1 Credit Management Overview - NIKKIE

8/13/2019 1 Credit Management Overview - NIKKIE

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CREDIT MANAGEMENT-

OVERVIEW AND PRINCIPLES

OF LENDING


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What is Credit Credit isdefined as confidence in

borrowers ability & intentions to repay the loan extended

to him by the creditor. Credit has become an integral partof modern industrialization economies. It has been

considered as oil of the commerce. It contributes to the

industrial growth and economic development.

What is Credit Management Credit Management

usually deals with the credit vetting of the customers,

allocation of available funds to different sectors/segments

of the economy, diversifying the applicable risk in

extending credit, internal funds movements &

reconciliation, as also maintaining relations with the

customers


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Goals of Credit Management in Banks

1. Optimize the mix of Banks assets2. Minimize bad debt loss

3. Analyze customer credit risk

4. Maintain financial flexibility

5. Be responsive to individual customer

6. Respect overall corporate financial constraints

7. Credit Managers must become strategic partners in

business operations

8. Credit Managers should learn how to manage

people of different culture

9. A Credit system is a foundation stone of modern

economy


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Credit Management has two facets :

Credit Appraisal

Credit Monitoring


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Credit Appraisal deals with the evaluation of credit needs of the

borrower, his worthiness, his ability, his risk, policy regarding

extension of credit to the borrowers, terms and conditions of the

credit, sanctioning process of the Bank and involves a decision

whether to extend the credit or not to the customer- pre sanction

stage. Once a decision to extend the credit is taken, the borrower is

asked to complete all the formalities of the terms and conditions,

signing of the documents etc.(Pre disbursal stage). After which the

credit is disbursed to the borrower.


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Credit Monitoring This is a post disbursal period and is very

important for the banker since the health of the unit is determined

during this phase. Banks are required to keep constant watch onthe unit vis--vis the loan account after disbursal of the loan, to

ensure that the amount disbursed to the unit is safe, is being utilised

for the purpose extended (ensuring end use of funds), generates

income and does not turn out to be sick.

There are three types of follow up that constitutes credit monitoring

a) Financial follow up

b) Physical follow up

c) Legal follow up


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Warning Signals

The loan account by itself would indicate explicitly the quality of the

loan. There are bound to be warning signals before an account

goes bad viz.,

(i) Reductions in credits (deposit entries) in the loan account if it is

a working capital account.

(ii) Issuing cheques to the creditors by the borrower in excess ofthe limit/Drawing Power (DP) available in the account, thereby

frequent returning of these cheques.

(iii) Delays and defaults in repaying the interest/ installments.

(iv) Non-submission/Delay in submission of the stock statements

and/or financial data to the Bank.

There is a need to identify these signals emanating from a loan a/c.


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If the Bank does not take prompt follow up action, it could result in

further defaults, thereby leading to a further degeneration in the

quality of the loan and create problem loans.


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Basic Requirement of Lending

Capital (register)

Credit Monitoring

Documentation Legal Remedy

Risk Management

Credit Information


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Documentation

The Banker grants financial facility to its customer under a valid

contract, the terms and conditions of the financial assistance areenumerated. Further, the terms of repayment as well as the

consequences in the event of breach of conditions are enumerated.

As a part of initial exercise, during the post sanction phase, the

bank obtains certain documents from the borrower/competent

authority of the borrowing Company duly signed so as to bind the

borrower legally and enforce charge.

The importance of the documents lies in the fact that with properdocumentation in force, there will not be any problem in enforcing a

claim by the bank in case of a default by the borrower.


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LEGAL REMEDY

In case of persistent default by the customer, where all other

measures taken by the banker including reviving of the unit are not

successful, the recourse open to the bank is

i. Enforce the repayment or enforce the security available through

the Court of Law. A common complaint of the banks and financial

institutions had been that they were facing enormous bottlenecks

in the recovery of loans through the Civil Courts. In view of this

the Government took initiative and established Debt Recovery

Tribunals (DRTs). However, even after establishment of DRTs,

enforcing security is still a time consuming process.


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(ii) To enter into a compromise proposal with the defaulting

borrower.

(iii) On recommendations of Narsimahan Committee for the purpose

of examining Banking Sector reforms, the GOI promulgated

Securitization and Reconstruction of Financial Assets and

Enforcement of Security Interest Ordinance 2002 (SARFAESI)which was later on replaced by an Act . The provisions of this act

will enable Banks and Financial Institutions to exercise power in

taking over the possession of the securities, sell them and reduce

their non-performing assets.


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The Act provided three alternative methods of recovery of non-

performing assets:

Securitization

Asset Reconstruction

Enforcement of Security without the intervention of Court

The provisions of this act are applicable to NPA loans with

outstandings above Rs. 1 lac. NPA loan accounts where the amount

is less than 20% of the principal and interest are not eligible to be

dealt with under this Act.

Non performing assets should be backed by securities charged to

the Bank by way of hypothecation or mortgage or assignment.

Security interest by way of pledge, lien, hire purchase, lease are not

liable for attachment under this act.


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The act empowers the banks

To issue demand notice to the defaulting borrower and guarantor,

calling upon them to discharge their dues in full within 60 days from the

date of notice.

To give notice to any person who has acquired any of the secured

assets from the borrower to surrender the same to the Bank.

To ask any debtor of the borrower to pay any sum due or becoming due

to the borrower.

CAUTION: ANY SECURITY INTEREST CREATEDOVER AGRICULTURAL LAND CAN NOT BE

PROCEEDED WITH.


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If on receipt of demand notice, the borrower makes any

representation or raises any objection, Authorised officer shall

consider such representation or objection carefully and if he comes

to the conclusion that such representation or objection is not

acceptable or tenable, he shall communicate the reasons for non-

acceptance within one week of receipt of such representation orobjection.

A borrower/guarantor aggrieved by the action of the Bank can file an

appeal with DRT and then


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With DRAT, but not with any Civil court. The borrower/guarantor is

required to deposit 50% of the dues before filing the appeal.

If the borrower fails to comply with the notice, the Bank may take

recourse to one or more of these measures:

Take possession of the security

Sale or lease the right over the security

Manage the same or appoint any person to manage the same.


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Illustration:

Excel Bank Ltd. has sanctioned following credit limits to Andheri

Enterprises Ltd.:

Cash- Credit Rs. 20 cr

Bills Discounting Rs. 5 cr

Term Loan Rs. 0 cr

L/C Rs. 5 cr

The stock statement submitted by M/s.Andheri Enterprises as on

30/06/2010 is as follows :

Raw Material : 8 cr

WIP Rs.3 cr FG: Rs. 8 cr

Receivables: Rs.8 cr (including receivables of Rs. 2 cr which are

more than 6 months & excluding those included under Bills

Discounting Limit).


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The present outstanding as on 15/10/2010 in Cash-Credit account

are Rs.22 cr (including overdrawing) and the account has remained

continuously irregular since 14/09/2010

First Term Loan installment of Rs. 2cr and quarterly interestamounting to Rs.0.60 cr has also remained unpaid till date. Further,

Bills discounted limit is fully utilised, however, bills amounting to

Rs.1.60 cr due for retirement till date also remained unpaid.

The margins applicable to RM, WIP, FG, Receivables are 30%,

40%, 30%& 40%. 8 Cheques amounting to Rs.3.40 crs have been recently returned

for want of required DP in the account.

Question:

Calculate the amount of irregularity in the account as on date. What

action should the bank take under the circumstances.


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Risk Management :

Banks Traditional role is to mobilize the funds from thehousehold sector/surplus from the Corporates and

deploy it with the household and Corporate Sectorfor consumption/productive purpose. Its role is thatof intermediary. As such Banks are exposed tovarious risks.

The price at which the Banks mobilize and transferfunds depend on two parametersthe time forwhich the funds are made available and creditworthiness of the person to whom the funds aremade available. Considering long term loans are

priced higher than short term loans and a high riskborrower pays a higher price (interest), banks willhave to factor liquidity risk and/or credit


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credit risk to earn spreads. There is also a definite linkage between

the various risks faced by the banks. For example, if the bank

charges a client floating rate of interest, in case of increasing ratescenario, the banks interest rate risk will be lower. Consequently,

the payment obligations of the borrower increases. Other things

remaining constant, the default risk increases if the client is not able

to bear the burden of the rising rates. There are many instances

where the interest rate eventually leads to credit risk.

Top priority of the banks is to improve their asset quality by

minimizing and managing their credit risk.A robust credit riskmanagement framework with a proper risk management model

coupled with the sound/speedy legal framework improves the quality

of the assets.


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Another technique being employed by the Banks to reduce interest and

liquidity risk is Asset-Liability Management (ALM).ALM has both

macro and micro level implications.

At macro level it leads to the formulation of critical business policies,

efficient allocation of capital and designing of products with

appropriate pricing strategies.

At micro level, the objective is two foldit aims profitability through

price-matching and ensuring liquidity by maturity matching. Price

matching maintains spreads by ensuring deployments of liabilities is

at a rate higher than the cost. Similarly, grouping the

assets/liabilities based on their maturity profile ensures liquidity. The

gap is then assessed to identify the future financing requirements.


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Credit Information: Banks and lending institutions

have a traditional resistance, to share creditinformation because of confidential nature of

banker-customer relationship. To serve this

purpose and to make credit and other data

available specialised institutions known asCredit information bureaus have been set up.

They serve as repository of current & historical

data of the existing and potential customers.


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CREDIT INFORMATION BUREAU OF INDIA

LTD.(CIBIL)

CIBIL was promoted by SBI, HDFC, Dun & Bradstreet Information

services (P) Ltd. to provide credit information of clients to its

members. Presently, its shareholding pattern has been diversified to

include number of banks and finance companies.

CIBIL collects commercial and consumer credit-data and collatessuch data to create and distributes credit reports to its members.

CIBIL primarily gets information from its members and at

subsequent stage will supplement it with public domain information

in order to create a truly comprehensive snapshot of an entitys

financial track record.


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Credit Information Report(CIR)

Credit information reportis a factual record ofborrowers credit payment history. Its purpose is

to help credit grantors make informed lending

decisions-quickly and objectively. CIBIL caters

to both consumer and commercial sectors.Consumer Credit Bureau covers credit availed

by individuals while the Commercial Credit

Bureau covers credit availed by non-individuals

e.g. partnership firms, proprietary concerns,

Private and Public Ltd. companies etc.


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Type Of Information vailable OnBorrower1.Basic information

Name, Address, ID No., Passport ID, Voters ID, Date of birth,

Registration No., Date of incorporation, Legal Constitutions, Board of

Directors etc.1.Record of all the credit facilities availed by the borrower

2.Past Payment history

3.Amount overdue (if any)

4.Suit filed status

5.No. of enquiries made on that borrower by member


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INFORMATION NOT INCLUDED IN CIR

- Income/Revenue details- Details of deposits with the banks

- Details of the borrowers assets

- Value of assets mortgaged

- Details of investments

CIBIL itself does not classify any accounts as

defaults account. It merely reflects theinformation of Asset Classification as permembers record.


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LENDING DECISION: CIBIL CIR only provides available credit information and

does not provide any opinion, indication or comment pertaining whether

credit should or should not be granted.

The Credit grantors who have received an application for credit will make the

credit decision. CIBIL does not own any responsibility merely on the basis of

Credit information provided to the creditor.

RIGHT TO INFORMATION ACT 2005 IS NOT APPLICABLE TO CIBIL

CIBIL is not a public authority.


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CREDIT FACILITIES EXTENDED

BY THE BANKS:

1. RETAIL: Risk Assessment on Scoring Model

Personal Loans: Amount sanctioned: Multiple of Monthly Income/Annual

Income, Repayment 5-7 years, Documentation- Loan Application, Loan

Agreement, Demand Promissory Note (DP Note) Check-off facility (ifavailable), PDCs for EMIs or mandate to debit the account through ECS for

monthly repayments.

Consumer loans: To buy consumer goods, Margin Nil to 25%, Repayment

5-7 years, documents as in personal loan additionaly Hypothecation

agreement


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Vehicle Loans: Cars/ScootersMargin 5% to 25%, Period 5-7

years, Documents as above, Charge to be registered with RTO,

Comprehensive Insurance to include Bank clause

Home Loans: Home Loans against mortgage of property, Equitable

Mortgage is preferred, Credit extended may be 60% to 85% of the

cost of house/cost of construction, Period may range from 10 to 30

years depending upon income and age of the borrower. Title

Documents relating to property are called for verification of

ownership.


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Photocopies of these documents are sent to Banks Legal Advisor to

seek his opinion regarding ownership of the customer and also to

know if the valid equitable mortgage can be created against the

property. Sometimes, if necessary technical report from approved

valuer to know the market value of the property is also called for.

Documentation: Home Loan application, Loan agreement, personal

guarantee agreements from the acceptable guarantors, Personal

guarantee of the spouse/legal heir, Deposit of titles of the property

for equitable mortgage, independent letter to be sent by the

customer to the bank detailing the details of the property and his

independent acceptability to equitable mortgage the property,

Recital to be prepared by the Banker, PDCs or ECS mandate for

EMIs.


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Construction of house : Inspection, progressive payments on the

basis of architects certificate, if title deed is not available, obtain any

other acceptable security for the intervening period.

Education Loan:Admission must be granted by a Recognised

Institution, good academic track record of the student, Family

financial position, scoring model

MARGIN


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MARGIN :

Upto Rs 4 lakhs Nil

Above Rs. 4 lacs : Studies in India 5% Studies Abroad15%-

Scholarship/ assistantship to be included in margin.

Margin may be brought-in on year-to-year basis as and when

disbursements are made on a pro-rata basis.

Loan repayment to start as soon as the student gets

employment or within 6 months of the completion of the

course.


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SECURITY :

Upto Rs 4 lacsCo-obligation of parents.

No securityAbove Rs.4 lacs and upto Rs7.5 lakhsCo-obligation

of parents together with collateral security in the form of suitable

third party guarantee. The bank may, at its discretion, in

exceptional cases, waive third party guarantee if satisfied with

the net-worth / means of parent/s who would be executing the

document as joint borrower.Above Rs.7.5 lakhsCo-obligation of

parents together with tangible collateral security of suitable

value, along with the assignment of future income of the student

for payment of instalments Loan application, Loan agreement to

be signed by the student and parents, personal guarantee

agreements (if applicable)


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LOAN AGAINST SHARES OF THE LISTED

COMPANIES: Sanctioned both as demand loan or

Limit/DP in Current Account. Facility should be extended

only in case of listed companies. Amount sanctioned

should not be more than 50% of the average market

price of the share. Documents: Application form, DP

Note, Transfer deed duly signed by the shareholder. If

EMI-PDCS/ECS, Bullet Payment.


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LOAN AGAINST BANKS OWN FDRS/NSCs etc.

Sanctioned both as demand loan or Limit/DP in Current

Account. Margin25% Lien of Bank is noted (in case of

NSCs/ KVPs with the issuing Post Office) Documents:

FDR/NSCS/KVPs duly discharged by the customer,

Application for loan, DP Note.


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REVERSE MORTGAGE

It is a contract between the Home owner and the financier/bank,

which enables the Home owner to receive a stream of income

(monthly/quarterly), from the future realizable value of home.

It enables senior citizens/Old age (60 years & above) to get

independent income and live honourably

Normally banks will provide the stream of income to couple, till the

last of two live but may put maximum tenure to 15 years

The recovery of loan amount is effected through sale of house afterthe death of last of couple

Even if maximum tenure of income stream is fixed for 15 years,

couple can continue to live in the house till last of two is alive


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Legal heirs after death of couple can also pay the loan amount along

with interest and can acquire the house

In case if sale of house takes place, any surplus amount afterclearing loan balance is passed on to the legal heirs

In case if the sale amount falls short of the loan amount, loss is

borne by the bank

Valuation of the property is got done and equity value on which

annuity is paid to the couple may range from 60% to 90% of the

property valuation

Property valuation is revisited periodically and if couple requires

annuity value can be increased


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Amount of annuity paid to the couple is based on factors like current

valuation, projected appreciation, age of applicant, current interest

rates

Higher the age, valuation, more is amount available

Benefit to the Bank:

Bank will be able to get expected return on the principal invested

No risk of account becoming NPA

Provisioning and capital adequacy norms still not defined by RBI

More profitable to offer mortgage to older people because of less life

expectancy


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Risk factors for Bank

Life expectancy/mortality risk: May have to pay annuity for longer

period, if borrower or spouse live longer. Risk is mitigated by fixing

tenure to 15 years

Interest rate risk: When interest rates move up: Can be mitigated by

entering into floating rate contract

Real Estate market risk: Depreciation in valuation: Real Estate

values seldom depreciate in long run

Benefits to Borrower:

Supplement retirement income

Remain economical independent

With real estate values increasing, better equity left over for heirs


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No upper age prescribed. In fact more the age, more easy to get

loan

It is a non recourse loan. Bank can recover the amount only when

last of couple dies

Disadvantage

Non convential retirement tool

May disturb emotional attachment

Pricing is complex; based on future value, life expectancy, interest

rate risk


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If borrower have two or more spouses, reverse mortgage agreement

will include only one and bank will be entitled to sell property

accordingly

Closure and servicing cost is highupfront cost, servicing cost

(Insurance etc), closure cost (Margins due to life expectancy&

others)Recommendationsgo only for 15 years or fixed annuity

period


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2. COMMERCIAL CREDIT FACILITIES:

Credit Facilities are extended to proprietary firms, partnership firms,

SMES/SSIs, Private Ltd. and Public Limited Companies based on

their CRA. The credit facility extended may be either Funded

Facility or Non Funded Facility.

Funded Facilities

Non Funded Facilities


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EXPORT FINANCE

Pre-shipment Finance:

a) Export Packing Credit (EPC)

denominated in Rupees

b) Packing Credit in Foreign

Currency (PCFC)

denominated in Euro, Dollar, Pound,

Yen

Post Shipment Finance:

a) Foreign Bill discounting Limit

with or without L/C.

IMPORT CREDIT

Letter of Credit (L/c)

for import of machinery/material

etc.


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LETTER OF CREDIT

It is a financial instrument issued

by the bank on application of its

customer (importer/purchaser) in

favour of exporter/seller,

guaranteeing reimbursement of

drafts (Bills of exchange) drawn

by the exporter/seller for the

supplies upto certain amount and

within a specified period as per

terms enumerated in the L/c.

Part ies inv olved:

Applicant-Importer/Purchaser

Negotiating Bank

Confirming Bank

Opening Bank/Issuing Bank

Reimbursing Bank

Advising Bank

Beneficiary


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Types of L/cs

Revocable L/c & Irrevocable L/c,

Confirmed L/c & Unconfirmed L/c

Revolving L/c

Transferable L/c

Back to back L/c Deferred Payment L/c:

Allows Bank to make payment in predetermined

installments

Anticipatory L/c:Red clause letter L/c, Green Letter clause L/c


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Guarantees

Sec.126 of the Contract Act. A contract of guarantee is a contract to

perform the promise or discharge the liability of the third person in

case of his default. The person who gives the guarantee is called

surety; the person on whose behalf /default the guarantee is given is

called principal debtor and the person to whom the guarantee is

given is called creditor/beneficiary. The liability of a guarantor/ surety

comes into existence upon the failure of a debtor. If the surety

extinguishes the liability of a debtor, then the surety will acquire all

the rights of the creditor, known as right of subrogation.


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Types of Guarantees

Financial Guarantees

Bid/Tender Guarantee

Deferred Payment

Guarantee (DPG)

Performance Guarantee

Advance Payment

Guarantee (APG)

Performance Guarantee

(PG)

Retention Money

Guarantee (RMG )


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DPGis a Financial Guarantee and can be said to be a substitute of

Term Loan. Difference between the two is that in case of Term

Loan, the lender bank lays down funds to the extent loan extended

for the purchase of FA. In case of DPG the bank does not lays down

the funds for acquiring FA by the borrower but has to make sure that

the borrower has sufficient cash flows at the time of retirement of

bills drawn by the seller and got discounted by his bank on the

strength of the purchaser/importers bank. It is therefore necessary

that the various aspects of appraisal of the project viz. economics of

the project, its technical feasibility and economic viability etc. are

assessed in detail, as done in case of Term Loan.

1 Credit Management Overview - NIKKIE

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