that borrower belongs. Borrowers, which are

similarly ranked in Terms of financial performance, operating performance of

business and quality of management may have different credit ratings due to the risks

inherent in their industry. The risk assessment in industry sectors is done at the

Central Office level and appropriate score for each industry has been allocated in the

tool. On selection of the relevant industry sector, the tool will automatically reckon

the allocated score.

Three types under SME tool

i) Manufacturing

ii) Services and

iii) Trading

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Various parameters under each of the above stated parameters for these three types of SME

tool are as under:

1 Manufacturing

i) Financial performance

Sr. No. Sub parameters Weightage (%)

F1 Net Sales Growth Rate (%) 10

F2 PBDIT Growth Rate (%) 7

F3 PBDIT/Sales (%) 10

F6 TOL/TNW 10

F7 Current Ratio 10

F8 Operating Cash Flow 8

F9 DSCR 8

F12*$ Foreign exchange risk 10

F13 Expected values of D/E, if 50% of NFB creditdevolves (corrected for margin)

5

F24 Realisability of Debtors 12

F27* State of export country economy 5

F28* Fund repatriation risk 5

TOTAL 100

* Applicable for export units

$Applicable for units having imports and or exports

ii) Operating performance of business

Sr. No. Sub parameters Weightage (%)

B7 Credit period allowed 10

B8 Credit Period Availed 10

B9 Working Capital Cycle 20

B10 Tax incentives 10

67

B13 Production Related Risk 10

B14 Product Related Risks 10

B15 Price Related Risk 10

B20 Client Risk 10

B21 Fixed Asset Turnover 10

TOTAL 100

iii) Quality of management

Sr. No. Sub parameters Weightage (%)

M1 HR policy/track record of industrial unrest 15

M2 Track Record in Default of Statutory Dues 16

M3 Market Report of Management reputation 15

M4 History of FERA violation/ED enquiry 8

M6 Too Optimistic Projections of Sales and OtherFinancials

16

M9 Technical & Managerial Expertise 15

M8 Capability to raise money 15

TOTAL 100

2 Services

i) Financial performance

Sr. No. Sub parameters Weightage (%)

F1 Net Sales Growth Rate (%) 10

F2 PBDIT Growth Rate (%) 7

F3 PBDIT/Sales (%) 10

F6 TOL/TNW 10

F7 Current Ratio 10

F8 Operating Cash Flow 8

68

F9 DSCR 8

F12*$ Foreign exchange risk 10

F13 Expected values of D/E, if 50% of NFB creditdevolves (corrected for margin)

5

F24 Realisability of Debtors 12

F27* State of export country economy 5

F28* Fund repatriation risk 5

TOTAL 100

* Applicable for export units

$Applicable for units having imports and or exports

ii) Operating performance of business

Sr. No. Sub parameters Weightage (%)

M1 HR Policy/Track Record in Industrial Unrest 15

M3 Market Report of Management Reputation 20

M4 History of FERA violation/ED enquiry 10

M6 Too Optimistic Projections of Sales and Other

Financials

20

M8 Capability to raise money 15

M12 Mix of Professional and Traditional

Management

20

TOTAL 100

iii) Quality of management

Sr. No. Sub parameters Weightage (%)

M1 HR Policy/Track Record in Industrial Unrest 15

M3 Market Report of Management Reputation 20

69

M4 History of FERA violation/ED enquiry 10

M6 Too Optimistic Projections of Sales and Other

Financials

20

M8 Capability to raise money 15

M12 Mix of Professional and Traditional

Management

20

TOTAL 100

3 Trading

i) Financial performance

Sr. No. Sub parameters Weightage (%)

F1 Net Sales Growth Rate (%) 10

F2 PBDIT Growth Rate (%) 7

F3 PBDIT/Sales (%) 10

F6 TOL/TNW 10

F7 Current Ratio 10

F8 Operating Cash Flow 8

F9 DSCR 8

F12*$ Foreign exchange risk 10

F13 Expected values of D/E, if 50% of NFB creditdevolves (corrected for margin)

5

F24 Realisability of Debtors 12

F27* State of export country economy 5

F28* Fund repatriation risk 5

TOTAL 100

* Applicable for export units

$Applicable for units having imports and or exports

70

ii) Operating performance of business

Sr. No. Sub parameters Weightage (%)

B3 Inventory Turnover 16

B7 Credit period allowed 10

B8 Credit Period Availed 12

B9 Working Capital Cycle 16

B10 Tax incentives 10

B14 Product Related Risks 12

B15 Price Related Risk 12

B24 Sustainability of Sales 12

TOTAL 100

iii) Quality of management

Sr. No. Sub parameters Weightage (%)

M1 HR Policy/Track Record in Industrial Unrest 15

M2 Track Record in Default of Statutory Dues 16

M3 Market Report of Management Reputation 15

M4 History of FERA violation/ED enquiry 8

M6 Too Optimistic Projections of Sales and OtherFinancials

16

M8 Capability to raise money 15

M12 Mix of Professional and TraditionalManagement

15

TOTAL 100

71

Definition of Parameters used in SME tool

F1 - Net Sales Growth Rate

Importance of this indicator

This ratio refers to the compounded annual growth rate of net sales over a period of three

years.

The company’s growth ratio vis-à-vis other companies in the industry will be a good tool to

assess its performance. If the growth rate is low compared to others in the industry, then it

will enable us to analyse the problems unique to this company.

Formula

The compounded annual growth rate over the past 3 years is calculated in percentage Terms.

CAGR (Compounded annual growth rate) for three years =

[{(Value of sales in current year)/(Value of sales in year –3)}(1/3) – 1}]*100

Thus it is the third root of sales in current year divided by sales three years ago,

minus 1, expressed as percent.

Notes

• Net sales = Gross sales – Indirect taxes

• For banks, NBFCs, and other financial institutions:

o Net sales = net interest income + other income

F2 - PBDIT Growth Rate

Importance of this indicator

This ratio refers to the compounded annual growth rate of profits before depreciation (non

cash), finance costs (interest) and tax over a period of three years.

A consistent growth in this ratio indicates an improved performance of the company,

reflected in increasing profitability (compared to its sales growth).

Formula

The compounded annual growth rate over the past 3 years is calculated in

percentage Terms.

CAGR (Compounded average growth rate) for three years =

72

[{(Value of PBDIT in current year)/(Value of PBDIT 3 years back)}(1/3) – 1}]*100

Thus it is the third root of PBDIT in current year divided by PBDIT three years

ago, minus 1, expressed as percent.

Notes

• PBDIT denotes profit before depreciation, interest and tax.

• For banks, NBFCs, and other financial institutions, use PBT instead of PBDIT

F3 - PBDIT/Sales

Importance of this ratio

This ratio indicates the profit before depreciation, interest and tax as a percentage of net sales.

The profit before interest, depreciation and tax is an indicator of the operational efficiency. If

this ratio as a percentage of sales is high, then it is a positive indication of the operating

efficiency in Terms of raw material consumption, employee productivity and power

consumption among other things. A high value indicates greater profitability and hence

betters capability to repay the debt. The ratio is a measure of the margin available to a

company from its operations.

Formula

This ratio (in %) is computed by dividing the PBDIT with Net Sales.

(PBDIT/Net Sales) x 100

• PBDIT = Operating profit before depreciation, interest and tax

• For banks, NBFCs, and other financial institutions:

o Net sales = net interest income + other income

o Use PBT instead of PBDIT

F6 - TOL/TNW

Importance of this ratio

This ratio gives a holistic representation of total outside liabilities in relation to tangible net

worth of company. It reflects the capacity of the business unit to assure the creditors of the

security they have for payment of both interest and instalment. It indicates the extent to which

the creditors are covered by asset.

This ratio shows how much outside borrowings are resorted to in comparison with owners’

funds

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Formula

The total outside liabilities are divided with the tangible net worth of the

company.

Total Outside Liabilities

Tangible Net Worth

• TOL = Total liabilities - TNW

• TNW as defined in Debt Equity ratio

• Also calculate this ratio for banks, NBFCs and other financial institutions, as it will

give an indication of the capital adequacy of the company

F7 - Current Ratio

Importance of this ratio

Current assets of company are the assets that can be easily liquidated and converted into cash.

The current ratio measures short-Term liquidity of the company and ability to meet its short-

Term financial obligations. A high ratio is good from the point of view of the bank but a very

high ratio may affect profitability through a high inventory carrying cost.

Formula

The ratio is worked out by dividing the Current Assets with Current Liabilities

Current Assets

Current liabilities (including instalments due during the year)

• To get a meaningful current ratio, we should account for the vulnerability of a company to

short Term insolvency. The current ratio could be high because of excess inventory or slow

realisation of debtors. Therefore, current assets must not include inventory which is older

than the normal working cycle of company (say 6-8 month), receivables over 6 months, dies,

spares required for more than 9 months of production and disputed receivables. If such

“excess assets” exist then please make necessary notes in the remarks column. In such cases

please indicate your assessment of the value of current ratio.

• Also calculate this ratio for banks, NBFCs and other financial institutions, as it will give an

indication of the duration mismatch of the company’s balance sheet

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F8 - Operating Cash Flow

Importance of this indicator

This measure indicates the company’s cash inflows and outflows arising from its operations.

It is different from funds flow of business.

It helps us to evaluate the company’s ability to generate cash inflows from operations to pay

debt, interest and dividends, and to explain the difference between net income and net cash

flow for operating activities. The operating cash flow can indicate the company’s need for

external financing.

While funds flow is good to match long Term and short Term use and source of funds, this

indicator tries to capture the capability of the firm to be able to meet its business obligations

.

Calculation

Operating cash flow ( for the last financial year) is computed in the following manner

Head Amount

Net Sales

Other income

Total receipts

Less: COGS

Gross Profit

Less: SGA/Operating expenses

PBDIT

- Increase / + decrease in non cash current assets

+ Increase / - decrease in current liabilities

Operating cash

Less: Income tax paid

Post tax operating cash

Less: Interest paid on LT & ST

Less: Dividend paid

Cash from operations

Repayment due of long Term debt

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How to rate

Compare “cash flow from operations” to “repayment due of long Term debt”.

The rating is done as explained in the table below.

Description Score

The company is likely to default on repayment of its Loans and

Interest

O

The company is not in a position to meet its repayment obligations

from its own resources and it faces difficulties to arrange outside

funds

1

The company is in a position to meet its repayment obligation from

its own resources and Term funds that are already applied for (and

expected to be sanctioned shortly)

2

The company is in a position to meet its repayment obligation from

its own resources and Term funds

3

The company is in a comfortable position to meet its repayment

obligation from its own resources (no need for outside funds)

4

F9 - DSCR (Debt Service Coverage Ratio)

Importance of this ratio

This ratio measures the capacity of the company to service its debt i.e. repayment of principal

and interest. DSCR measures the number of times a company’s earnings cover its total long-

Term debt-servicing requirement, including interest and principal repayments in Term Loans,

over a period of one year.

This ratio will help us to evaluate if an adequate cash flow will be available to meet debt

obligation and also for providing margin of safety to lenders. This ratio also helps to

deTermine the time when repayment should commence and the pay-back period of the Loan.

This ratio is a good indicator of the long-Term solvency of a company.

Formula

The profit before depreciation and interest (PBDI) is divided by installments due

during the year plus interest.

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P B D I__________

Instalments for the year + interest

• Do not fill in this ratio for banks, NBFCs and other financial institutions

F12 - Foreign exchange risk

Importance of this indicator

Adverse movements in the foreign exchange rate can have a tremendous impact on the

company’s financial strength.

Foreign exchange risk may be either transaction based or portfolio based. Transaction based

risk is due to time lags between purchases being made and payment being made, or sales

being made and payment being received against these sales. Portfolio based risk is on account

of foreign exchange Loans where the repayment is made on future dates in foreign currency.

The rater needs to know how the likely fluctuation in exchange rate will affect the profits of

the company. Depending on composition of international trade, the adverse exchange rate

movement could affect the profitability/cash flow. Prudent borrowers hedge their exposure to

foreign exchange. Only the un-hedged part of the foreign exchange exposure should be taken

into account.

How to rate

The rater has to subjectively rate this indicator on a score of 0 to 4 based on his perception

and knowledge of the foreign exchange risk. A potential model to allocate score can be the

following:

Description Score

The risk involved is > 10% of TNW 0

The risk involved is between 8% and 10% of

TNW

1

The risk involved is between 5% and 8% of TNW 2

The risk involved is less than 5% of TNW 3

The entire portfolio is hedged 4

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Important notes

• The foreign exchange risk can be quantified by using the forward exchange rates prevailing

in the currency market.

• The risk involved can be estimated by evaluating two measures:

1. exports as % of TNW

2. Natural hedge involved, with a proxy measure being (1- imports divided by exports)

(always divide the smaller number by the larger one). When this ratio is

1, foreign exchange risk from exports and imports cancels each other out (provided it is

to/from similar currency zones)

Example: total sales = 100, exports = 20, imports = 10, TNW = 200

Risk involved = exports x (1- imports/exports) = 20 x (1- 10/20) = 10

= 5% of TNW

• Also calculate this ratio for banks, NBFCs and other financial institutions

F13 - Expected values of Debt Equity ratio if 50% NFB credit devolves

Importance of this indicator

This indicator gives us an idea about the future expected debt equity structure in an extreme

situation.

It recalculates the Debt/Equity ratio when 50% of non-fund based limits devolve. In doing so,

it gives a sense of the long-Term financial stability in an extreme situation. This is quite a

good comforting factor for the bank. Most companies have to put up a margin for their non-

fund based credits. The new D/E ratio will have to be corrected for this when the limits

devolve, since part of it will be covered by the margin

Calculation

The calculation is the same as for F5 – Debt/Equity ratio, with

Debt = Long Term debt

+ 50% of the company’s non-fund based limits

- margin that the company put up for its non-fund based limits.

• Do not calculate this ratio for banks, NBFCs and other financial institutions

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F24 - Realisability of Debtors

Importance of this indicator

This indicator should indicate the quality of the debtors of the company and if money can be

recovered from them quickly and easily. A lot depends on how auditors have treated the

receivables.

There are many ways in which the auditors can play around with the receivables viz. the

receivables may be disputed. Receivables may be unrelated to business activity of the

company or there could be high amount of bad debts in the receivable portfolio of the

company. Any delay in receipt of payment from debtors/non-receipt of amount can hamper

the production cycle of a company as well as increase collection costs and the probability of

default on the part of the debtor of the company. Hence the realisability of the debtors of a

company is a critical input for assessing the financial risk of a borrower.

F27 – State of the export country economy

Importance of this indicator

The economy of the country(ies) to which is being exported, will have a significant impact on

the exporter’s business. A slowdown in the economic growth might even have a more than

linear impact on the exporter’s turnover and profitability, since importers will typically may

have the reaction to cut costs by cutting relationships with overseas’ suppliers.

How to rate

The rater has to subjectively rate this indicator on a score of 0 to 4 based on his perception

and knowledge of the foreign exchange risk. The minimum score of 0 could be assigned to

exporters who trade the bulk of their products/services with 1 single country, that is currently

in a recession. The maximum score of 4 can be granted to parties who have a wide portfolio

of export countries, with most (or all) of these countries showing strong economic growth.

F28 – Fund repatriation risk

Importance of this indicator

Exporters are often paid in the currency of the country to which they export.Some of these

currencies may be difficult to exchange or to wire back to India. In that case, significant costs

and risks are involved in the repatriation of funds, which could affect the overall risk profile

of the exporter

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How to rate

The rater has to subjectively rate this indicator on a score of 0 to 4 based on his perception

and knowledge of the foreign exchange risk. The minimum score of 0 could be assigned to an

exporter who trades the bulk of his products/services with a country that has very stringent

foreign exchange and currency repatriation policies. The maximum score of 4 could be

granted to exporters who only trade with countries, which have no restrictions on the flow or

repatriation of funds.

B3 - Inventory Turnover(Trading)

Importance of this ratio

This ratio indicates the velocity (number of times) with which the inventory circulates in the

business, during the relevant period.

A decrease in ratio could be a significant danger signal. Low ratio could indicate the presence

of slow moving items in stock. A high ratio is good from the point of liquidity since

inventory will be quickly converted into cash. This ratio also indicates the efficiency of the

company in utilizing its inventory and maintaining it at an optimum level. Thus, the higher

the ratio, the higher the sales per unit of investment in inventories. A lower ratio results in

high carrying cost and blocking of funds, thus limiting the liquidity of the company.

Formula

The ratio is worked out by dividing the net sales with average inventory maintained.

Net sales

Average inventories

• Average inventory = (opening stock of inventory + closing stock of inventory)/2

• Inventory = raw materials + WIP + finished goods

• Do not calculate this ratio for banks, NBFCs and other financial institutions

B7 - Credit period allowed

Importance of this indicator

This indicates the period of realisation of sales proceeds. It is the average length of time that

customers who buy on credit take to pay their dues. It indicates the efficiency of management

in debt collection.

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A lower value of this ratio indicates a speedy realisation of sale proceeds. The industry’s

practice should be given due consideration. A high ratio could be indicative of disputed

receivables or a high amount of bad debts. The appraisal officer should be careful when

assessing this ratio, since it also reflects the bargaining power enjoyed by the company in the

market with respect to the buyers.

Formula

The period of collection (in days) is calculated by dividing the average debtors outstanding

with average daily sales.

Average debtors

Average daily sales

Average debtors = (Sundry debtors in the beginning of the year + sundry debtors at the

close of the year)/2

• Do not calculate this ratio for banks, NBFCs and other financial institutions

B8 - Credit period availed

Importance of this indicator

It measures the average time taken by the company to pay its suppliers for purchases made on

credit. This ratio relates credit availed to its total purchases. This indicator is a measure of the

bargaining power that the company enjoys with its suppliers. A stronger company will avail a

longer credit period from its suppliers than a weak company. A longer credit period offered

by suppliers also indicates that the suppliers are confident of the ability of the company to

pay

them. A word of caution, a very high ratio could indicate short-Term liquidity problems also.

Formula

The credit period availed (in days) is computed by dividing the average (non financial)

creditors outstanding during the year with average daily cost of sales.

Average creditors

Average daily cost of sales

Average creditors = (Sundry creditors in the beginning of the year + sundry creditors at

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the close of the year)/2

• Do not calculate this ratio for banks, NBFCs and other financial institutions

B9 – Working capital cycle (Manufacturing, Trading)

Importance of this indicator

Working capital represents an important part of the employed capital of many companies.

Therefore, a good performing company should carefully manage this part of its assets, since it

represents an important invest Also, the way a company go about their working capital, says

a lot about the management of the company. In a sense one could argue that good working

capital management is an indicator of good management Factors to be considered Inventory

turnover and credit period allowed

How to calculate

Net sales

Working capital

Working capital = Raw materials and spares+ Finished and semi finished goods+

Debtors

• Do not calculate this ratio for banks, NBFCs and other financial institutions

B10 - Tax Incentives

Importance of this indicator

Tax incentives can be a major driver of profitability for many companies. A unit located in

backward area or in some of the states (like Goa or union territory of Daman & Diu etc.)

enjoy special tax incentives. (Both states grant income tax and sales tax holidays for 3-5 yrs.)

Such tax holiday period is helpful for company to take advantage especially in a commodity

market and thus improve profitability.

How to rate

The rater has to subjectively rate this indicator on a score of 0 to 4 based on his perception

and knowledge of the government policies and industry. The rater should also be aware of the

management strengths and their ability to make best use of the existing government

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incentives. Score of 4 indicates a high probability of successfully getting tax incentives.

Score of 0 means no or negative effect of taxes.

B13 - Production related risk (Manufacturing)

Importance of this indicator

This measures the risk of a company with respect to its production activities. It evaluates the

ability of company to sustain the production activity at a diversified level. A company having

little production related uncertainties in production would be better placed in the industry.

Problems in production would lead to impact on overall performance of the company. Thus

the efficiency, stability and consistency of quality of the production activities are a critical

deTerminant of performance. The state of technology can be considered an overall driver of

this risk

Factors to be considered

Capacity Utilisation; Availability of raw material, State of technology used; Flexibility in

product manufacturing; Patents and proprietary technology; R&D Number of manufacturing

plants.

How to rate

The rater has to subjectively rate this indicator on a score of 0 to 4 based on his perception

and knowledge of the production risk. A potential model to allocate score can be the

following:

Score =2, if company is upgrading

but has old technology

Score = 4, if company is upgrading

and technology is new

Score = 0,1 if company is not

upgrading and has old technology

Score = 3, if company is not upgrading but

has new technology

• Do not calculate this ratio for banks, NBFCs, other financial institutions or service

Companies

B14 – Product/service related risk

Importance of this indicator

This indicator measures the risk relating to the products manufactured / services provided by

the company.

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The risks associated with the product can be those related to obsolescence, substitution,

decrease in demand etc. A product should be of a consistent high quality; otherwise its

market reputation will suffer. The company’s ability to standardize product quality, getting

ISI benchmarks or ISO certificates will add to its advantage. The expected product life cycle

will also contribute to the overall product risk. The shorter the expected life of the product,

the riskier the company’s business performance

.

Factors to be considered

Product range; Product/service quality; Brand value, Highly customized product/service;

Obsolescence, Demand supply position/gap.

How to rate

The rater has to subjectively rate this indicator on a score of 0 to 4 based on his perception

and knowledge of the product risk. A potential model to allocate score can be the following:

Description Score

High variability in product/service quality (e.g. frequent recalls) and

short product life (<1 year)

0

High variability in product/service quality and medium product life

(1 to 3 years)

1

Low variability in product/service quality and medium product life

(1 to 3 years)

2

No variability in product/service quality and long product life (> 3

years)

3

No variability in product/service quality and very long product life (> 5

years)

4

B15 - Price Related Risk

Importance of this indicator

This indicator measures the ability of a company to dictate prices in the marketplace as well

as to cut its prices in case of a price war. The price competitiveness of a company is an

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important indicator of the competitive position of a company. A company that is in a position

to charge a premium over its competitors is better placed in the industry. Similarly, a

company with lower costs is in a good position to withstand price competition in the market.

If the company’s products enjoy a high reputation, it can price the product to its advantage.

Factors to be considered

Economies of scale/cost effective technology; Brand Equity; Pricing Flexibility; Financing

edge over competitors; Bargaining power of buyers

How to rate

The rater has to subjectively rate this indicator on a score of 0 to 4 based on his/her

perception and knowledge of the price risk. A score of 4 means that the company is not at all

subject to price risk, i.e. can charge a sustainable price premium. A score of 0 indicates that

the company has no control at all over its price, thus being subject to high price risks.

B20 – Client risk(Services, Manufacturing)

Importance of this indicator

Smaller to midsized companies can face considerable risks at the client side. This risk is

twofold: number of clients and quality of clients. Medium-sized companies sometimes

depend on a very small portfolio of clients, or have 1 predominant clients who makes or

breaks the company. Also, medium sized companies are sometimes closely connected to

clients with a shady or poor reputation. This might not only adversely impact their own

reputation, but also

represent a barrier to recruiting and retaining of talent, innovation, …

Factors to be considered

Number of clients, quality/reputation of clients

How to rate

The rater has to subjectively rate this indicator on a score of 0 to 4 based on his/her

perception and knowledge of the client risk. A score of 4 means that the company has a well

diversified portfolio of high quality clients. A score of 0 indicates that the company depends

on a small set of clients, which can be perceived as 2nd or 3rd rank in their respective

industry.

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B21 – Fixed asset turnover (Manufacturing)

Importance of this indicator

Fixed assets represent an important part of the capital employed at manufacturing companies.

A well performing company should therefore make sure that it gets the maximum out of its

machine park.

How to rate

Net sales

Fixed tangible assets

With fixed tangible assets = replacement or acquisition value of fixed tangible assets

(land, machines, buildings,..)

B22 – Quality of internal processes & systems (Services)

Importance of this indicator

The business performance of service companies is often determined by the quality of their

internal processes and systems. It is therefore important to assess how these companies score

on these dimensions, since they will be an important contributor to the potential success and /

or risk of the company

Factors to consider

Consistency of delivered service, timeliness or response time, internal sharing of know-how,

quality of internal training programs,

How to rate

The rater has to subjectively rate this indicator on a score of 0 to 4 based on his/her

perception and knowledge of the quality of internal processes and systems. A score of 4

means that the company’s processes and systems are considered top class in the industry. A

score of 0 indicates that the company has a very poor service offering and resulting

reputation.

B23 – Competence to innovate(Services)

Importance of this indicator

The success of a company can often be related to the overall performance of its service

offering. Therefore, a company’s capability to develop services which respond to its users’

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needs (through efficiency, customization, effectiveness …) will influence its competitive

position and hence its success

How to rate

The rater has to subjectively rate this indicator, based on his understanding of the company’s

innovation capabilities. A rating scale from 0 to 4 will be used. A score of 2 means that the

company can be seen as having “average” innovation skills. A score of 3 or 4 indicates a

stronger or outstanding (respectively) innovational strength compared to its competitors. A

score of 1 or 0 indicates a weaker or poor (respectively) innovation skill compared to

competitors.

B24 – Sustainability of sales(Trading)

Importance of this indicator

An important driver of the success of a trading company, is the level of sales it is able to

generate. Therefore, the risk associated with a trading company is very much linked to the

sustainability of its sales. A company with sustainable sales will have a core portfolio of

products, which will not switch quickly. Opportunistic trading companies do run the risk of

making the wrong “bet”, resulting in impressive declines in sales.

How to rate

The rater has to subjectively rate this indicator, based on his understanding of the company’s

sales sustainability. A rating scale from 0 to 4 will be used. The maximum score of 4 can be

assigned to trading companies with a strong portfolio of core products, showing continuous

growth as a result of a well laid out strategy. The minimum score of 0 could be given to

opportunistic trading companies, showing a very random path in performance, and without a

clear-cut strategy.

Subjective Assessment of Quality of Management

How to rate:

The rater should rate the ratios and indicators on the score of 0 to 4 depending on his

understanding and comfort levels.

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A score of 4 means that the rater feels that promoters and their management will perform

very well on the ratio/indicator. Adversely, the rater should assign a score of 0 if he/she

thinks that management will perform poorly on the ratio/indicator.

The importance of each of the above ratios and indicators are now listed.

M1 - HR policy / Track record of industrial unrest

Importance of this indicator

This factor relates to labour unrest, lock out, and work slow down, strike and strained

management – employee relation. Industrial harmony is a key factor for success of an

industry/business. In short, this indicator reflects the quality of the company’s HR policy.

Factors to assess include: is the HR system fair and equitable, are promotions based on

merits, does the company provide a supportive environment, and do employees feel

appreciated?

M2 - Track record in default of statutory dues (e.g. Electricity bills, PF dues, etc.)

(Manufacturing ,Trading)

Importance of this indicator

This factor takes into account the seriousness of the company and its management towards

contractual obligation. If management is not serious about the legal and statutory dues then

there is a high probability of it not being committed to fulfil the Loans taken from the bank.

M3 - Market report of management reputation

Importance of this indicator

This market report assesses the reputation or general perception about integrity and fair

dealing of the promoters. The reputation of promoters regarding their integrity, adhering to

commitments, fair dealings has important bearing on quality of management. This

incidentally becomes one of the most important ratios and indicators, as past behaviour is

often a good proxy for their future behaviour.

Adverse performance of associate concerns controlled by the corporate should also be

considered.

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M4 - History of FEMA violation /ED enquiry

Importance of this indicator

A company may have a track record of FEMA violation or might have faced raids by the

Enforcement Directorate. Companies also indulge in unhealthy practice of electricity thefts or

evasion of ST, IT or Excise or indulge in Hawala transactions, under-invoicing or over-

invoicing. Such instances speak about poor integrity of company and indicate about company

working against national interest.

M6 – Too optimistic projections of sales and other financials

Importance of this indicator

There is sometimes a conscious attempt to over-estimate financial projections to secure

excess borrowings. Recurrent non-achievement of targets could be indicative of such

practice. Careful scrutiny of past track records help develop an idea of reliability of

projections.

M8 – Capability to raise resources

Importance of this indicator

Management’s capability of raising additional resources is an important factor in assessing

the creditworthiness of the company. If management is likely to find additional outside

funding (from capital market, partners, family, group company,…) whenever this is

necessary, this should contribute to a reduced risk for the bank.

M9 - Technical & Managerial expertise(Manufacturing)

Importance of this indicator

This indicator relates to the technical knowledge and experience of the promoters in the

relevant area of operation. Technical skills will contribute to a greater efficiency of

operations and quality of products. Managerial know-how will enable management to avoid

typical pitfalls and to put together a consistent and feasible strategy.

M12 – Mix of professional and traditional management (Services,Tarding)

Importance of this indicator

This indicator tries to evaluate the professionalism of the company’s management. It is

important that the management consists of people who know the business, the industry and

who have the necessary experience to make things work. However, a lot of companies are

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still family-owned, which is often reflected in the composition of the management team.

Therefore, it is important to assess if the company maintains a good balance between

traditional management (who often own the client relations) and professional management.

Monitoring Tool

Introduction

The web based credit rating model consists of the following two tools:

1) Credit rating tool

2) Monitoring tool

The model has been provided with the following two options:

1) Scenario I

2) Scenario II

At the time of sanctioning of a fresh advance, the concerned client should be rated in the

credit rating model under the Scenario I option. This would activate the Credit rating tool

provided in the rating model and based on the data entered, the tool would compute a credit

rating for the client.

After the sanction and disbursement of the advance, rating of the borrower should be

reviewed at a frequency indicated by the rating wise schedule (as indicated in the Credit

Policy of the Bank). This rating exercise should be done in the model under the Scenario II

option. This would activate both the Credit rating tool and the Monitoring tool in the

model. The model would re-compute the overall rating after reckoning the data both from

rating tool and the monitoring tool. Once an account has been re-rated using the Scenario-II

option, further modifications / re-ratings pertaining to that account will compulsorily have

to be done using Scenario-II option only. In other words, the access to Scenario-I option will

be blocked in such cases

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The following

weightages have been

allocated under the

above stated respective

scenarios: Parameters

LCMC SME

Scenario 1 Scenario II Scenario 1 Scenario II

Financial 40.00 35.00 55.00 47.50

Business 22.50 17.50 15.00 15.00

Management 22.50 20.00 15.00 15.00

Industry 15.00 12.50 15.00 12.50

Monitoring Tool

(Conduct)

Not Applicable 15.00 Not Applicable 10.00

(The above stated weightages are subject to change)

Bases on an exercise conducted to examine the robustness of the monitoring tool; the

erstwhile conduct rating parameters have been condensed and divided into two groups:

1) Hurdles: These are parameters which lack the discriminating power between a good

and a bad account but they are nevertheless important as far as behavior of an obligor

is concerned.

2) Discriminants: These are parameters which have higher discriminating power between

a good and a bad account and maybe used for predicting defaults.

Since inputs for the monitoring tool will be available with the branches, data input in the

monitoring tool will be done by the branches only. In case of any clarifications the user may

get in touch with the Risk Department at Central Office

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.

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Parameter

Hurdles

A1 Creation of Charge on Primary Security

A2 Creation of charge on collateral and / or execution of personal /

corporate guarantee

A3 Other Terms & conditions not complied with

A4 Receipt of periodical data / Stock & Book Debt statements

A5 Receipt of Balance Sheet / Renewal data

A6 Compliance of financial covenants

A7 Unit inspection reports observations

A8 Routing of proportionate turnover / business

A9 Utilisation of facilities (not applicable for Term Loan)

A10 Adequacy of insurance for the primary / collateral security

B1 Negative Deviation in Net Sales (actual vs. estimates)

B2 Financial Discipline

Overdue discounted bills during the period under review

Devolved bill under L/C outstanding during the period under

review

Invoked BGs issued outstanding during the period under review

Frequency of RETURN of cheques per quarter deposited by

borrower

Frequency of issuing of cheques without sufficient balance per

quarter

Payment of INTEREST or INSTALMENT

B3 Frequency of requests for Ad Hoc increase in limits

B4 Frequency of overdrawing in CC account

B5 Any other adverse features financial / non-financial, including

corporate governance issues such as adverse publicity, strictures

from regulators, political risk and adverse trade environment not

covered elsewhere

Hurdles

A1: Creation of Charge on Primary Security

Primary security refers to the asset/s taken as the main tangible security for the funding of

which the bank grants finance, such as inventory, receivables, other current assets, fixed

assets, etc. When these assets are taken as security, they should be properly charged to the

bank by way of hypothecation, mortgage, pledge and assignment which should be legally

enforceable. In case the primary security is not properly created or charged as required under

the relevant law, the bank’s advance may become unsecured thus increasing the risk in the

exposure. Check whether the charge on primary security stipulated in the sanction has been

created and registered with the RoC (where ever required) or any other authority. If any of

the requirements of proper creation of charge on the primary security is not fulfilled, charge

on the stipulated security is considered as not created for this exercise. Even if the delay in

creation of security is allowed by the sanctioning authority, security is considered as not

created.

A2: Creation of charge on collateral and / or execution of personal / corporate

guarantee

Collateral security is taken as an additional security over and above the primary security. The

collateral security offers additional comfort to the bank partly mitigating the risk involved in

the exposure. The requirements stated in respect of the primary security (under A1) are

applicable for the collateral security also.

A personal / corporate guarantee further enhances the degree of mitigation of risk. It is

important to ensure that these have been executed / obtained strictly as per the sanction

Terms and legal requirements.

A3: Other Terms & conditions not complied with

Apart from the security, various other Terms and conditions are stipulated for enabling the

bank to mitigate risk from the exposure. Some of the stipulations assume greater importance

to the safety of advance such as obtention of NOC from the existing lenders for creation of

first / second / paripassu charge in favour of the bank, bringing in another bank for sharing /

tying up the gap, end use certification, etc.

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A4: Receipt of periodical data / Stock & Book Debt statements

Timely receipt of various data from the borrower is of utmost importance in monitoring the

health of an account. Apart from deTermining the drawing power (where ever applicable),

the data is considered as an indicator of conduct of the borrower’s business operation which

have implication on the conduct / performance of the account. Non receipt of such data (for

any reason whatsoever) itself is considered as a risk factor. Even in case of frequent delays in

submission of stock statements, FFR, etc the parameter should be rated as ‘Not Complied’.

A5: Receipt of Balance Sheet / Renewal data

The balance sheet is one of the sources of tangible information on the company’s operation

which can be objectively analysed to assess the effectiveness of the business model. Scrutiny

of the balance sheet can help notice salient and abnormal features in the areas of cash flow,

fund flow, capital base, production, inventories, receivables, sales, borrowings, diversion of

funds, and profitability. A timely submitted balance sheet enables the Bank to assess potential

adverse features and take appropriate action well in time. Non finalisation of audited balance

sheet, non submission / delayed submission of audited balance sheet / renewal data reflects

poorly on the corporate governance of the borrower and considered as one of the risk factors.

A6: Compliance of financial covenants

Financial covenants are stipulated for mitigating risk in an exposure. Some of these

stipulations relate to creation of Debt Service Reserve, maintenance of minimum asset cover,

current ratio level, TOL/TNW ratio, infusion of funds by promoters, raising of long Term

funds, liquidation of investments, restrictions of investments/dividend etc. These risk

mitigation measures provide extra comfort to the bank while sanctioning the advance. In case

the stipulated financial covenants are not complied with, partly or fully, the exposure would

carry a higher risk which needs to be captured in the monitoring tool.

A7: Unit inspection reports observations

Physical inspection of borrower’s unit enables the bank to verify the information supplied by

the borrower. Inspection should cover the following indicative areas:

• Idle plant and machinery.

• Attendance of labour / staff and their working conditions.

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• Adequate availability of utilities / infrastructure such as water, power, etc.

• Quality & value of inventory & finished product.

• Legal / statutory / lender’s notices pasted in the factory or on the Plant and Machineries.

In case of borrowers engaged in activities other than manufacturing, the borrower’s godown /

office / branches / outlets should be visited for ascertaining the overall conduct of business.

A8: Routing of proportionate turnover / business

The user is required to select whether the borrower enjoys:

Sole Banking

Multiple / Consortium Banking

And rate the borrower as per the options provided there under.

Apart from supplementing other income from the borrower the routing of entire /

proportionate turnover / business enables the bank to capture the borrower’s cash flow which

an important indicator of the borrower’s operations.

In case of sole banking arrangement, the borrower is expected to route its entire turnover /

business through the bank. In other cases, at least proportionate business should be routed.

Points to note:

In case of Term Loan facility without working capital facility, the routing of

turnover/business through the bank is considered as an added advantage to the bank, although

it may not be one of the stipulations.

A9: Utilisation of facilities (not applicable for Term Loan)

Full utilisation of cash credit facilities without variations for a long period requires closer

scrutiny to ensure that the liquidity of the borrower is not strained. The parameter intends to

capture such risk. Optimum utilisation of account apart from indicating soundness of

borrower’s cash flow also ensures adequate earnings for the bank.

A10: Adequacy of insurance for the primary / collateral security

Inadequacy of insurance indicates low value of assets or the possibility that the borrower has

inadequate interest in the assets. Underinsurance would result in application of ‘average

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clause’ leading lower settlement of claim. These implications are undesirable from a lender’s

point of view.

Discriminants

B1: Negative Deviation in Net Sales (actual vs. estimates)

The amount of estimated/projected net sales is one of the major parameters of credit

assessment. Non-achievement of estimated/projected net sales by the company indicates

setback in the borrower’s business performance. Non-achievement of sales could be one of

the early indicators of the weakening of an account and we need to look for the reason/s for

the set back. The user needs to input the sales turnover as per the latest Audited Annual report

as well as the sales turnover estimated / projected in the credit appraisal for the corresponding

period.

B2: Financial Discipline

Overdue discounted bills during the period under review

Non realisation of bills discounted by the bank reflects adversely on the borrower’s customer

profile and hence considered as risk.

Devolved bill under L/C outstanding during the period under review

Adequate cash flows are one of the important indicators of satisfactory health of a borrower.

Devolvement of bills under LC indicates inadequate cash flows of the borrower. Historically,

in most of the cases, such features are the starting point of financial deficiency ultimately

leading to default. A borrower having adequate cash flows and efficient cash flow

management system would not allow devolvement of contingent liability such as bills under

LC.

Invoked BGs issued outstanding during the period under review

Invocation of a guarantee indicates the borrower’s failure to perform the contract or meet the

requirement for which the guarantee was issued and considered as a risk factor. Further, non-

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payment of the invoked Bank Guarantee obligation within a reasonable period is considered

risky.

Frequency of return of cheques per quarter deposited by borrower

Return of cheques deposited by the borrower indicates low credit worthiness of the

borrower’s clients or the goods supplied by the borrowers do not conform to the Terms of

sale qualitatively. This may ultimately affect the business of the borrower and hence

considered as a risk factor.

Frequency of issuing of cheques without sufficient balance per quarter deposited by

borrower

Issuance of cheques by the borrower without maintaining sufficient balance in the account

impacts his credit worthiness. This would have negative impact on the health of the borrower.

Payment of interest or instalment

Failure to meet interest / instalment payment obligation indicates crystallization of credit risk.

Default / delay in payment of interest or instalment represent a strong warning signal about

the health of the account.

B3: Frequency of requests for Ad Hoc increase in limits

Frequent requests for ad hoc increase in limits indicate lack of proper management of funds

or inability of the borrower to raise funds from other sources or lack of cash flows to manage

the working capital cycle. The signal adds to risk profile of the borrower.

B4: Frequency of overdrawing in CC account

The requirement of working capital finance is assessed on the basis of borrower’s estimated /

projected level of operations. Hence, the borrower should be able to manage his funds

requirement within the sanctioned facilities. Frequent overdraft of the CC account due to any

reason (such as Term instalment, interest, temporary liquidity mismatch etc.) indicates poor

management of working capital finance and may be a potential risk of default.

B5: Any other adverse features financial / non-financial, including corporate

governance issues such as adverse publicity, strictures from regulators, political risk

and adverse trade environment not covered elsewhere

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No exposure is risk free nor can all risk factors in an exposure be objectively listed or

foreseen at a given point of time. As this parameter is subjective the rater should select a

suitable option based on his/her understanding of the borrower and the exposure.

Factors including market forces like capital market perception (continuous fall in the stock

price which are signals of deteriorating financial conditions, as well as other issues) may be

considered while selecting the option.

Rating Scales

The rating tool for SME has an 8-point rating scale, which ranges from SME 1 to SME 8.

Borrower Rating Range of Scores Risk Level

SME 1 Above 85 Lowest risk

SME 2 76-85 Lower risk

SME 3 66-75 Low risk

SME 4 56-65 Moderate risk

SME 5 46-55 High risk

SME 6 36-45 High risk

SME 7 26-35 Higher risk

SME 8 Below 26 Highest risk

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CHAPTER- 8

CASE STUDY

Details of case study

Name M/s Dynemic Products Limited (DPL)

Constitution Public Limited Company

Office Address B- 301, Satyamev Complex-1, Opp. New Gujarat High Court,

S.G.Highway, Sola, Ahmedabad-380 060, Gujarat, India.

Line of activity Manufacturing of Food Colour Products

Sector Chemical and Chemical Products

Dealing with us New Connection

Incorporation 14th June 1990

Name of Directors Mr. Dashrathbhai Prahladbhai Patel (DIN : 00008160)

Mr. Rameshbhai Bhagwanbhai Patel (DIN : 00037568)

Mr. Hitendra Hargovinddas Sheth (DIN : 00037705)

Mr. Jagdishbhai Sevantilal Shah (DIN : 00037826)

Mr. Harishbhai Keshavlal Shah (DIN : 00037932)

Mr. Bhagwandas Kalidas Patel (DIN : 00045845)

Mr. Dixit Bhagwandas Patel (DIN : 00045883)

Mr. Shashikant Purshottambhai Patel (DIN : 00045957)

Mr. Vishnubhai Gangarambhai Patel (DIN : 00270413)

Mr. Shankarlal Baluram Mundra (DIN : 00388204)

Group Not a recognized group

Rating External: Not done.

Internal: SME 3 (ABS 31.03.2009)

Associate Concern Dynemic Overseas (India) Private Limited

Dynemic USA Inc.

Share holding pattern As mentioned below

Share Price movement Listed on the BSE

Current Market Price – Rs.22.35/- (27.11.2009)

52 week high/low – Rs. 15.15 ( 22 Apr' 09)   /  Rs. 27.35 ( 16 Jan' 09) 

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Brief Background:

The Company was incorporated on 14th June, 1990 as Private Limited Company. The Name

was subsequently changed to Dynemic Products Limited on 31/12/1992. The Company was

promoted with the objective of carrying on the business of manufacturing S.P.C.P, the raw

material for Food Color, reactive & Raazole Dyes.

In the Year 2000 the company acquired the running business of M/s Safforn Dye Stuff

Industries and started manufacturing wide range of food colors at the premises 3709/6, GIDC

Estate, Ankleshwar having plot area of admeasuring 3700 Sq.Mtr.

As the company aims to provide entire range qualitative and quantitative service to food

industry, as its Unit I. The company commenced manufacturing of food colors namely

Tratrazine in the year 2000-01. Both the units at Ankleshwar are Ultra modern and have eco

friendly plants with in house testing facilities to control quality at every level of

manufacturing. The Company gained goodwill in the short span of time due to its quality

product. The company has well equipped state of art in house laboratory which conduct test

of every parameter of food color & Dye intermediates laid down under national and

international authorities. The Company exports its product to around 41 countries worldwide.

All these have led the company to acquire and retain a status of largest manufacturer and

supplier of food colors and dye intermediates in India.

Qualitative Factors:

The Company has a pro-active Management and Promoters who have hands on

experience in manufacturing of Dyes InTermediaries and Food Colours.

Profit making Company since last 13 years.

The company has to its credit an award for Indirect Export of Self Manufactured Dyes

for the year 2001-02 & 2002- 03 received by Gujarat Dyestuffs Manufacturers’

Association.

The company has obtained certificate of approval From Bureau Verities Quality

International (BVQI) for achievement of ISO 9001: 2000 quality standards, the

Company has also received certificate of approval from Bureau Verities Quality

International (BVQI) for achievement of 14001:1996 and 14001:2004 quality

standards for both its units satiated at Ankleshwar.

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The company has also obtained HAACP Code: 2003 certificate of registration from

TQCS International (Group) Pty Ltd under food safety programme for both its units

situated at Ankleshwar

The company was awarded with trophy for export performance of more than Rs. 6.00

& 8.00 Crore for Self

Manufactured Indirect Export of Dyes & inTermediates in the year 2002-03 by

Gujarat Dyestuffs Manufacturers’Association.

Both the Units of the company are exporting Oriented Units and have obtained the

status of One Star Export House.

Marketing Strategy/Marketing arrangement

Strong and experience people are leading company’s marketing department. Company’s total

turnover is divided into:

Exports Sales

Local Sales

Exports Sales:

Company’s 70% turnover is generated by way of exports sales. Company has its own

presence in all most all countries. The company is exporting Food colors in Latin

America, African countries, Middle East, Far East, US and Europe. Almost all export

customers are dealing with company for many years.

Out of total exports turnover 60 to 70% percentage orders are repeated orders and rest

of the orders are new orders.

The Company has region wise Export Managers who can cater the need of customers

individually. Due to the quality and timely delivery of the material the company have

less competition from these countries.

Globally many countries have discontinued production of Dyes, Food colors and

Intermediates, new market has opened for Indian manufacturer of Dyes and

Intermediates. As Dynemic Products Ltd is already a well recognized name in the

field globally, it has more opportunities to grab from growing International market.

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Local Sales:

In Local Market Company is doing marketing its Dyes & Intermediates to the end

customers.

The company is the largest manufacturer of S.P.C.P in India which generating

repeated order from the local customers.

Now, company is planning to market the food colors in small packing through its

dealers and distributors which cater the local needs.

Company is also planning to arrange marketing arrangement with soft drink

manufactures and pharmaceutical manufactures for food colors.

Proposal for Proposal for fresh sanction of credit facilities by way of take over (with

enhancement) from HDFC Bank

a) Sanction of Cash Credit Limit of Rs. 500.00 lacs for working capital

requirement ( take over of Rs. 500.00 lacs from HDFC Bank).

b) Sanction of Letter of Credit (Inland/Foreign) of Rs. 300.00 lacs for

working capital requirement as a sub-limit of cash credit limit (take over of Rs.

300.00 lacs from HDFC Bank).

c) Sanction of EPC/FBD/FBP/PCFC/PSCFC of Rs. 500.00 lacs for working

capital requirement as a sub -limit of cash credit limit (take over of Rs. 500.00

lacs from HDFC Bank).

d) Sanction of Corporate Loan of Rs. 200.00 lacs (take over of Working

Capital Term Loan of Rs. 200.00 lacs from HDFC Bank).

e) Sanction of LER limit of Rs. 25.00 lacs (equivalent to forward cover of

Rs.500.00 lacs).

f) Waiver of credit opinion report from existing bankers of M/s. DPL

(HDFC Bank) and group concerns of M/s. DPL i.e. M/s. Dynemic Overseas

(India) Limited based on justifications given in the proposal.

g) Concession in processing fees at Rs. 1.00 lacs against norm of 1.00%.

h) Permitting time of 30 days for completion of take over formalities with

HDFC and creation of mortgage by CMC.

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Existing & Proposed Facilities (R

s. in lacs)

Type of FacilityExisting Limits

(HDFC)

Proposed + Inc / – Dec

Proposed Limits

(Axis Bank)Cash Credit Limit – Stock cum Book Debt

500.00 -- 500.00

Corporate Loan 200.00 -- 200.00EPC/FBD/FBP/PCFC/PSCFC – As a sub limit of Cash Credit Limit

(500.00) -- (500.00)

LC(Inland /Foreign) - As a sub limit of Cash Credit Limit

(300.00) -- (300.00)

LER Limit (as a sub-limit of CC limit)

(15.00) +25.00 +25.00

Total700.00 +25.00 725.00

PurposeWC/LC/LER : To meet working capital requirements.

Corporate Loan : For NWC built up.

Tenor WC/LC/LER : 12 months.

Corporate Loan : 24 months from the date of first disbursement.

Repayment WC/LC/LER : On Demand.

Corporate Loan : 23 monthly instalments of Rs. 834000 each and last

instalment of Rs. 818000. Repayment to commence from December 2011.

Interest to be serviced as and when debited.

Security Primary Hypothecation of entire current assets (Pari passu) of the

company (Both present & future). (Value as on 31.03.2011

is of Rs. 1326.42 lacs).

Hypothecation over Plant and Machinery (Pari Passu)

(Both present & future). (Value is of Rs. 1529.55 lacs as

per empanelled valuer of Citi Bank).

Collateral Pari – Passu charge being shared by Citi Bank Limited on

following properties :

i. Factory Land and Building, Plant and Machinery at Plot No.

6401,6415,6416, G.I.D.C., Ankleshwar, Dist.Bharuch

admeasuring 5664 sq.mts. standing in name of M/s. Dynemic

Products Limited.

ii. Office situated at B- 301,308,309,310 Satyamev Complex-1,

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Opp. New Gujarat High Court, S.G.Highway, Sola,

Ahmedabad-380 060, Gujarat admeasuring 4272 square feets

standing in the name of M/s. Dynemic Products Limited.

iii. Factory Land and Building, Plant and Machinery at Plot No.

3709/6,3710/3,3710/1, G.I.D.C., Ankleshwar, Dist.Bharuch

admeasuring 12290.80 sq. mts. standing in name of M/s.

Dynemic Products Limited.

Guarantee Personal Guarantee of :

Mr. B.K.Patel having net worth of Rs. 264.88 lacs (approx.) as on 31.03.2011.

Mr. Ramesh B.Patel having net worth of Rs. 152.57 lacs (approx.) as on 31.03.2011.

Mr. Dashrath P.Patel having net worth of Rs. 257.89 lacs (approx.) as on 31.03.2011.

Mr. Shashikant P.Patel having net worth of Rs. 148.22 lacs (approx.) as on 31.03.2011.

Mr. Dixit B.Patel having net worth of Rs. 36.33 lacs (approx.) as on 31.03.2011.

Credit

enhancement

Nil.

Interest Rate BPLR - 3.50% i.e. 11.25% p.a. with monthly rests (presently BPLR @ 14.75%).

LC Charges Bank’s standard schedule of charges.

Processing fees Rs. 1 lacs for the sanctioned facilities plus applicable taxes.

Banking

Arrangement

Multiple with Citi Bank (Proposed).

Unit visit

The unit was visited Mr. Asim Bhaduri (VP – SME and Center Head), Mr. P.C.Dash (AVP

and SCO – SME) and Mr. Kuntal Bhatt (Manager and RM - SME) on 13th November 2011

and the overall operations of the unit were found to be satisfactory.

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Operational & Financial Analysis

(Rs. in lacs)

Particulars

 

31.03.09 31.03.10 31.03.11 31.03.12 31.03.13

(Actuals) (Actuals) (Actuals) (Projected) (Projected)

Gross Sales 3231.12 3657.70 4911.20 6500.00 7500.00

Net Sales 3231.12 3657.70 4911.20 6500.00 7500.00

Net Sales Growth Rate % 12.79% 13.20% 34.27% 32.35% 15.38%

Operating Profit 227.49 313.80 261.62 621.29 729.97

Other Income 141.52 (5.36) 56.07 55.00 65.00

PBDIT 322.88 412.89 503.87 881.74 1018.09

Depreciation 47.94 50.62 96.12 110.94 107.00

Interest 47.45 48.47 146.12 149.50 181.12

PBT 369.01 308.44 317.69 676.29 794.97

PAT 266.95 184.99 190.03 446.42 524.76

Cash Profit 182.35 103.07 153.62 424.83 499.22

Operating Profit Margin % 7.04% 8.58% 5.33% 9.56% 9.73%

PBDIT Margin % 9.99% 11.29% 10.26% 13.57% 13.57%

PAT Margin % 8.26% 5.06% 3.87% 6.87% 7.00%

Paid up Capital - Equity 1132.84 1132.84 1132.84 1132.84 1132.84

Unadjusted TNW 2649.73 2707.33 2764.96 3078.84 3471.06

Unadjusted TOL 1109.42 1589.26 2331.73 2890.12 3094.44

Unadjusted TOL/ TNW 0.42 0.59 0.84 0.94 0.89

Adjusted TNW 2710.84 2725.68 2828.34 3237.48 3629.70

Adjusted TOL 1048.31 1570.91 2268.35 2731.48 2935.80

Adjusted TOL/ TNW 0.39 0.58 0.80 0.84 0.81

Interest Coverage 9.82 8.44 3.84 6.27 5.98

Current Ratio 1.76 1.34 0.94 1.13 1.24

DSCR 7.67 1.83 1.21 2.35 2.20

NOCF 105.69 230.12 654.38 (269.99) 149.24

Net Profit / NOCF 2.53 0.80 0.29 (1.65) 3.52

NOCF / Interest 2.23 4.75 4.48 (1.81) 0.82

NOCF / Financing Payments 0.08 0.13 0.29 (0.08) 0.04

Total Debt / NOCF (No. of 1.17 0.78 0.60 (0.45) (0.00)

105

years)

Rating

The rating of the company as per SME Rating Tool comes to SME - 3 (ABS 31.03.2011).

The segment wise scoring is as under:

Particulars Rating

Overall Scoring SME-3

Financial scoring SME-4

Business scoring SME-3

Management scoring SME-3

Industry scoring SME-3

CIBIL/RBI/ECGC Defaulters’ List/CA Verification/ Auditor Verification

Particulars As of Date Position

RBI Defaulters list 31.12.2011 No match found.

ECGC Specific Approval List 31.07.2011 No match found.

CIBIL Defaulters List Satisfactory.

CA Verification (Auditor) 13.11.2011 Verified.

Auditor’s Firm Verification 13.11.2011 Verified.

Reference Check

Reference check was made through some of Bank’s clients in the same line of activity

financed by Axis bank and the same was reported to be satisfactory.

Analysis

a) The promoters of the company are having rich experience of more than 19 years in

various Industries.

b) The proposed expansion of the company is having huge market potentials.

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c) The Company is the leader in Manufacturing and export of food colours.

d) The overall credit rating of company is SME –3.

e) The business is 19 years old.

f) The sale of the company has been showing an increasing trend throughout the years

under consideration. The sale of the company was increased from Rs. 3231.12 lacs in

FY08-09 (Aud) to Rs. 3657.70 lacs (Aud) in FY09-10 and further to Rs. 4911.20 lacs

in FY10-11 (Aud).

g) Since the company is into Manufacturing of Food Colours, the net margin normally

remains between 5.00% - 9.00%. The net profit of the company was decreased from

Rs. 266.95 lacs in FY08-09 (Aud) showing margin of 8.26% to Rs. 184.99 lacs in

FY09-10 (Aud) showing margin of 5.06%. However, the same was maintained at Rs.

190.03 lacs in FY10-11 (Aud) showing margin of 3.87% due to decrease in margins

in the chemical industry on account of raw material price fluctuations worldwide. The

same was an aberration. But, now the industry is on revival and boom path.

Considering the same, the company has estimated the profit of Rs. 446.42 lacs for

FY11-12 @ margin of 6.87%, which may be accepted.

h) The TOL/TNW of the company increased from 0.42 in FY08-09 (Aud) to 0.59 in

FY09-10 (Aud) and to 0.84 in FY10-11 (Aud). The company has estimated

TOL/TNW at 0.94 and 0.89 for FY11-12 and FY12-13 respectively on account of

increased bank borrowings, which may be considered comfortable.

i) The current ratio of the company was 1.76 in FY08-09 (Aud) which decreased to 1.34

in FY09-10 (Aud) and which further plummeted to 0.94 in FY10-11 (Aud), on

account of capex expansion which will be completed in the current fiscal. The

company has estimated its current ratio at 1.13 and 1.24 for FY11-12 and FY12-13,

which is reasonably acceptable as regards to the liquidity position of the company.

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j) The NOCF is positive during FY 2010-11 (Aud) by Rs. 654.38 lacs. NOCF is

estimated negative in FY 2011 –12 at Rs. 269.99 lacs, as per projected financials

submitted by the company on account of increase in stock and receivables which is

keeping in line with the increase in turnover and the holding levels are as per the

industry practice.

k) The overall conduct of the account, repayment status etc. at Citi Bank and HDFC is

satisfactory.

l) The main director is dynamic and has rich experience of more than 20 years in his line

of activity.

m) The company is a registered SSI unit.

n) Market reference of the company is satisfactory

.

o) The overall projected performance and financial of the unit are satisfactory.

108

Analysis

a) The market reputation of promoter is satisfactory.

b) Firm has achieved sales of Rs. 204.49 lacs in FY. 2009- 10 and Rs. 431.02 lacs in FY.

2010-11, this is more than double of the last year. Firm has submitted estimated sales

of Rs. 568.57 lacs for FY 2011-12, against which firm has achieved sales turnover of

Rs. 235.70 lacs till 31st October 2011, which is 41.45 % of estimated sales.

c) Profitability of the firm is also showing increasing trend y-o-y bases. Firm has

achieved PBT of Rs. 3.71 lacs in FY 2009-10 & Rs. 8.55 lacs in FY 2010-11.

Profitability has also rose in line with increase in sales of previous financial year.

PBDIT of the firm is also on increasing trend, which can be considered as

satisfactory.

d) Net worth of the firm is increasing y-o-y bases, with plough back of the profit in the

business. Unadjusted gearing of the firm is on higher side for FY 2010-11 mainly due

to higher side of creditors at particular point in March 2010. In March 2011,

proprietor submitted that purchase of raw material was at better price & the suppliers

also allowed credit period. Hence, the creditor base was on higher side.

e) Debtor’s level of the firm is average 60 days for all the past 3 years. Proprietor has

submitted that average payment duration is 60 days maintained in the business.

Debtors maintain regularity in payment, which can be considered as acceptable.

f) The Current Ratio of the firm has been on higher side, above the benchmark level of

1.33 for all the past 3 years. Current ratio for FY 2009-10 was 1.44 & for FY 2010-11

was at 1.77. Estimated ratio is 1.66 for FY 2011-12. Although, it has been maintained

above the benchmark level, which can be considered as acceptable.

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CHAPTER - 9

FINDINGS

Credit appraisal is done to check the commercial, financial & technical viability of the

project proposed its funding pattern & further checks the primary or collateral security

cover available for the recovery of such funds

Credit is the core activity of the banks & important source of their earnings which go

to pay interest to depositors, salaries to employees & dividend to shareholders

Credit & risk go hand in hand

In the business world risk arises out of:-

Deficiencies / lapses on the part of the management

Uncertainties in the business environment

Uncertainties in the industrial environment

Weakness in the financial position

Bank’s main function is to lend funds/ provide finance but it appears that norms are

taken as guidelines not as a decision making

A banker’s task is to indentify/assess the risk factors/parameters & manage/mitigate

them on continuous basis

The Credit Appraisal process adopted by the bank take into account all possible

factors which go into appraising the risk associated with a loan

These have been categorized broadly into financial, business, industrial, management

risks & are rated separately

110

The assessment of financial risk involves appraisal of the financial strength of the

borrower based on performance & financial indicators

The norms of the bank for providing loans are not stringent, i.e. even if a particular

client is not having the favorable estimated and financial performance, based on its

past record and future growth perspective, the loan is provided.

By providing various schemes of loans, Axis bank tries to cater to the financial

requirements of almost all the types of SME units.

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CHAPTER - 10

CONCLUSION

Finance management is the backbone of any organizations and hence yields a number

of job options ranging from strategic financial planning to sales.

From the study of Credit appraisal of SME, it can be concluded that credit appraisal

should therefore be based on the following factors, the same are applied at Axis Bank:

Financial performance

Business performance

Industry outlook

Quality of management

Conduct of account

Axis Bank loan policy contains various norms for sanction of different types of loans.

These all norms do not apply to each & every case. Axis Bank norms for providing

loans are flexible & it may differ from case to case.

Usually, it is seen that credit appraisal is basically done on the basis of fundamental

soundness. But, after different types of case studies, our conclusion was such that

credit appraisal system is not only looking for financial wealth. Other strong

parameters also play an important role in analyzing credit worthiness of the

firm/company.

In all, the viability of the project from every aspect is analyzed, as well as type of

business, industry, promoters, past records, experience, projected data and estimates,

goals, long term plans also plays crucial role in increasing chances of getting project

approved for loan.

112

CHAPTER - 11BIBLIOGRAPHY

Web Sites

www.rbi.org.in

www.Axis Bank.com

www.indianbankassociation.com

www.bankersindia.com

www.wikipedia.com

Books:

“Credit and banking” By: K. C. Nanda

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