SUMMER TRAINING REPORT SUBMITTED TOWARDS

THE PARTIAL FULFILLMENT OF POST GRADUATE DIPLOMA IN MANAGEMENT

CREDIT APPRAISAL AND RISK RATING IN PUNJAB NATIONAL BANK

SUBMITTED BY: VISHNU SONI
ROLL NO-PGFA1160 (BATCH OF 2011-13)

INDUSTRY GUIDE Mr. B.B. PURI (CHIEF MANAGER) (CRDIT DEPARTMNT)

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FACULTY GUIDE Dr. RICHA MISRA

DECLARATION

I hereby state that the dissertation entitled CREDIT APPRAISAL AND RISK RATING IN PUNJAB NATIONAL BANK submitted by me in partial fulfillment of the requirements for the award of PGDM (General) is my original work and that it has not previously formed the basis for the award of any other Degree, Diploma, Fellowship or other similar titles.

DATED: 28 JUNE2012

VISHNU SONI (PGFA1160)

ACKNOWLEDGEMENT
Some of us in our growth period are lucky enough to be guided by some truly special people, who are respected and admired. Some amount of aspiration, motivation and creativity is required at every step and we need some people to provide us right guidance to do our work. For any project to be undertaken there has to be certain amount of inputs provided by a lot many people around us. While the number of people who supported me throughout the project are numerous but some deserve special attention. I would like to express my sincere thanks to Prof Richa Misra (Faculty, JIM Noida), my project guide, for his valuable support. He gave me the opportunity to do this project and his timely guidance helped me and making this project what it has come out to be.

VISHNU SONI

CHAPTER PLAN

Page No.

CHAPTER 1: EXECUTIVE SUMMARY... 7 CHAPTER 2: INTRODUCTION TO CREDIT APPRAISAL.. 9 CHAPTER 3: OBJECTIVES.. 12 CHAPTER 4: RESEARCH METHODOLOGY.. 13 CHAPTER 5: INDUSTRY PROFILE. 14 CHAPTER 6: COMPANY PROFILE.. 16 CHAPTER 7: REVIEW OF LITERATURE 19 7.1Working Capital Assessment 7.2Assessment of Term Loans 7.3Basel Accord & Risk Management CHAPTER 8: CREDIT APPRAISAL. 33 8.1Introduction 8.2Market Analysis 8.3Technical Analysis 8.4Financial Analysis 8.5Management & Organizational Analysis 8.6Credit Appraisal Checklist CHAPTER 9: CREDIT RISK MANAGEMENT 46 9.1Credit Risk 9.2 Credit Risk Management System in PNB CHAPTER 10: POST SANCTION FOLLOW UP OF LOANS 53
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CHAPTER 11:11.1 ANALYSIS & INTERPRETATION. 60 11.1.1 PNBs Loan Policy 11.1.2 Objective 11.1.3 Basic Tenets of the Policy 11.1.4 Methods of Lending 11.2 CREDIT APPRAISAL AT PNB.. 62 11.2.1 Flowchart 11.2.2 Brief on the Process 11.2.3 Risk Rating of the Borrower 11.2.4 Determination of the Applicable Rate of Interest 11.2.5 Post Sanction Follow Up CHAPTER 12: CASE STUDY: ABC mills Pvt. Ltd. ....................... 68 12.1 Borrowers Profile 12.2 Credit Appraisal of ABC mills Pvt. Ltd. Management Evaluation Business Evaluation Technical Evaluation Financial Evaluation SWOT analysis 12.3 Security 12.4 Present Proposal 12.5 Credit Risk Rating
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12.6 Recommendations CHAPTER 13: CONCLUSION AND RECOMMENDATIONS....... 85 13.1 Conclusion 13.2 Findings 13.3 Recommendations 13.4 Limitations REFRENCES. 88

CHAPTER 1

EXEXUTIVE SUMMARY

This project was undertaken at the Punjab National Bank Circle Office Meerut, at the Credit Department. Financial requirements for Project Finance and Working Capital purposes are taken care of at the Credit Department. Companies that intend to seek credit facilities approach the bank. Primarily, credit is required for following purposes: a. Working capital finance (FB & NFB) b. Term loan. Project Financing discipline includes understanding the rationale for project financing, how to prepare the financial plan, assess the risks, design the financing mix, and raise the funds. In addition, one must understand some project financing plans have succeeded while others have failed. A knowledge-base is required regarding the design of contractual arrangements to support project financing; issues for the host government legislative provisions, public/private infrastructure partnerships, public/private financing structures; credit requirements of lenders, and how to determine the project's borrowing capacity; how to analyze cash flow projections and use them to measure expected rates of return; tax and accounting considerations; and analytical techniques to validate the project's feasibility Project finance is different from traditional forms of finance because the credit risk associated with the borrower is not as important as in an ordinary loan transaction; what is most important is the identification, analysis, allocation and management of every risk associated with the project. The purpose of this project is to explain, in a brief and general way, the manner in which risks are approached by financiers in a project finance transaction. Such risk minimization lies at the heart of project finance. Efficient management of credit portfolio is of utmost importance as it has tremendous impact on the Banks assets quality & profitability. The ongoing financial reforms have no doubt provided unparalleled opportunities to banks for growth, but have simultaneously exposed them to various risks, which need to be effectively managed. The concept of Credit Management is undergoing radical changes. Credit Risk in all exposures calls for precise measuring and monitoring for taking considered credit decisions with suitable risk mitigates, risk premium, etc. Credit portfolio should be well diversified in various promising sectors with a cautious approach to be adopted in risky segments. Also, lending continues to be a primary function in banking. In the liberalized Indian economy, clientele have a wide choice. External Commercial Borrowings and the domestic capital markets compete with banks. In another dimension, retail lendingboth personal advances and SME advances- competes with corporate lending for funds
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and for human resources. But lending by nature cannot be an aggressive selling activity, disregarding the risks involved. Bank has to be competitive without compromising on the basic integrity of lending. The quality of the Banks credit portfolio has a direct and deep impact on the Banks profitability. The study has been conducted with the purpose of getting in-depth knowledge about the credit appraisal and credit risk management procedure in the organization for the above said first two purposes .

CHAPTER 2

CREDIT APPRAISAL AN INTRODUCTION

Project / Credit appraisal is a skill which has to be acquired by study and supplemented by practice. Intuitive guess work has little place in appraising the credit rating or credit needs of corporate unit. The credit managers of banks and Non-Banking Finance Companies (NBFCs) are duty bound to accept or reject a proposal on the basis of its viability or non - viability. Project / Credit appraisal is done by banks or financial institutions by obtaining credit information of the borrowing company .

Credit information of the borrowing company can be obtained by the following sources:
1. Banks and Financial Institution 2. Bank References 3. Trade References 4. Credit Rating Agencies 5. Published Books: Basic information about a company may be taken from printed sources like the Stock Exchange Year book, Corporate Path finders data base, etc. 6. Company Financial Reports 7. Press Reports 8. Stock Market Opinion 9. Charges Registered: Charges created on the assets of a company have to be registered with the Registrar of Companies. 10. Personal discussion 11. Factory Visit

12. Study of Financial Statements: Financial analysis determines the significant

operating and financial characteristics of a firm form accounting data and financial statements. Analysis can be done through: a. Ratio Analysis b. Trend analysis: Trend analysis can be through: Intra firm comparison that is review of the trend of the ratios over the years within the firm and Inter firm comparison.

c. Reading of notes to accounts and other information: Careful reading and analysis of the notes on accounts, one can gauge the policies of the management, performance of the company, and its future planning. 13. Cash flow statement

Information required to (Borrower) to the Bank

be

submitted

by

the

Company

The company should make sure that the following information required for processing credit requests are collected by the company for submitting it to the bank or financial institution in order to obtain the required credit facility: Basic background information on the company Required facility Key industry dynamics Management

Management information system: Details of the planning, controlling monitoring systems which have been put in place have to give. Financials( B/S, P/S)

and

Details of the Security to be pledged.

Detail of loan from other banks/ FIs, along with details of conduct of their account with them.
Confidential report of unit, borrower and guarantors. 10

 Assets and Liability statements of promoters/ guarantors along with latest

income tax return, sales tax return & wealth tax return.

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CHAPTER 3: OBJECTIVES
To study broad contours of management of credit, the loan policy, credit appraisal for business units i.e. for working capital loan or Term Loan To understand the basis of credit risk rating and its significance To utilize the above learning and appraise the creditworthiness organizations those approach PUNJAB NATIONAL BANK for credit. This would entail undertaking of the following procedures: Management Evaluation Business / Industry Evaluation Technical Evaluation Legal Evaluation Financial Evaluation Credit Risk Rating

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CHAPTER 4: RESEARCH METODOLOGY

The methodology being used involves two basic sources of information primary sources and secondary source.

Primary sources of Information

Meetings and discussion with the Chief Manager and the Senior Manager of both Credit and Credit Risk Management Department.

Secondary sources of Information

Loan Policy and Internal Circulars of the bank. Research papers, power point presentations and PDF files prepared by the bank and its related officials. Referring to information provided by CIBIL, Income Tax files, Registrar of Companies (Ministry of Corporate Affairs), and Auditor reports.

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CHAPTER 5:

INDUSTRY PROFILE

THE INDIAN BANKING INDUSTRY

The last decade has seen many positive developments in the Indian banking sector. The growth in the Indian Banking Industry has been more qualitative than quantitative and it is expected to remain the same in the coming years. Based on the projections made in the "India Vision 2020" prepared by the Planning Commission, the report forecasts that the pace of expansion in the balance-sheets of banks is likely to decelerate. The total asset of all scheduled commercial banks by end-March 2010 is estimated at Rs 40, 90,000 crores. That will comprise about 65 per cent of GDP at current market prices as compared to 67 per cent in 2002-03. Bank assets are expected to grow at an annual composite rate of 13.4 per cent during the rest of the decade as against the growth rate of 16.7 per cent that existed between 1994-95 and 2002-03. It is expected that there will be large additions to the capital base and reserves on the liability side. The Indian Banking Industry can be categorized into non-scheduled banks and scheduled banks. Scheduled banks constitute of commercial banks and co-operative banks. There are about 67,000 branches of Scheduled banks spread across India. As far as the present scenario is concerned the Banking Industry in India is going through a transitional phase. The Public Sector Banks (PSBs), which are the base of the Banking sector in India account for more than 78 per cent of the total banking industry assets. Unfortunately they are burdened with excessive Non Performing assets (NPAs), massive manpower and lack of modern technology. On the other hand the Private Sector Banks are making tremendous progress. They are leaders in Internet banking, mobile banking, phone banking, ATMs. As far as foreign banks are concerned they are likely to succeed in the Indian Banking Industry. Currently, banking in India is generally fairly mature in terms of supply, product range and reach-even though reaching rural India still remains a challenge for the private sector and foreign banks. In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its: Fundamentally upgrading organizational capability to stay in tune with the changing market. Adopting value-creating M&A as an avenue for growth.
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Continually innovating to develop new business models to access untapped opportunities.

Opportunities and Challenges for the Players The bar for what it means to be a successful player in the sector has been raised. Four challenges must be addressed before success can be achieved. The market is seeing discontinuous growth driven by new products and services that include opportunities in credit cards, consumer finance and wealth management on the retail side, and in fee-based income and investment banking on the wholesale banking side. These require new skills in sales & marketing, credit and operations. Banks will no longer enjoy windfall treasury gains that the decade-long secular decline in interest rates provided. With increased interest in India, competition from foreign banks will only intensify. Given the demographic shifts resulting from changes in age profile and household income, consumers will increasingly demand enhanced institutional capabilities and service levels from banks.

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CHAPTER6: COMPANY PROFILE

Punjab National Bank (PNB) was set up in 1895 in Lahore - and has the distinction of being the first Indian bank to have been started solely with Indian capital. The bank was nationalized in July1969 along with 13 other banks. Today, PNB is a professionally managed bank with a successful track record of over 110 years. The bank has the 2nd largest branch network in India, with 4525 branches including 432 extension counters spread throughout the country. Punjab National Bank is not only the first bank to specialize in credit rating models in India but also the first one to launch image based cheque transaction system for collection of intra bank intercity cheques thereby providing credits merely in 48 hrs. in 13 cities.

CORPORATE VISION
To be a Leading Global Bank with Pan India footprints and become household brand in the Indo-Genetic Plains providing entire range of financial products and services under one roof.

MISSION
Banking for the unbanked with over 56 million satisfied customers and 5002 offices, PNB has continued to retain its leadership position amongst the nationalized banks. From its modest beginning; the bank has grown in size and stature to become a frontline banking institution in India at present. Based on its sound and prudent banking experience and consistent profit performance, PNB looks confidently to the future the name you can bank upon PNB has achieved significant growth in business which at the end of March 2010 amounted to Rs4, 35,931 crore. Today, with assets of more than Rs 2,96,633 crore, PNB is ranked as the 3rdlargest bank in the country (after SBI and ICICI Bank) and has the 2nd largest network of branches (5002 offices including 5 overseas branches ). During the FY 2009-10, with 40.85%share of CASA deposits, the bank achieved a net profit of Rs 3905 crores. Bank has a strong capital base with capital adequacy ratio of 14.16% as on Mar10 as per Basel II with Tier I and Tier II capital ratio at 9.15% and 5.01% respectively. As on March10, the Bank has the Gross and Net NPA ratio of 1.71% and 0.53% respectively. During the FY 2009-10, its ratio of Priority Sector Credit to Adjusted Net Bank Credit at 40.5% & Agriculture Credit to Adjusted Net Bank Credit at 19.7% was also higher than the stipulated requirement of 40% & 18%.

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The performance highlights of the bank in terms of business and profit are shown below: PARAMETER OPERATING PROFIT NET PROFIT DEPOSIT ADVANCE TOTAL BUSINESS MARCH09 MARCH10 MARCH11 CAGR% 5744 3091 209760 154703 364463 7326 3905 249330 186601 435931 9056 4433 312899 242106 555005 26.16 19.76 22.14 25.10 23.40

Bank always looked at technology as a key facilitator to provide better customer service and ensured that its IT strategy follows the Business strategy so as to arrive at Best Fit. The Bank has made rapid strides in this direction. All branches of the Bank are under Core Banking Solution (CBS) since Dec08, thus covering 100% of its business and providing Anytime Anywhere banking facility to all customers including customers of more than 3200 rural & semi urban branches. The Bank has also been offering Internet banking services to its customers which also enables on line booking of rail tickets, payment of utilities bills, purchase of airline tickets, etc. Towards developing a cost effective alternative channels of delivery, the Bank with 5050 ATMs has the largest ATM network amongst Nationalized Banks With the help of advanced technology, the Bank has been a frontrunner in the industry so far as the initiatives for Financial Inclusion is concerned. With its policy of inclusive growth, the Banks mission is Banking for Unbanked. The Bank has launched a drive for biometric smart card based technology enabled Financial Inclusion with the help of Business Correspondents/Business Facilitators (BC/BF) so as to reach out to the last mile customer. The Bank has started several innovative initiatives for marginal groups like rickshaw pullers, vegetable vendors, dairy farmers, construction workers, etc. Bank has launched a welfare scheme of adoption of village viz., PNB VIKAS. Under the scheme, Bank has selected 117 villages (60 in lead districts and 57 in non-lead district) in different circles for all-round improvement in the living standards of the villagers. Besides, Bank has formed PNB PRERNA, an association of the wives of the Banks senior management. The association through its voluntary initiatives has undertaken
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activities like distribution of food to the poor and needy, provision of computers, books, stationary items to poor girl students at various orphanages and schools etc. Backed by strong domestic performance, the Bank is planning to realize its global aspirations. Bank has opened one branch each at Kabul and Dubai, two branches at Hong Kong and an Off Shore Banking Unit at Mumbai. In addition to the above, Bank has Representative offices at Almaty, Dubai, Shanghai and Oslo, a wholly owned subsidiary in UK with 7 branches and a subsidiary each in Kazakhstan & Bhutan, and joint venture with Everest Bank Ltd. Nepal. During the year, Bank acquired majority equity stake of 63.64% in Dana Bank of Kazakhstan

ORGANISATIONAL STRUCTURE

HEAD OFFICE

CIRCLE OFFICE

BRANCH OFFICE

CHAPTER 7:

REVIEW OF LITERATURE
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7.1 WORKING CAPITAL AND ITS ASSESSMENT

The objective of running any industry is earning profits. An industry will require funds to acquire fixed assets like land and building, plant and machinery, equipments, vehicles etc and also to run the business i.e. its day to day operations. Working capital is defined, as the funds required for carrying the required levels of current assets to enable the unit to carry on its operations at the expected levels uninterruptedly. Thus working capital required (WCR) is dependent on

The volume of activity (viz. level of operations i.e. Production and Sales) The activity carried on viz. manufacturing process, product, production programmer, and the materials and marketing mix.

The purpose of assessing the WC requirement of the industry is to determine how the total requirements of funds will be met. The two sources for meeting these requirements are the units long-term sources (like capital and long term borrowings) and the shortterm borrowings from banks. The long-term resources available to the unit are called the liquid surplus or Net Working Capital (NWC). It can be explained by visualizing the process of setting up of industry. The units starts with ascertain amount of capital, which will not normally be sufficient, even to meet the cost of fixed assets. The unit, therefore, arranges for a long-term loan from a financial institution or a bank towards a part of the cost of fixed assets. From these two sources after meeting the cost of fixed assets some funds remain to be used for working capital. This amount is the Net Working Capital or Liquid Surplus and will be one of the sources of meeting the working capital requirements. The remaining funds for working capital have to be raised from banks; banks normally provide working capital finance by way of advantage against stocks and sundry debtors. Banks, however, do not finance the full amount of funds required for carrying inventories and receivables: and normally insist on the stake of the enterprise at every stage, by way of margins. Bank finance is normally restricted to the amount of funds locked up less a certain percentage of margins. Margins are imposed with a view to have adequate stake of the promoter in the business both to ensure his adequate interest in the business and to act as a protection against any shocks that the business may sustain. The margins stipulated will depend on various factors like salability, quality, durability, price fluctuations in the market for the commodity etc. taking into account the total working capital requirements as assessed earlier, the permissible limit, up to which the bank finance cab be granted is arrived. While granting working capital advances to a unit, it will be necessary to ensure that a reasonable proportion of the working capital is met from the long-term sources viz. liquid surplus. Normally, liquid surplus or net working capital be at least 25% of the working capital requirement (corresponding to
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the benchmark current ratio of 1.33), though this may vary depending on the nature of industry/ trade and business conditions.

Various methods for assessment of Working Capital are discussed in detail: 1. Operating cycle method
Any manufacturing activity is characterized by a cycle of operations consisting of purchase of raw materials for cash, converting them into finished goods and realizing cash by sale of these finished goods. The time that lapses between cash outlay and cash realization by sale of finished goods and realization of sundry debtors is known as length of operating cycle. That is, the operating cycle consists of: Time taken to acquire raw materials and average period for which they are in store Conversion process time Average period for which finished goods are in store and Average collection period of receivables (sundry debtors).

Operating Cycle is also called cash-to-cash and indicates how cash is converted into raw materials, stocks in process, finished goods, bills (receivables) and finally backs to cash. Working capital is the total cash that is circulating in this cycle. Therefore, working capital can be turned over or deployed after completing the cycle. Factors, which influence working capital requirement, are Level of operating expenses and Length of operating cycle. Any reduction in either of the both will mean reduction in working capital requirement or indicate an efficient working capital management. It can thus be concluded that by improving the working capital turnover ratio (i.e. by reducing the length of operating cycle) a better management (utilization) of working capital results. It is obvious that any reduction in the length of the operating cycle can be achieved only by better management only by better management of one or more of the individual phases of the operating cycle period for which raw materials are in store, conversion process time, period for which finished goods are in store and collection period of receivables. Looking at whole problem from another angle, we find that we can set up extremely clear guidelines for working capital management viz. examining the length of each of the phases of the operating cycle to assess the scope for reduction in one or more of these phases. The length of the operating cycle is different from industry to industry and from one firm to another within the same industry. For instance, the operating cycle of a
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pharmaceutical unit would be quite different from one engaged in the manufacture of machine tools. The operating cycle concept enables to assess working capital need of each enterprise keeping in view the peculiarities of the industry it is engaged in and its scale of operations. Operating cycle is an important management tool in decision making.

2 Traditional method of assessment of working capital requirement

The operating cycle concept serves to identify the areas requiring improvement for the purpose of control and performance review. But, as bankers, we require a more detailed analysis to assess the various components of working capital requirement viz., finance for stocks, bills etc. Bankers provide working capital finance for holding an acceptable level of current assets viz. raw materials, stock-in-process, finished goods and sundry debtors for achieving a predetermined level of production and sales. Quantification of these funds required to be blocked in each of these items of current assets at any time will, therefore provide a measure of the working capital requirement of an industry.

Raw material
Any industrial unit has to necessarily stock a minimum quantum of materials used in its production to ensure uninterrupted production. Factors, which affect or influence the funds requirement for holding raw material, are:

Average consumption of raw materials Time taken to procure raw materials (procurement time or lead time) Imported or indigenous. Minimum quantity supplied by the market [Minimum Order Quantity (MOQ)]. Cost of holding stocks (e.g. insurance, storage, interest) Criticality of the item. Transport and other charges [Economic Order Quantity (EOQ)]. Availability on credit or against advance payment in cash. Seasonality of the material.

Stock in process
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Barring a few exceptional types of industries, when the raw material get converted into finished products within few hours, there is normally a time lag or delay or period of processing only after which the raw materials get converted into finished product. During this period of processing, the raw materials get converted into finished goods and expenses are being incurred. The period of processing may vary from a few hours to a number of months and unit will be blocked working funds in the stock In-process during this period. Such funds blocked in SIP depend on

The processing time. Number of products handled at a time in the process. Average quantities of each product, processed at each time (batch quantity). The process technology. Number of shifts.

Finished goods
All products manufactured by an industry are not sold immediately. It will be necessary to stock certain amount of goods pending sale. This stock depends on:

Whether the manufacture is against firm order or against anticipated order. Supply terms. Minimum quantity that can be dispatched. Transport availability and transport cost. Seasonality of goods. Variation in demand. Peak level/ low level of operations. Marketing arrangement- e.g. direct sale to consumers or through dealers/wholes alers.The requirement of funds against finished goods is expressed so many months cost of production.

Sundry debtors (receivables)

Sales may be affected under three different methods:
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Against advance payment Against cash On credit

A unit grants trade credit because it expects this investment to be profitable. It would be in the form of sales expansion and fresh customers or it could be in the form of retention of existing customers. The extent of credit given by the industry normally depends upon:

Trade practices Market conditions Whether it is bulky by the buyer Seasonality Price advantage

Even in cases where no credit is extended to buyers, the transit time for the goods to reach the buyer may take some time and till the cash is received back, the unit will have to be cut out of funds. The period from the time of sale to receipt of funds will have to be reckoned for the purpose of quantifying the funds blocked in sundry debtors. Even though the amount of sundry debtors according to the units books will be on the basis of Sale Price, the actual amount blocked will be only the cost of production of the materials against which credit has been extended- the difference being the units profit margin- (which the unit does not obviously have to spend). The working capital requirement against Sundry Debtors will therefore be computed on the basis of cost of production (whereas the permissible bank finance will be computed on basis of sale value since profit margin varies from product to product and buyer to buyer and cannot be uniformly segregated from the sale value).The working capital requirement is expressed as so many months cost of production.

Expenses
It is customary in assessing the working capital requirement of industries, to provide for 1 months expenses also. A question might be raised as to why expenses should be taken separately, whereas at every stage the funds required to be blocked had been taken into account. This amount is provided merely as a cushion, to take care of temporary
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bottlenecks and to enable the unit to meet expenses when they fall due. Normally 1month total expenses, direct and indirect, salaries etc. are taken into account.

While computing the working capital requirements of a unit, it will be necessary to take into account 2 other factors,

Is the credit received on purchases- trade credit is a normal practice in trading circles. The period of such credit received varies from place to place, material to material and person to person. The amount of credit received on purchases reduces the working capital funds required by the unit. Industries often receive advance against orders placed for their products. The buyers, in certain cases, have to necessarily give advance to producers e.g. custom made machinery. Such funds are used for the working capital of an industry. It can be thus summarized as follows:

Raw material Stock in progress Finished goods

Months requirement Months( cost production)

Rs. A of Rs. B

Months cost of Rs. C production required to be stocked Months cost of Rs. D Production (o/s credits) One month(normally) Rs. E A+B+C+D+E on Rs. F Rs. G

Sundry debtor Expenses Total current assets Credit received purchase

Advance payment on order received

WORKING CAPITAL REQUIRED (H) =

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(A+B+C+D+E)- (F+G)

Projected Annual Turnover Method for SME units (Nayak Committee)

For SME units, which enjoy fund based working capital limits up to Rs.5 crores, the minimum working capital limit should be fixed on the basis of projected annual turnover. 25% of the output or annual turnover value should be computed as the quantum of working capital required by such unit. The unit should be required to bring in 5% of their annual turnover as margin money and the Bank shall provide 20% of the turnover as working capital finance. Nayak committee guidelines correspond to working capital limits as per the operating cycle method where the average production/ processing cycle is taken to be 3 months.

Example: Anticipated annual output (A) Working capital requirement: 25% of A (B) Margin: 5% of A (C) Maximum permissible bank finance B-C (D)

(IN LACS) 120 30 6 24

Important clarifications:

The assessment of WC limits should be done both as per Projected Turnover Method and Traditional Method; the higher of the two is to be sanctioned as credit limit. If the operating cycle is more than 3 months, there is no restriction on extending finance at more than 20% of the turnover provided that the borrower should bring and proportionally higher stake in relation to his requirements of bank finance. While the approach of extending need based credit will be kept in mind, the financial strengths of the unit is also important, the later aspect assumes greater significance so as to take care of quality of banks assets. The margin requirement, as a general rule, should not be diluted.
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3 MPBF Method (Tandon Recommendations)

and

Chore

Committee

The Tandon Committee was appointed to suggest a method for assessing the working capital requirements and the quantum of bank finance. Since at that time, there was scarcity of banks resources, the Committee was also asked to suggest norms for carrying current assets in different industries so that bank finance was not drawn more than the minimum required level. The Committee was also asked to devise an information system that would provide, periodically, operational data, business forecasts, production plan and resultant credit needs of units. Chore Committee, which was appointed later, further refined the approach to working capital assessment. The MPBF method is the fall out of the recommendations made by Tandon and Chore Committee. Regarding approach to lending: the committee suggested three methods for assessment of working capital requirements.

First Method of lending

According to this method, Banks would finance up to a max. of 75% of the working capital gap (WCG= the total current assets - current liabilities other than bank borrowing) and the balance 25 % of the WCG considered as margin is to come out of long term source i.e. owned funds and term borrowings. This will give rise to a minimum current ratio of 1.17:1. The difference of (1.17-1) represents the borrowers margin which is popularly known as Net Working Capital (NWC) of the unit

Second Method of lending

As per the 2nd method Bank will finance maximum up to 75%of total current assets (TCA) & Borrowers has to provide a minimum of 25% of total current assets as the margin out of long term sources. This will give a minimum current ratio of 1.33:1

Third Method of lending

Same as 2nd method, but excluding core current assets from total assets and the core current assets is financed out of long term funds. The term core current assets refers to the absolute minimum level of investment in current assets, which is required at all times to carry out minimum level of business activity. The current ratio is further improved i.e.1.79: 1

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4 Projected Balance Sheet Method (PBS)

The PBS method of assessment will be applicable to all borrowers who are engaged in manufacturing, services and trading activities that require fund based working capital finance of Rs. 25 laces and above. In case of SSI borrowers, who require working capital credit limit up to Rs.5cr. the limit shall be computed on the basis of Nayak Committee formula as well as that based on production and operating cycle of the unit and the higher of the two may be sanctioned. The assessment will be based on the borrowers projected balance sheet, the funds flow planned for current/ next year and examination of the profitability, financial parameters etc. unlike the MPBF method, it will not be necessary in this method to fix or compute the working capital finance on the basis of a stipulated minimum level of liquidity (Current Ratio). The working capital requirement worked out is based on the following:

CMA assessment method is continued with certain modifications. Analysis of the Profit and Loss account, Balance Sheet, Funds flow etc. for the past periods is done to examine the profitability, financial position, and financial management etc. of the business. Scrutiny and validation of the projected income and expenses in the business and projected changes in the financial position (sources and uses of funds). This is carried out to examine whether these parameters are acceptable from the angle of liquidity, overall gearing, efficiency of operations etc.

In the PBS method, the borrowers total business operations, financial position, management capabilities etc. are analyzed in detail to assess the working capital finance required and to evaluate the overall risk. The assessment procedure is as follows:

Collection of financial information from the borrower. Classification of current assets / current liabilities. Verification of projected levels of inventory/ receivables/ sundry creditors. Evaluation of liquidity in the business operation. Validation of bank finance sought.

7.2 ASSESSMENT OF TERM LOANS

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Term Loans are generally granted to finance capital expenditure, i.e. for acquisition of land, building and plant and machinery, required for setting up a new industrial undertaking or expansion/diversification of an existing one and also for acquisition of movable fixed assets. Term Loans are also given for modernization, renovation, etc. to improve the product quality or increase the productivity and profitability. The basic difference between short-term facilities and term loans is that shortterm facilities are granted to meet the gap in the working capital and are intended to be liquidated by realization of assets, whereas term loans are given for acquisition of fixed assets and have to be liquidated from the surplus cash generated out of earnings. They are not intended to be paid out of the sale of the fixed assets given as security for the loan. This makes it necessary to adopt a different approaching examining the application of the borrowers for term credits. For the assessment to Term Loan Techno Economic Feasibility Study is done. The success of feasibility study is based on the careful identification and assessment of all of the important issues for business success. A detailed Project Report is submitted by an entrepreneur, prepared by approved agency or a consultancy organization. Such report provides in-depth details of the project requesting finance. It includes the technical aspects, Managerial Aspect, the Market Condition and Projected performance of the company. It is necessary for the appraising officer to cross check the information provided in the report for determining the worthiness of the project. The feasibility study is a part of Credit Appraisal process and the same is discussed in the following chapter.

7.3 BASEL ACCORD & RISK MANAGEMENT The Basel accord/accords refer to the banking supervision accords namely Basel I and Basel II issued by the Basel Committee on Banking Supervision (BCBS). BASEL I ACCORD
The 1988 Basel Accord primarily addressed banking in the sense of deposit taking and lending. The main focus was Credit Risk. It described the strength of the Bank as measured by the Capital employed. Accordingly it put a minimum level of capital adequacy (Capital to Credit Risk Weighted Assets ratio) at 8%. Basel I allocated 4 risk weights i.e. 0%, 20, 50% and 100% to different exposure types, based on the risk perceived on the exposure types under the
28

credit portfolio. Basel I provided a set norm for capital allocation which helped many banks to allocate capital to counter the risks faced by them.

CRAR= Capital / Risk Weighted Assets (Credit Risk+ Market Risk +Operational Risk) CAPITAL Tier I capital Paid Up Equity Capital + Statutory Reserves + Other disclosed free reserves + Capital Reserves representing surplus arising out of sale proceeds of Assets + Innovative Perpetual Debt instruments Revaluation Reserves (at a discount of 55%)
29

Tier II capital

+ General Provisions and Loss Reserves + Subordinated Debt + Hybrid Debt Capital Instruments

30

Risk Weighted Assets

Basel I introduced the concept of Risk Weighted Assets (RWA). All the assets of a bank (advances, investments, fixed assets etc.) carry certain amount of risk. In proportion to the quantum of this risk, bank must maintain capital. Quantification of risk is done in percentage (0%, 20%, 50% etc.). Exposure when multiplied with these percentages gives risk based value of assets. These assets are also called Risk Weighted Assets (RWA).

BASEL II ACCORD
Banking has changed dramatically since the Basel I document of 1988. Advances in risk management and the increasing complexity of financial activities / instruments prompted international supervisors to review the appropriateness of regulatory capital standards under Basel I. To meet this requirement, the Basel I accord was amended and refined which came out as the Basel II document. The Basel II document is structured into three parts. Each part is called as a pillar. Thus these three parts constitute three pillars of Basel II.

PILLAR I

This pillar is compatible with the credit risk, market risk and operational risk. The regulatory capital will be focused on these three risks. This pillar gives the bank responsibility to exercise the best ways to manage the risk specific to that bank. It also casts responsibility on the supervisors to review and validate banks risk measurement models. This pillar is on market discipline is used to leverage the influence that other market players can bring.

PILLAR II

PILLAR III

DIFFERENCE BETWEEN
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BASEL I 1 Limited role of collateral as 1 risk mitigate. Not recognizing operational 2 risk. Risk weights assignment on 3 transaction basis. Not recognizing tenure or 4 remaining time to maturity of exposures in risk assessment Provisions are through Asset 5 Classification.

BASEL II Recognizes wide range of Collateral &Guarantees as risk mitigate. Recognizes Operational Risk and prescribes explicit capital charge for. Risk weight assignment on risk rating basis Recognizes the tenure or remaining time to maturity of exposures in risk assessment Provisions are through Expected Loss Estimation

3 4

CHAPTER 8:

CREDIT APPRAISAL
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8.1 INTRODUCTION
Effectiveness of Credit Management in the bank is highlighted by the quality of its loan portfolio. Every Bank is striving hard to ensure that its credit portfolio is healthy and that Non Performing Assets are kept at lowest possible level, as both of these factors have direct impact on its profitability. In the present scenario efficient project appraisal has assumed a great importance as it can check and prevent induction of weak accounts to our loan portfolio. All possible steps need to be taken to strengthen pre sanction appraisal as always Prevention is better than Cure. With the opening up of the economy rapid changes are taking place in the technology and financial sector exposing banks to greater risks, which can be broadly classified as under:

Industry Risks:
Government regulations and policies, availability of infrastructure facilities, Industry Rating, Industry Scenario & Outlook, Technology Up gradation, availability of inputs, product obsolescence, etc.

Business Risks:
Operating efficiency, competition faced from the units engaged in similar products, demand and supply position, cost of labor, cost of raw material and other inputs, pricing of product, surplus available, marketing, etc.

Management Risks:
Background, integrity and market standing/ reputation of promoters, organizational set up and management hierarchy, expertise/competence of persons holding key position in the organization, delegation and decentralization of authority, achievement of targets, track record in execution of project, debt repayment, industry relations etc.

Financial Risks:
Financial strength/standing of the promoters, reliability and reasonableness of projections, past financial performance, reliability of operational data and financial ratios, adequacy of provisioning for bad debts, qualifying remarks of auditors/inspectors etc. In light of the foregoing risks, the banks appraisal methodology should keep pace with ever changing economic environment. The appraisal system aims to determine the
33

credit needs/requirements of the borrower taking into account the financial resources of the client. The end objective of the appraisal system is to ensure that there is no under financing or over -financing. Following are the aspects, which need to be scrutinized and analyzed while appraising:

8.2 MARKET (DEMAND & POTENTIAL)

The market demand and potential is to be examined for each product item and its variants/substitutes by taking into account the selling price of the products to be marketed vis-a-vis prices of the competing products/substitutes, discount structure, arrangement made for after sale service, competitors' status and their level of operation with regard to production and products and distribution channels being used etc. Critical analysis is required regarding size of the market for the product(s) both local and export, based on the present and expected future demand in relation to supply position of similar products and availability of the other substitutes as also consumer preferences, practices, attitudes, requirements etc. Further, the buy-back arrangements under the foreign collaboration, if any, and influence of Government policies also needs to be considered for projecting the demand. Competition from imported goods, Government Import Policy and Import duty structure also need to be evaluated.

8.3 TECHNICAL ASPECTS

In a dynamic market, the product, its variants and the product-mix proposed to be manufactured in terms of its quality, quantity, value, application and current taste/trend requires thorough investigation.

Location and Site

Based on the assessment of factors of production, markets, Govt. policies and other factors, Location (which means the broad area) and Site (which signifies specific plot of land) selected for the Unit with its advantages and disadvantages, if any, should be such that overall cost is minimized. It is to be seen that site selected has adequate availability of infrastructure facilities viz. Power, Water, Transport, Communication, state of information technology etc. and is in agreement with the Govt. policies. The adequacy of size of land and building for carrying out its present/proposed activity with enough scope for accommodating future expansion needs to be judged.

Raw Material
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The cost of essential/major raw materials and consumables required their past and future price trends, quality/properties, their availability on a regular basis, transportation charges, Govt. policies regarding regulation of supplies and prices require to be examined in detail. Further, cost of indigenous and imported raw material, firm arrangements for procurement of the same etc. need to be assessed.

Plant & Machinery, Plant Capacity and Manufacturing Process

The selection of Plant and Machinery proposed to be acquired whether indigenous or imported has to be in agreement with required plant capacity, principal inputs, investment outlay and production cost as also with the machinery and equipment already installed in an existing unit, while for the new unit it is to be examined whether these are of proven technology as to its performance. The technology used should be latest and cost effective enabling the unit to compete in the market. Purchase of reconditioned/old machinery is to be dealt in terms of laid down guidelines. Compatibility of plant and machinery, particularly, in respect of imported technology with quality of raw material is to be kept in view. Also plant and machinery and other equipments needed for various utility services, their supply position, specification, price and performance as also suppliers' credentials, and in case of collaboration, collaborators' present and future support requires critical analysis. Plant capacity and the concept of economic size has a major bearing on the present and future plans of the entrepreneur(s) and should be related to the availability of raw material, product demand, product price and technology. The selected process of manufacturing indicating the adequacy, availability and suitability of technology to be used along with plant capacity, manufacturing process needs to studied in detail with capacities at various stages of production being such that it facilitates optimum utilization and ensures future expansion/ debottlenecking, as and when required. It is also to be ensured that arrangements are made for inspection at intermediate/final stages of production for ensuring quality of goods on successful commencement of production and completion, wherever required.

8.4 FINANCIAL ASPECTS

The aspects which need to be analyzed under this head should include cost of project, means of financing, cost of production, break-even analysis, and financial statements as also profitability/funds flow projections, financial ratios, sensitivity analysis which are discussed as under.

Cost of Project & Means of Financing

(I) The major cost components of any project are land and building including transfer, registration and development charges as also plant and machinery, equipment for
35

auxiliary services, including transportation, insurance, duty, clearing, loading and unloading charges etc. It also involves consultancy and know-how expenses which are payable to foreign collaborators or consultants who are imparting the technical knowhow. Recurring annual royalty payment is not reflected under this head but is accounted for under the profitability statements. Further, preliminary expenses, such as, cost of incorporation of the Company, its registration, preparation of feasibility report, market surveys, pre-operative expenses like salary, travelling, startup expenses, mortgage expenses incurred before commencement of commercial production also form part of cost of project. Also included in it are capital issue expenses which can be in the form of brokerage, commission, advertisement, printing, stationery etc. Finally, provisions for contingencies to meet any unforeseen expenses, such as, price escalation or any other expense which have been inadvertently omitted like margin for working capital requirements required to complete the production cycle, interest during construction period, etc. are also part of capital cost of project. It is to be ensured while appraising the project that cost and various estimates given are realistic and there is no under/over estimation. Further, these cost components should be supported by proper quotations, specifications and justifications of land, machinery and know-how expenses etc. (II) Besides Banks loan, the project cost is normally financed by bringing capital by the promoters and shareholders in the form of equity, debentures, unsecured long term loans and deposits raised from friends and relatives which are not repayable till repayment of Banks loan. Resources are raised for financing project by raising term loans from Institutions/Banks which are repayable over a period of time, deferred term credits secured from suppliers of machinery which are repayable in installments over a period of time. The above is an illustrative list, as the promoters have now started raising funds through Euro-issues, Foreign Currency loans, premium on capital issues, etc. which are sometimes comparatively cheap means of finance. Subsidies and development loans provided by the Central/State Government in notified backward districts to attract entrepreneurs are also means of financing project. It is to be ascertained that requirement of finance has been properly tied-up for unhindered implementation of a project. The financing structure accepted must be inconsonance with generally accepted levels along with adequate Promoters' stake. The resourcefulness, willingness and capacity of promoter to contribute the same have also to be investigated. In case of project finance, the promoter/borrower may bring in upfront his contribution (other than funds to be provided through internal generation) and the branches should commence its disbursement after the stipulated funds are brought in by the promoter/borrower. A condition to this effect should be stipulated by the sanctioning authority in case of project finance, on case to case basis depending upon the resourcefulness and capacity of the promoter to contribute the same. It should be
36

ensured that at any point of time, the promoters contribution should not be less than the proportionate share.

Profitability Statement
The profitability statement which is also known as `Income and Expenditure Statement' is prepared after considering the net sales figure and details of direct costs/expenses relating to raw material, wages, power, fuel, consumable stores/spares and other manufacturing expenses to arrive at a figure of gross profit. Thereafter, all other expenses like salaries, office expenses, packing, selling/distribution, interest, depreciation and any other overhead expenses and taxes are taken into account to arrive at the figure of net profit. The projections of profit/loss are prepared for a period covering the repayment of term loans. The economic appraisal includes scrutinizing all the items of cost, and examining the assumptions, if any, to ensure that these are realistic and achievable. There should not be any optimism or pessimism in working out profitability projections since even a little change in the product-mix from nonremunerative to remunerative or vice-versa can distort the picture. While preparing profitability projections, the past trends of performance in an industry and other environmental factors influencing the cost and revenue items should also be considered objectively. Generally speaking, a unit may be considered as financially viable, progressive and efficient if it is able to earn enough profits not only to service its debts timely but also for future development/growth.

Break-Even Analysis
Analysis of break-even point of a business enterprise would help in knowing the level of output and sales at which the business enterprise just breaks even i.e. there is neither profit nor loss. A business earns profit if it operates at a level higher than the break-even level or break-even point. If, on the other hand, production is below this level, the business would incur loss. The break-even point in an algebraic equation can be put as under:

Break-even point per unit) (Volume or Units)

=Total Fixed Cost / (Sales price per unit - Variable Cost

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Break-even point (Sales in rupees)

= (Total Fixed Cost x Sales) / (Sales - Variable Costs)

The fixed costs include all those costs which tend to remain the same up to a certain level of production while variable costs are those costs which tend to change in proportion with the volume of production. As regards unit sales price, it is generally the same for all levels of output. The break-even analysis can help in making vital decisions relating to fixation of selling price make or buy decision, maximizing production of the item giving higher contribution etc. Further, the break-even analysis can help in understanding the impact of important cost factors, such as, power, raw material, labor, etc. and optimizing product-mix to improve project profitability.

Fund-Flow Statement
A fund-flow statement is often described as a Statement of Movement of Funds or where got: where gone statement. It is derived by comparing the successive balance sheets on two specified dates and finding out the net changes in the various items appearing in the balance sheets. A critical analysis of the statement shows the various changes in sources and applications (uses) of funds to ultimately give the position of net funds available with the business for repayment of the loans. A projected Fund Flow Statement helps in answering the under mentioned points. o How much funds will be generated by internal operations/external o How the funds during the period are proposed to be deployed? o Is the business likely to face liquidity problems? sources?

Balance Sheet Projections

The financial appraisal also includes study of projected balance sheet which gives the position of assets and liabilities of a unit at a particular future date. In other words, the statement helps to analyze as to what an enterprise owns and what it owes at a particular point of time.

38

An appraisal of the projected balance sheet data of the unit would be concerned with whether the projections are realistic looking to various aspects relating to the same industry.

Financial Ratios RATIO 1. FORMULA REMARK

There cannot be a rigid rule to a satisfactory debt-equity ratio, lower the ratio higher is the degree of protection enjoyed by the creditors. These days the debt equity ratio of 1.5:1 is considered reasonable. It, however, is higher in respect of capital intensive projects. But it is always desirable that owners have a substantial stake in the project. Other features like quality of management should be kept in view while agreeing to a less favorable ratio. In financing highly capital intensive projects like infrastructure, cement, etc. the ratio could be considered at higher level.

Debt-Equity Debt(Term Ratio Liabilities) / Equity (Where, Equity = Share capital, free reserves, premium on shares, , etc. after adjusting loss balance)

Debt-Service Coverage Ratio

Debt + Depreciation + Net Profit (After Taxes)+ Annual interest on long-term debt / Annual interest on longterm debt + Repayment of debt

This ratio of 1.5 to 2 is considered reasonable. A very high ratio may indicate the need for lower moratorium period/repayment of loan in a shorter schedule. This ratio provides a measure of the ability of an enterprise to service its debts i.e. interest' and `principal repayment' besides indicating the margin of safety. The ratio may vary from industry to industry but has to be viewed with circumspection when it is less than 1.5 This ratio gives a view of borrower's capital structure. If the ratio shows a decreasing trend, it indicates that the borrower is relying more on his own funds and less on outside funds and vice

Tangible worth/ Outside liabilities ratios

net Tangible Net Worth(Paid up Capital +Reserves and Surplus-Intangible Assets) / Total outside Liabilities(Total Liability 39

Net Worth)

versa.

Profit-Sales Ratio

Operating profit(before This ratio gives the margin available after taxes and excluding income meeting cost of manufacturing. It from other sources) / Sales provides a yardstick to measure the efficiency of production and margin on sales price i.e. the pricing structure. Sales / Total Assets Intangible Assets - This ratio is of a primary importance to see how best the assets are used. A rising trend of the ratio reveals that borrower has been making efficient utilization of his assets. However, caution needs to be exercised when fixed assets are old and depreciated, as in such cases the ratio tends to be high because the value of the denominator of the ratio is very low.

Sales-Tangible Assets Ratio

Current Ratio

Current Assets/ Liabilities

Current Higher the ratio greater the short term liquidity. This ratio is indicative of short term financial position of a business enterprise. It provides margins well as it is measure of the business enterprise to pay-off the current liabilities as they mature and its capacity to withstand sudden reverses by the strength of its liquid position. Ratio analysis gives indications; to be made with reference to overall tendencies and parameters in relation to the project.

Output Investment Ratio

Sales / Total capital This ratio is indicative of the efficiency employed(in fixed & current with which the total capital is turned over assets) as compared to other units in similar lines.

Internal Rate of Return

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The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. Higher a project's IRR the more desirable it is to undertake the project. IRR should be higher than the Cost of the project (interest rate in case of project financing).

Sensitivity Analysis
While preparing and appraising projects certain assumptions are made in respect of certain critical/sensitive variables like selling price/cost price per unit of production, product-mix, plant capacity utilization, sales etc. which are assigned a `VALUE' after estimating the range of variation of such variables. The `VALUE' so assumed and taken into consideration for arriving at the profitability projections is the `MOST LIKELY VALUE'. Sensitivity Analysis is a systematic approach to reduce the uncertainties caused by such assumptions made. The Sensitivity Analysis helps in arriving at profitability of the project wherein critical or sensitive elements are identified which are assigned different values and the values assigned are both optimistic and pessimistic such as increasing or reducing the sale price/sale volume, increasing or reducing the cost of inputs etc. and then the project viability is ascertained. The critical variables can then be thoroughly examined by generally selecting the pessimistic options so as to make possible improvements in the project and make it operational on viable lines even in the adverse circumstances.

8.5 MANAGEMENT & ORGANIZATION ASPECTS

Appraisal of project would not be complete till it throws enough light on the person(s) behind the project i.e. management and organization of the unit. It is seen that some projects may fail not because these are not viable but because of the ineffectiveness of the management and the organization in controlling various functions like production, marketing, finance, personnel, etc. The appraisal report should highlight the strengths and weaknesses of the management by commenting on the background, qualifications, experience, and capability of the promoter, key management personnel, and effectiveness of the internal control systems, relation with labor, working conditions, wage structure, and the other assigned essential functions. In case the promoter(s) have interest, in other concerns as Proprietor or Partner or Director, the appraisal report should also comment on their performance in such concerns. A business is more vulnerable if decision making in all the functional areas rests with a particular person, in other words, `one man show'. Further, the management and the organization should be conducive to the size and type of business. In case it is not so, it should be ensured that professional managers are inducted to strengthen the organization.
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8.6 APPRAISAL OF PROJECT - A CHECK LIST An indicative list of issues which need to be looked into while appraising a project is given below:
MARKETING 1. Reasonable demand projections keeping in view the size of the market, consumption level, supply position, export potential, import substitute, etc. 2. Competitors status and their level of operation with regard to production and sales. 3. Technology advancement/Foreign Collaborator's Status/Buyback arrangements etc. 4. Marketing policies in practice, for promotion of product(s) and distribution channels being used. Expenses on marketing are done so as to popularize the product. 5. Local/foreign consumer attitudes, requirements etc. preferences, practices adopted,

6. Influence of Govt. policies, imports and exports in terms of quantity and value. 7.Marketing professionals employed their competence, knowledge and experience

TECHNICAL

1. Product and its life cycle, product-mix and their application. 2. Location, its advantages/disadvantages, availability of infrastructural facilities, Govt. concessions, if any, available there. 3. Plant and machinery with suppliers' credentials and capacity attainable under normal working condition. 4. Process of manufacturing indicating the choice of technology, position with regard to its commercialization and availability. 5. Plant and machinery - its availability, specification, price, performance. 6. Govt. clearance/ license, if any, required. 7. Labor/ Manpower, type of skills required and its availability.
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FINANCIAL

1. Total project cost and how it is being funded/financed. 2. Contingencies and inflation duly factored in project cost. 3. Profitability projections based on realistic capacity utilization and sales forecast with proper justification. Unrealistic/ambitious sales projections without reference to past performance and justification to be avoided. 4. Break-even analysis, fund flow and cash flow projections. 5. Balance sheet projections should be realistic and based on latest available data. The components of financial ratios should be subjected to close scrutiny. 6. Aspect of support of parent company, wherever applicable, may be taken into account.

MANAGERIAL 1. Financial standing and resourcefulness of the management.

2. Qualifications and experience of the promoters and key management personnel. 3. Understanding of the project in all of its aspects -financing pattern, technical knowledge and marketing programme etc. 4. Internal control systems, delegation of adequate powers and entrusting responsibility at various levels. 5. Other enterprises, if any, wherein the promoters have the interest and how these are functioning.

ECONOMINC

1. Impact on increase in level of savings and income distribution in society and standard of living. 2. Project contribution towards creation and rate of increase of employment opportunity, achieving self-sufficiency etc. 3. Project contribution to the development of the region, its impact on environment and pollution control.

To judge whether the project is viable, i.e. it can generate adequate surplus for servicing its debts within a reasonable period of time and still left with some funds for future development. This involves taking an over-all view to analyse the strengths and
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weaknesses of the project. It should also be analysed to see whether the management and organization can prove effective for successful implementation of the project.

The following instructions should be kept in view while appraising a credit proposal:

Under risk perception, comments about generation of employment, social development aspects, backward area development incentives, social disorder/unrest and availability of pollution control certificate, changes in regulatory policies of local/State/Central Govt. etc. activity is prohibitive or not, location of unit in restrictive area (i.e. near to Residential, Historic Monuments etc.) be given. Sensitivity analysis with regard to various adverse scenario viz. increase in project cost, increase in raw material cost, decrease in selling price etc. and its impact on DSCR with affected DSCR/IRR should be discussed in proposal. The officials while appraising a credit proposal should comment about the segment reporting and disclosure, genuineness of related party transactions, impact of intra-group transactions on the profitability of the borrowing unit and any material adverse impact observed in the consolidated financial statement. Status of charge/mortgage to be given and validity of charge created be furnished. Since Bank is required to keep a close watch on the progress of the project during the currency of the term loan by carrying out inspection of the project site periodically and submit the report to sanctioning authority, a condition of maintaining proper records of fixed assets (i.e. equipments /machinery) and make the same available to the inspecting officials of the bank, should be incorporated in terms of sanction to facilitate the inspection While submitting the Appraisal Note, no column of the Board Format should be left blank/deleted and all pages/Annexures should be duly authenticated. The proposal should be sent by e-mail on the same day followed by the hard copy. It should be ensured that the hard copy submitted should not be at variance with the proposals sent through e-mail.

In case the limits sanctioned by HO/CO are at variance with those recommended by the Circle Office/Branch, then while conveying the sanction, appraisal note should also be forwarded to the respective Appraisal Cell/Circle/Branch along
44

with the reasons of variance so as to minimize the instances of variance in future.

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CHAPTER 9:
9.1 CREDIT RISK

CREDIT RISK MANAGEMENT

Credit risk means the possibility of loss associated with diminution in the credit quality of borrowers. In a banks portfolio, losses stem from outright default due to inability or unwillingness of a customer or counter party to meet, commitments in relation to lending, trading, settlement and other financial transactions.

9.2 CREDIT RISK MANAGEMENT SYSTEM IN PNB

A comprehensive credit risk management system, which is in place in the bank, encompasses the following processes: Identification of Credit Risk Measurement of Credit Risk Grading of Credit Risk Reporting and analysis of rating related data Control of Credit Risk

CREDIT RISK IDENTIFICATION

In order to take informed credit decisions, it is necessary to identify the areas of credit risk in each borrower as well as each industry. Risk Management Division HO, in coordination with other Divisions involved in disbursal of credit and also the risk management departments of various zonal offices identifies these risks areas and develops necessary tools and processes to measure and monitor the risk.

CREDIT RISK MEASUREMENT

In order to measure the credit risk in banks portfolio, the bank has developed the following models:

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Credit Risk Credit Risk Rating Model Rating Model Large Corporate Above Rs.15 crore

SALE

SECTOR

Above Rs.100 Crore

Manufacturing and service

Mid Corporate

Above Rs.5 crore Above Rs. 25 Manufacturing, and up to Rs.15 crore and up to Service and crore Rs.100 crore Trading Above Rs.50 lakh Up to and up to Rs. 5 crore crore Above Rs.2 lakh Up to and up to Rs.50 crore lakh Irrespective of limit Above Rs.5 crore Cost of project All sectors above Rs.15 except NBFC/ crore Banks/ FIs and trading up to two years of operations Rs.2 All sectors except NBFC/ Banks/ FIs Rs.25 All sectors except NBFC/ Banks/ FIs

Small Loans

Small loans II

NBFC New Projects

Entrepreneur New Above Rs.20 lakh Cost of project All sectors Business and up to Rs. 5 up to Rs. 15 except NBFC/ crore crore Banks/

The credit risk rating models have been developed with a view to provide a standard system for assigning a credit risk rating to all the borrowers on the basis of the overall credit risk involved in them. Inputs to the models are the financial, management,
47

business and conduct of account, industry information. The evaluation of a borrower is done by assessment on various objective/subjective parameters. The model evaluates the credit risk rating of a borrower on a scale of AAA to D with AAA indicating minimum risk and D indicating maximum risk. The credit risk-rating models incorporate therein all possible risk factors, which are important for determining the credit quality/ rating of a borrower. These risks could be:

Internal and specific to the company Associated with the industry in which the company is operating or Associated with the entire economy and can influence the repayment capacity and/or willingness of the company .

Evaluation methodology under rating models

The scores are assigned to each of the parameters on a scale of 0 to 4 with 0 being very poor and 4 being excellent. The scoring of some of these parameters is subjective while for some others it is done on the basis of pre-defined objective criteria. The scores given to the individual parameters multiplied by allocated weights are then aggregated and a composite score for the company is arrived at, in percentage terms. Higher the score obtained by a company, the better is its credit rating. Weights have been assigned to different parameters based on their importance. Weights assigned to different parameters have been loaded in the software. After allocating/evaluating scores to all the parameters, the aggregate score is calculated and displayed by the software. The overall percentage score obtained is then translated into a rating on a scale from AAA to D according to a pre-defined range of scores. Wherever a particular parameter is not applicable, no score should be given and the parameter should be made Not Applicable. For multi-divisional companies, which are involved in more than one industrial activity, evaluation should be done separately for each business. However, the management evaluation, conduct of account and financial evaluation will be done on a common basis. In such cases, for the business section, each business should be evaluated and scored separately, taking into account the different industrial activity involved.

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Rating Category PNB-AAA PNB-AA

Description

Score obtained Grade within (%) the rating Category Above 80.00 PNB-AAA

Minimum risk Marginal risk

Above 72.50 up PNB-AA to 77.50 Above 72.50 up to 77.50 Above 70.00 up to 72.50

PNB-A

Modest risk

Above 67.50 up PNB-A to 70.00 Above 62.50 up to 67.50 Above 60.00 up to 62.50

PNB-BB

Average risk

Above 57.50 up PNB-BB to 60.00 Above 52.50 up to 57.50

Rating Category

Description

Score obtained Grade within (%) the rating Category Above 50.00 up
49

to 52.50 PNB-B Marginally Acceptable Risk Above 47.50 up PNB-B to 50.00 Above 42.50 up to 47.50 Above 40.00 up to 42.50 PNB-C PNB-D High Risk caution Above 30.00 up PNB-C to 40.0 30.00 and below PNB-D

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SYSTEM FOR ASSIGNMENT & APPRAISAL OF RATING

The process of rating and vetting is as under:

Loan Sanctioning Authority Head Office

Credit Risk Vetting/ Rating Authority Authority Zonal CRMD in GM (RMD), HO consultation with branches Large Corporate Branches

Confirming

Zonal Office

Circle Officer/Manager, Zonal CRMD Credit Section Officer/Manager, An official designated by the Credit Section Incumbent not connected with Processing/recommending/rating of the concerned loan proposal

Branch Office

In order to adopt internal rating based approaches (IRB) for credit risk, Basel II has placed certain minimum requirements which inter-alia require, validation of rating system, process and estimation of all relevant risk components. Banks must regularly compare realized default rates with estimated probability of default (PD) of each grade and able to demonstrate to its supervisor (RBI), that the internal validation process enable it to assess the performance of internal rating and risk estimation system consistently and meaningfully. In view of above fact, not only rating but consistent practices in evaluation of credit risk rating as well as evolving and updating robust data on various risk components is must for adopting IRB approaches.

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CONTROLS
The Credit Risk Management process in the bank encompasses the following management Control techniques which help in mitigating the adverse impacts of credit risk in its credit portfolio Credit Approving Authority Credit Committee Linkage of loaning powers with risk rating categories

Prudential Exposure limits Risk Based Pricing Portfolio Management Loan Review Mechanism Legal documentation Preventive Monitoring System Others Use of CIBIL data and RBI defaulters list Diversification of Risk

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CHAPTER 10

POST SANCTION FOLLOW UP OF LOANS

Supervision and Follow-up of bank credit has assumed considerable significance particularly after introduction of new norms of assets classification, provisioning and de recognition of interest income on NPAs, affecting profitability. System of supervision and follow up can be defined as the systematic evaluation of the performance of a borrower account to ensure that it operates at viable level and, if problems arise, to suggest practical solutions. It helps in keeping a watch on the conduct and operational/financial performance of the borrower accounts. Further, it also helps in detecting signals/symptoms of sickness and deteriorations, if any, taking place in the conduct of the account for initiating timely corrective actions to check slippage of accounts to NPA category. The goals and objectives of monitoring may be classified into fundamental and supplementary goals. Fundamental goals help a bank to ensure safety of funds lent to an enterprise while, supplementary goals are directed towards keeping abreast of problems arising out of changes in both the internal and the external environment for initiating timely corrective actions. Some of the important goals of monitoring are listed as under:

To keep a watch on the project during implementation stage so that there are no time & cost overruns. To ensure that the funds released are utilized for the purpose for which these have been provided and there is no diversion of such funds. To evaluate operational and financial results, such as production, sales, profit/loss, flow of funds, etc. and comparing these with the projections/estimates given by the borrower at the time of sanction of credit facilities. To ensure that the terms and conditions as stipulated in the sanction have been complied with. To monitor operations in the account particularly cash credit facilities which indicate health of the account. To obtain market report on the borrower, to gather information like reputation /financial standing etc. To detect signals and symptoms of sickness or deterioration taking place in conduct /performance of the account.
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To ensure that the unit's management and organizational set-up is effective. To keep a check on aspects like accumulation of statutory liabilities, creditors, debtors, raw-material, stocks-in-process, finished goods, etc. To ensure charging of applicable rate of interest/penal interest/ commitment charges as per bank's guidelines. System of supervision & monitoring of credit as laid down by the Bank needs to be meticulously followed by the branches/controlling an office which, inter alia, covers the following:

Conveying the sanction Maintenance of Loan Document File Quarterly Review Sheet Preventive Monitoring System Quarterly Monitoring System Inspection and Physical Verification of stocks Stock Audit

A. Adherence to Terms & Conditions

Instances have come to notice that advances were disbursed by the Branch without fulfilling the terms and conditions stipulated in the relative sanctions, which is highly irregular practice. It should be realised that there are specific intentions behind stipulating the terms and conditions and if these are violated, the very basis of making the advance itself is forfeited and it may be difficult to enforce compliance after disbursement of the loan. Incumbents are advised to ensure that all the terms and conditions laid down in the sanctions are duly complied with before releasing the funds to borrowers. The Incumbents are also advised to send a certificate to the sanctioning authority, within one month of the receipt of sanction that the advances were disbursed only after fulfilling the terms and conditions laid down in the sanctions.

In order to have control over compliance of all terms and conditions of the sanction, it is advised as under:
COs should diaries this and ensure compliance. 54

In case there is any difficulty in complying with the terms of the sanction, the branch should immediately refer the matter to competent authority. Necessary approval must be obtained and kept with the documents before permitting any deviation from the terms of sanction. Banks internal auditors/concurrent auditors should ensure compliance of the guidelines.

B. End Use of Funds

As a matter of prudence, Bank needs to ensure end-use of funds it has lent. It is necessary to ensure that the Bank does not depend entirely on the end-use certificates issued by the Chartered Accountants but strengthens its internal controls and the Credit Risk Management System to ensure end-use of funds which would enhance the quality of the loan portfolio. Some of the illustrative measures that could be taken by the branches to ensure end-use of funds are: i. Meaningful scrutiny of quarterly progress reports/operating statements, balance sheets of the borrower. ii. Regular inspection of borrowers assets charged to the Bank as security. iii. Periodical scrutiny of borrowers books of accounts. iv. v. Periodical visits to the assisted units. System of periodical stock audit, in case of working capital finance.

vi. The appraising office, i.e. Branch Office/CCPC, as the case may be, should conduct pre-sanction visit of borrowers factory/business premises/IP offered as security in the loan account/borrowers place of work/residence as part of appraisal and annex the copy of visit report with the proposal. vii. In order to minimise the instances of selling off of mortgaged IP/multiple mortgages, etc. a well-defined system for periodic visit to the mortgaged site already in place to ensure that the security remains charged to the bank during the currency of the loan should be followed. In order to closely monitor the end use of funds, branches are advised to obtain necessary certificates from the borrowers, particularly in case of Corporate Loans, Working Capital Finance, Project Finance, Short Term Loans etc., certifying that the funds have been used for the purpose for which these were obtained and are not diverted to Capital Market/some other use.

viii.

C. Quarterly Monitoring Through Review Sheets (QRS)

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i.

Present system for Post-sanction Follow-up and Control of Advances provides for quarterly review of loan accounts sanctioned by Incumbent incharge as well as Circle Heads and higher functionaries as on the last day of March, June, September and December except in exempted categories of loan accounts. Branches should submit the review sheets, complete in all respects within 10 days from the close of quarter, to the sanctioning authority. Primary responsibility for scrutiny/processing of Quarterly Review Sheets (QRS) rests with the Sanctioning Authority. It enables the sanctioning authority to form an opinion about conduct/ position of the account and operational/financial performance of the Unit. The information required to be given in the Review Sheet covers, inter-alia, critical areas like compliance of the terms and conditions of the sanction, position of the various accounts, data regarding checking of stocks, report regarding serious audit irregularities and financial information (regarding Sales, Production, Net Profit, Sundry Creditors, Sundry Debtors and Statutory Liabilities, etc.) for previous and current quarters. In case various columns of the Review Sheets give complete and factual information, the Monitoring Authority can get a very clear idea of the state of the account. In actual practice, it has been observed that the information is not complete, rather evasive and more often than not, financial information regarding sales, production, net profit, sundry creditors, statutory liabilities, sundry debtors, etc. for the previous and the current quarter is missing/incomplete/left blank. Clear picture is also not available from the Review Sheet regarding verification of stocks and/or removal of serious irregularities. Circle Offices are required to analyse the information given in the Review Sheets and pick up early warning signals, if any, noticed for taking timely corrective steps to maintain proper health of the concerned borrowers. It is, however, noted that adequate attention is not being given by the Monitoring Authorities at various levels to the gaps/deficiencies contained in the Review Sheets or the warning signals emanating from them. Gaps/deficiencies in the information continue to be repeated from quarter to quarter.

ii.

iii.

iv.

v.

D. PREVENTIVE MONITORING SYSTEM (PMS)

PMS is a monitoring tool consisting of a number of signals/ indicators for evaluating the health of a borrowal account on a continuous basis. It assigns numerical score to each
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signal and captures the conduct of an account based on indicators of past one year in a single numerical value called PMS Index Score. It is basically a branch or micro levelmonitoring tool and may be effective in nature and pro-active in approach.

Objectives of PMS
The objective of PMS is to track & evaluate the health of borrowers account on a continuous basis and detect: Unsatisfactory/adverse signals/indicators at an early stage in a comprehensive manner. Thorough probe into reasons behind observed signals and analysis thereof. Speedy corrective/remedial actions/steps to prevent the account from becoming NPA as well as to minimize the loan losses.

Preventive Monitoring System consists of two parts: I. PMS Index and Rank
PMS Index is a numerical index consisting of 29 indicators Parameters grouped into 6 sections. Penalty rates (weights) in the form of numerical values have been assigned to PMS Index is a numerical index consisting of 29 indicators Parameters grouped into 6 sections. Penalty rates (weights) in the form of numerical values have been assigned to each indicator (parameter) depending upon their degree of impact on health of an account. The score assigned to any parameter is stored for last one year at any point of time, which is known as Cumulative score. The section-wise maximum of cumulative scores is to be summed up to arrive at PMS Index Score. Based on PMS Index Scores a scale of 1 to 10 has been devised, which is known as PMS Ranking Scale. The PMS Rank indicates the state of health of an account. The lower the PMS Rank, better the health of account and vice-versa.

II.

PMS Report
PMS Report, which has eight parts, describes brief profile of the borrower, position of accounts, details of signals contributing to PMS Index Score, reasons behind adverse signals and proposes corrective/ remedial steps with time frame.

E. QUARTERLY MONITORING SYSTEM (QMS)

Bank has prescribed the QMS system for monitoring performance of big borrower accounts enjoying working capital facilities of Rs. 1crore & above from
57

the banking system. QMS includes the submission of data on the prescribed formats depending upon the economic activity of the borrower. Under this system financial and operational information/ data is required to be submitted in two different sets of formats:

i. QMS I
This form is required to be submitted within six weeks from the close of the quarter to which it relates. It gives information about the operations of the unit and its performance for the quarter, also giving reasons for non-achievement of sales/production targets.

ii. QMS II
This form is required to be submitted within two months from the close of the half-year to which it relates. In addition to providing comparative position of the actuals vis-a-vis the projections accepted at the time of sanction relating to the operations of the unit, this form also indicates the `SOURCES' and `USES' of the funds generated by the unit, during the half year. Critical analysis of this form can reveal the diversion of short-term funds for long term uses.

F. Inspection of Stock
i. Inspection of stocks at prescribed intervals is not being conducted by many offices. In several cases, wherever the stocks are lying at outstation offices and/or the factory of the party is located at a place other than the branch where the account is maintained, checking is either not done at all or done perfunctorily. The position is also not satisfactory in respect of consortium advances where checking is to be done by the Lead Bank or by other consortium members in rotation. Monthly/Quarterly inspection/checking may be carried out alternatively by the Manager and the Assistant Manager/Officer. Whereas checking may be entrusted to the Assistant Manager/Officer as permitted under the instructions, it shall continue to be the personal responsibility of the Incumbent incharge to ensure that the checking has been done in all cases every month/quarter (as the case may be) or as per stipulations made in the letter of sanction. Branches are advised to ensure that securities be checked regularly in all Credit Accounts (including NPA/PA accounts). During these periodical inspections, the Incumbents should satisfy themselves that the security is intact both qualitatively and quantitatively, readily marketable and has not
58

ii.

iii.

become old or obsolete or deteriorated in any way. If not, the facts should be brought to the notice of the higher authorities and instructions asked for.

G. Stock Audit
Bank has a policy to conduct annual stock audit (including book debts) as under: i. Annual stock audit should be got compulsorily done in respect of all borrowers whether standard or NPAs, enjoying fund based working capital limits of Rs. 5 crore and above from our bank. In case of borrowers enjoying fund based working capital limits less than Rs.5 Crore, Stock Audit may also be got done in emergent cases and/or where banks interests demand. However, for modalities of stock audit prior concurrence of Circle Heads be obtained. In cases where the borrower is enjoying working capital limits (fund based) of less than Rs. 5 crore from our Bank and Rs. 20 crore and above in aggregate from the banking system, the matter should be taken up with lead bank/major share-holder banks in multiple banking arrangement for getting the stock audit conducted. Annual Stock Audit should be compulsorily conducted in all B to D risk rated accounts enjoying fund based working capital limits of Rs. 1 crore and above. In respect of consortium advances, where we are the leader, the stock audit may be got conducted with the consent of the member banks and in cases where we are not the leader, we may take up the matter with the Lead Bank for getting the stock audited of the borrowal account. The final decision regarding getting the stock audited of the borrowal account under consortium advances should, however, is based on consensus.

ii.

iii.

iv.

v.

CHAPTER 11:

ANALYSIS & INTERPRETATION

11.1 PNBs LOAN POLICY 11.1.1 Objective

The Credit Management & Risk Policy of the bank at the macro level is an embodiment of the Banks approach to understand measure and manage the credit risk and aims at ensuring sustained growth of healthy loan portfolio while dispensing the credit and
59

managing the risk. This would entail reducing exposures in high risk areas, emphasizing more on the promising industries / productive sectors/ segments of the economy, optimizing the return by striking balance between the risk and the return on assets and striving towards maintaining/improving market share.

11.1.2 BASIC TENETS OF THE POLICY

All loan facilities considered only after obtaining loan application from the borrower and compilation of Confidential Report on them and the guarantor. The borrowers should have the desired background, experience/expertise to run their business successfully Project for which the finance is granted should be technically feasible and economically/commercially viable i.e. it should be able to generate enough surplus so as to service the debts within a reasonable period of time. Cost of the project and means of financing the same should be properly assessed and tied up. Both, under-financing and over- financing can have an adverse impact on the successful implementation of the project. Borrowers should be financially sound, enjoy good market reputation and must have their stake in the business i.e. they should possess adequate liquid resources to contribute to the margin requirements.

Loans should be sanctioned by the competent sanctioning authority as per the delegated loaning powers and should be disbursed only after execution of all the required documents. Projects financed must be closely monitored during implementation stage to avoid time and cost overruns and thereafter till the adjustment of the bank's loan. The policy sets out minimum or base rate i.e. 10.50%. The policy lays down norms for takeover of advances from other banks/ financial institutions. As a matter of policy the bank does not take over any Non-performing Asset (NPA) from other banks.

11.1.3 METHODS OF LENDING For Working Capital

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Simplified method linked with turnover

Simplified method based on turnover for assessing working capital finance up to Rs.2 crore (upto Rs. 5 crore in case of SSI units).

MPBF System
Existing MPBF system with flexible approach shall be followed for units requiring working capital finance exceeding the above-mentioned amount.

Cash Budget System

Cash Budget System shall be followed in Sugar, Tea, Service Sector and Film Production accounts. It will be our endeavor to introduce the same selectively in other areas also.

TERM LOAN In case of infrastructure/mega projects, proper appraisal will be made by utilizing the services of specialized / Technical officers. The term loans with remaining maturity period of above 5 years shall not exceed 50% of the term deposits with remaining maturity period of above 5 years after taking into account the renewal of term deposits as per the past trend.

11.2 CREDIT APPRAISAL PROCESS AT PNB 11.2.1 FLOWCHART

Submission of Project Report along with request letter. Carrying out Due Diligence on the Client.

Determining of Interest Rate and preparation of proposal.

Feasible

Preparing Credit Report / Feasibility report and risk rating. Report and RiskNot feasible Rating

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Submission of Proposal to designated authority (circle office)

Submission of Proposal to designated authority.

Queries
Re-verification and analysis of the proposal. Meeting with the client to clarify the queries.

No Queries
Vetting of Credit Risk Rating Report. Acknowledgement of Sanction Terms & conditions by the client Application to comply with Sanction T&C. Execution of loan documents. T&C. Execution of Loan Documents Procedures at Branch 11.2.2 BRIEF ON THE Office Level.

Approval of request made by the client like reduction of interest rate etc.

Sanction of Proposal on various Terms & conditions.

Disbursement of Sanctioned Amount from the branch office.

PROCESS

Procedures at Circle Office Level

At Punjab National Bank, proposal for financing working capital limits and term loans can relate to any of the following: New proposal Renewal of existing limits Enhancement of existing limits Once a proposal is received, financial statements, project report and other important documents are used to evaluate:
1. Maximum permissible bank finance (in case of WC limit).

62

2. Techno Economic Feasibility Analysis of the project (includes all the 5

evaluation).
3. Various risks associated, if any. 4. Various approvals of issues the borrower seeks (reduction of ROI, processing fee

etc.).
5. Risk rating of the borrower. 6. Reasonableness of estimates/projection in regard to sales, chargeable current

assets, current liabilities (other than bank borrowings) and net working capital..
7. Classification of current assets and current liabilities in conformity with the

guidelines issued by the Reserve Bank/HO. 8. Maintenance of minimum current ratio of 1.33:1 (Except where a relaxation is permitted as in the case of sick/weak units, diamond exporters, etc.). 9. An undertaking by the borrower to submit his annual accounts promptly. Further annual review is carried out regularly by the bank even where enhancement in credit limits is not involved. 10. Provisions of Foreign Exchange Management Act, 2000 (FEMA), wherever applicable are complied with. 11. In respect of industries where norms relating to inventory and receivables have been laid down by Reserve Bank/HO, credit limits should be determined in accordance with such norms and in other cases in tune with past trends. 12. In cases where deviations from norms/past trends are warranted, it should be ensured that these are justified and specific comments in this behalf are incorporated in the notes placed before the competent authority for sanction. 13. Specific guidelines issued by RBI/HO for sanctioning credit limits for financing certain specific activities such as diamond exports, leasing and hire-purchase, tea, sugar and computer software industries will continue to be in force.

11.2.3 RISK RATING OF THE BORROWER

Punjab National Bank uses a system of internal ratings for the assessment of the credit quality and risk profile of its borrowers. An internal rating refers to a summary indicator of the risk inherent in an individual credit quality in an individual credit. Ratings typically embody an assessment of the risk of loss due to failure by a given borrower to pay as promised, based on consideration of relevant counterparty and
63

facility characteristics. A rating system includes the conceptual methodology, management process, and systems that play a role in the assignment of a rating.

Credit risk rating tools at Punjab national bank

With respect to Punjab National Bank, credit risk rating has been developed with a view to provide a standard system for assigning a credit rating to the borrowers of the bank according to their risk profile. The management of credit risk at PNB includes a continuing review of credit limits, policies and procedures; the approval of specific exposures and workout situations; the constant re-evaluation of the loan portfolio and the sufficiency of provisions thereof. PNB was also one of the first banks to develop their own credit models to ease up their way to risk management, PNB Trac -- for its entire category of lending. The loans with exposure of above Rs.20 lacs have been rated individually, while loans with exposure under Rs. 20 lakh have been rated segment-wise on portfolio basis as per the terms of Basel II accord. This means that the bank would be able to do credit ratings on its own for its lendings.

Inputs (parameters) to PNB Trac

The rating tool is designed to cater all the industry. The difference between ratings of two borrowers lie in the limits he/she is seeking from the bank and the industry of the same. There are broad categories defined in every model that require different parameters or inputs (both quantitative and subjective) depending on the industry the borrower serves. To explain the above statement an example of the inputs is described below.

Rating Model Facilities Required

New Project Model Term Loan

Industry Limits

ABC Sector Rs. 1200 lacs

Inputs to the Model for the above mentioned loan will be:

CATEGORY Management Evaluation

PARAMETERS / INPUTS Capital market perception Management Setup. of the group. Risk bearing capacity.
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Integrity,

commitment

and sincerity. Track record repayment. Business Evaluation Quality of service offered. Economies of operation. Ambience of service outlet. Range of services. in debt Financial flexibility. Level of satisfaction. customer

Advertising / promotional strategies. Brand equity. Expected growth. market

Effectiveness of distribution Locational advantage. channels. Quality of available. Financial Evaluation infrastructure Technology adopted in the process. Internal Rate of Return. (in TOL / TNW Working capital cycle (in months). Expected time overrun. Status of clearances. obtaining

Debt Equity Ratio. Repayment years). Period

Foreign exchange risk. Project Project complexities.

Implementation Expected cost overrun. Risk Evaluation Funding risk.

Service period (in years).

How the Rating is done

1. The scores are assigned to each of the parameters of each of the broad category in the different sections on a scale of 0 to 4 up to two decimal points with 0 being very poor
65

and 4 being excellent. The scoring of some of these parameters is subjective while for some others it is done on the basis of pre-defined objective criteria. 2. The scores given to the individual parameters multiply by allocated weights are aggregated and a composite score for the company is arrived at in percentage terms. Higher the score obtained by a company, better is its credit rating. Weights have been assigned to different parameters based on their importance.

Example: Factor Financial Evaluation Business & Evaluation Management Evaluation Conduct of Account AGGREGATE SCORE %score obtained 55.00 Weight (%) 40.00 25.00 20.00 15.00 Weighted Score 22.00 12.50 16.00 11.25 61.75

Industry 50.00 80.00 75.00

The Aggregate Score of 61.75 refers to PNB- A THIS MEANS THE RATING OF THE BORROWER IS PNB A

11.2.4 DETERMINATION OF THE APPLICABLE RATE OF INTEREST BASE RATE

Bank has determined Benchmark Base Rate after taking into account actual cost of funds, operating expenses and a minimum margin to cover regulatory requirement of provisioning / capital charge and profit margin. At present, Base Rate has been fixed at 10.50%. Base Rate is the reference rate for determination of rate of interest for the borrowers accounts.
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Base Rate System is for the banks to set a level of minimum interest rates charged while giving out the loans. This Base Rate System has many advantages over the older method of Prime Lending Rate (PLR). One advantage is, in the Prime Lending Rate (PLR), one could sanction the loan for lower price for the preferred customer or the corporate bodies and retail customers may have to pay more for the same type of loans. In the base rate system, there will not be much variance on the loans. However, the base rate system will not be applicable for the following type of loans: Agricultural Loans Loans given to own employees Loans against deposit Export Credit Base rate system is arrived at taking into the account, the cost of deposits and cost of keeping aside cash to meet CLR and SLR. It is convenient for the banks to adjust the lending rates after the changes on policy rates by the RBI.

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CHAPTER 12 CASE STUDY: ABC mills Pvt. Ltd.

12.1 BORROWERS PROFILE Group Name Address of Regd. Corporate Office No recognized group. / C-21, XYZ, Phase I, PQR city. S-242, KLM city Works/ Factory KPO village Uttarakhand Limited

Constitution/Constitution Private Code as per LADDER Company/ 34 Date of incorporation Dealing with PNB since Industry/Sector Business (Product)/

22nd May, 2006 April, 2007 Paper Manufacturing/ Private Sector

Activity Manufacturing of writing & printing paper Installed Capacity. 19800 MT PA

BACKGROUND
ABC mills Pvt. Ltd., established on 22.05.06, having registered office at C-21, XYZ, Phase1, PQR city and administrative Office at S-242, KLM city has set up a paper manufacturing unit at KPO village Uttarakhand. The company is manufacturing writing & printing paper based on waste paper process. The installed capacity of the plant is 19800 MTPA on 100% efficiency taking 360 working days in a year on a continuous process basis.

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The company has setup the paper mill in the State of Uttarakhand to take advantage of various benefits like exemption from Excise Duty and Income Tax being provided by the Government of India to the new units being established in the state of Uttarakhand. The company has started commercial production wef. 6th October, 2008. The company is dealing with PNB since 2007. The company is already availing facility of Rs. 916.15 lacs for building, construction and machinery and rest as car loan.

SHAREHOLDING Name of Promoters/ Share holders Promoters Holding the No. of shares Major 7896500 Amount (Rs. in lakh) 789.65 789.65 % Holding 100.00 100.00

FIs/ Mutual Funds/ UTI/ Banks/ FIIs NRIs/ OCBs Public Total 7896500

12.2 CREDIT APPRAISAL FOR ABC MILLS PRIVATE LIMITED Comments on Management, Production and Marketing Management
The affairs of the Company are mainly looked after by following directors: 1. Sh. Bhagwat Prasad 2. Sh. Rajesh Agarwal Sh. Bhagwat Prasad and Sh. Rajesh Agarwal are having 19 years experience in the running of Paper Mills. They were also directors in M/s Nav Bharat Duplex Limited, Hapur a paper manufacturing unit having installed capacity of 10000 MTPA. Subsequently, they resigned from the directorship of M/s Nav Bharat Duplex Limited for setting up their own paper manufacturing unit in the name of ABC mills Pvt. Ltd. Previously, Sh. Bhagwat Prasad and Sh. Rajesh Agarwal were also directors in M/s Jay Bharat Tissues Limited but they have resigned wef. 08.02.2007
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Production
The company has set up modern manufacturing facilities by availing financial assistance from our Bank. Present installed capacity of the unit is 19800 MT/ pa.

Marketing
The company has three tiers selling and marketing arrangement, i.e., (i)to sell the products directly to the customers, (ii)through the company appointed authorized dealers at various places and (iii)from the companys Depot. The main customers of the company are Publication Houses, Newspaper Publishers, Copy/ Text Book Manufacturers etc. The company proposes to sell its products in the main Cities of the State of Uttar Pradesh such as Meerut, Lucknow, Allahabad, Varanasi, Kanpur, Agra, Mathura, Barielly etc.

The promoters had been in the line of manufacturing and selling of paper since last many years and enjoy very good reputation in the paper market. They are quite confident that selling of extra quantity produced due to increased capacity utilization will not be a problem for them due to good quality of paper.

BUSINESS EVALUATION Comments on industry scenario and industry outlook

The paper industry in India is more than a century old. The Indian Paper Industry accounts for about 1.6% of the worlds production of paper and paperboard. The industry provides employment to more than 0.12 million people directly and0.34 people indirectly. The Govt. of India has relaxed the rules and regulations and also delicensed the paper industry to encourage investment into this sector and joint ventures are allowed and some of the joint ventures have also started in India. The paper industry in India is looking for state-of-art technologies to reduce its production cost and to upgrade the technology to meet the international standards. Demand of paper has been hovering around 8% for some time. During the period 200207 while news print register a growth of 13%, writing and printing, containerboard, cartoon board and others registered a growth of 5%, 11%, 9% and 1% respectively. So far, the growth in paper industry has mirrored the growth in GDP and has grown on an average 6-7 per cent over the last few years. India is the fastest growing market for paper globally and it presents an exciting scenario; paper consumption is poised for a
70

big leap forward in sync with the economic growth and is estimated to touch 13.95 million tons by 2015-16. The futuristic view is that growth in paper consumption would be in multiples of GDP and hence and increase in consumption by one kg per capita would lead to an increase in demand of 1 million tons. As per industry an estimate, paper production is likely to grow at a CAGR of 8.4% while paper consumption will grow at a CAGR of 9% till 2012-13. The import of pulp & paper products is likely to show a growing trend. Foreign funds interest in the Indian paper sector is growing.

TECHNICAL EVALUATION Raw material

The main raw material is water paper & chemical (rosin & soap stone) which are easily available in market. The company is using 100% indigenous raw material. At present the average cost of raw material i.e. waste paper is 13000/-per MT. As per Audited Balance Sheet as at 31st March 2011 actual expenditure on the chemical consumed is Rs.1457/-per MT of production. Therefore the chemical consumed is assumed at 1460/-per MT of production. As per the Audited Balance Sheet as at 31 st March 2011 actual spare parts consumed are Rs.1044/-MT of production. So the expenditure on other Spares Consumed is assumed at Rs.1050/-per MT of production.

Transport & Labour

Since the unit is located on the state highway and as such there is no problem in transporting the raw material, finished goods and chemicals.

Power
The unit has already been sanctioned a power load of 3 MW for running the factory from Uttarakhand Power Corporation Limited. The power load of the company is sufficient for the modernization project also. There is no need in increase in the power load.

Water
The company has already installed two inches bore well which are sufficient for the working of the company.

Effluent disposal & pollution

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The company has already received consent from Uttarakhand Environment Protection and pollution Control Board for the period 10-5-2010 to 31-3-2011.

Manpower
Production has been started from October 2008, so sufficient manpower is available in the unit.

FINANCIAL EVALUATION Financial Statements of the company are as follows:

Particulars Sale Turnover/ Receipts - Domestic - Exports Growth Other Income Operating Profit Profit Before Tax Tax Profit After Tax Depreciation Misc. Exp. Written Off Cash Profit Interest Paid EBIDTA Paid Up Capital Share Application Money Reserves & Surpluses (Excl. Reval. Reserves) Misc. Exp. Not W/off Accumulated Losses Deferred Tax Liability (+)/ Asset (-) Tangible Net worth Investment in Allied Concerns & Amount of Cross Holdings Net Owned Funds/ Adjusted TNW
Share Application Money Total Borrowings

31.03.09 31.03.10 31.03.11 31.03.11 31.03.12 31.03.13 AUDITED AUDITED EST. AUDITED PROJ. PROJ. 1500.91 3912.77 5268.48 5068.04 5755.22 5795.88 1500.91 3912.77 5268.48 5068.04 5755.22 5795.88 2.99 148.31 151.30 0.35 150.95 128.19 1.41 280.55 87.28 368.18 789.25 5.00 150.94 10.17 160.69 10.67 133.10 143.77 0.08 143.69 285.00 1.74 430.43 258.07 688.58 789.65 0.00 314.23 8.43 34.65 11.00 277.56 288.56 0.00 288.56 308.06 1.74 598.36 284.50 882.86 789.65 0.00 602.79 6.70 29.53 14.72 43.62 58.33 2.98 55.35 321.00 1.21 377.56 314.28 694.83 789.65 0.00 369.58 7.22 13.56 12.00 138.89 150.89 0.00 150.89 472.99 1.21 625.09 340.87 965.96 799.10 0.00 605.49 6.01 0.71 12.00 292.44 304.44 0.00 304.44 412.41 1.21 718.06 334.74 1052.80 799.10 0.00 909.93 4.81

935.02 0.00 935.02

0.00 1764.49

1095.45 1385.74 0.00 0.00 1095.45 1385.74

0.00 0.00 2405.04 2246.33 72

1152.01 1398.57 0.00 0.00 1152.01 1398.57

0.00 0.00 2431.89 2543.31

1704.21 0.00 1704.21

0.00 2187.48

Secured Unsecured Investments Total Assets Out of which: - Net Fixed Assets - Non Current Assets - Current Assets Net Working Capital Current Ratio Current Ratio (Excluding Export Receivables) Debt Equity Ratio Term Liability/ Adjusted TNW TOL/ Adjusted TNW Operating profit/ Sales(%age) Fund Flow: Long Term Sources Long Term Uses Surplus/ Deficit (-) Short Term Sources Short Term Uses Surplus/ Deficit (-)

1563.22 201.27 0.00 2810.50

2271.44 133.60 0.00

2112.73 133.60 0.00

2235.37 2327.56 196.53 0.00 215.75 190.00

1971.73 215.75 504.96 4074.50

3544.76 3862.81

3849.75 4127.22

1899.44 57.52 853.54 245.03 1.40 1.40 1.36 1.36 2.01 9.88

2117.94 1809.89 65.06 56.42

1905.62 71.83

1901.79 206.86

1489.37 521.82 2063.30 630.50 1.44 1.44 0.55 0.55 1.39 5.05

1361.76 1996.50 388.53 1.40 1.40 1.35 1.35 2.24 3.40 715.76 1.56 1.56 0.86 0.86 1.79 5.27

1872.30 2018.57 476.25 1.34 1.34 1.13 1.13 2.34 0.86 583.23 1.41 1.41 0.92 0.92 1.95 2.41

2201.99 1956.96 245.03 608.51 853.54 -245.03

2571.53 2582.07 2183.00 388.53 1866.31 715.76

2453.70 2691.88 1977.45 2108.65 476.25 583.23

2641.70 2011.20 630.50 1432.80 2063.30 -630.50

973.23 1280.74 1361.76 1996.50 -388.53 -715.76

1396.05 1435.34 1872.30 2018.57 -476.25 -583.23

Brief Discussion on Financial Indicators

Paid Up Capital
There was no change in paid up capital during last FY 2010-11.
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Tangible Net worth (TNW)

TNW improved as at 31.03.11 with the plough back of profits.

Reconciliation of TNW TNW as on close of FY ended 31.3.2010 Add: Net Profit for the year Decrease in Miscellaneous Exp. TNW as on close of FY ended 31.3.2011 SALES
During last FY 2009-10, actual sales of Rs.5068.04 lakh were 96.20% of estimated sales of Rs.5268.48 lakh and thus the company sales performance was satisfactory. For the current FY 2011-12, the company has projected gross sales of Rs.5755.22 lakh, which are considered reasonable & achievable in view of sales performance during the i.e. June 2011.

1095.45 55.35 1.21 1152.01

PROFITABILITY
During last FY 2010-11, actual PBT of Rs.58.33 lakh was 20.21% of estimated PBT of Rs.288.56 lakh. However, cash profit has been 62% of estimates. The company could not achieve the estimated PBT due to increase in overheads, viz. stores & spares, power & fuel, direct labour, manufacturing expenses, general administrative expenses and increase in interest rates yet actual cash profit of Rs.377.56 lakh was 63.10% of projected cash profit of Rs.598.36 lakh which may be considered reasonable.. The company is hopeful of improving the profitability in the coming days by containing the aforesaid overheads and also by improving yield for which it is implementing a modernization project and it has projected higher operating profit/ sales ratio and profitability accordingly. Since the modernization project will be completed by 31.03.2012, benefits would accrue during next FY 2012-13 and accordingly, the company has projected higher profitability for next FY 2012-13 vis--vis the same for current FY 2011-12 even though marginal increase in sales is projected.

NWC, Current Ratio, DER, Term Liability/ adjusted TNW ratio and TOL/ adjusted TNW ratio
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NWC has increased as at 31.03.2011 with the plough back of profits but the company could not achieve the projected NWC due to lower actual cash accruals vis--vis the estimates and addition to fixed assets. However, current ratio as at 31.03.11 was 1.34:1, which indicates adequate NWC availability. Current ratio has declined as at 31.03.11 with the increase in the volume of current assets and current liabilities else there was no decrease in long term surplus. However, actual current ratio at 1.34:1 was less than projected current ratio of 1.56:1 due to lower profitability vis--vis the estimates. DER and Term Liability/ adjusted TNW ratio have decreased as at 31.03.11 with the plough back of profits and repayment of long term loans and the same at 1.13:1 was within permissible levels even though the same were more than estimated levels due to lower profitability and higher long term liabilities vis--vis the estimates. TOL/ adjusted TNW has increased as at 31.03.11 with the increase in the outside liabilities and lower profitability vis--vis the estimates, however, the same at 2.34:1 was within permissible levels.

DIVERSION OF FUNDS
There is no diversion of funds Overall financial position of the company is satisfactory.

Brief Profitability Projections

Particulars Installed Capacity (MT/ pa) Capacity Utilization (%) Capacity Utilization (MT/ pa) Net sales Profit after Tax Cash Profit (Rs. in lakh) Projections 31.3.12 31.3.13 31.3.14 31.3.15 31.3.16 31.3.17 19800 19800 19800 19800 19800 19800 96.00 96.00 96.00 96.00 95.00 96.00 19008 19008 19008 19008 18810 19008 5755.22 5795.88 5797.44 5797.44 5797.44 5797.44 150.89 304.44 417.57 525.65 594.02 638.39 625.09 718.06 731.18 765.24 778.04 780.58

DSCR
(Rs. in lakh) Particulars PAT Depreciation Misc. Exp. w/off Interest Projections 31.3.12 31.3.13 31.3.14 31.3.15 31.3.16 31.3.17 150.89 304.44 417.57 525.65 594.02 638.39 472.99 412.41 313.61 239.59 184.02 142.19 1.21 1.21 0.00 0.00 0.00 0.00 134.83 125.14 73.02 34.16 15.41 4.31 75 Total 2630.95 1764.82 2.42 386.87

A. Total Cash accrual TL Installments Interest on TL B. Total DSCR (A/B) Average DSCR

759.93 843.20 804.20 799.40 793.45 784.89 332.55 355.82 355.38 212.28 76.13 75.15 134.83 125.14 73.02 34.16 15.41 4.31 467.38 480.96 428.40 246.44 91.54 79.46 1.63 1.75 1.88 3.24 8.67 9.88

4785.06 1407.33 386.87 1794.20 2.67

SWOT ANALYSE Strengths

Sh. Bhagwat Prasad and Sh. Rajesh Agarwal, directors are having adequate experience in the paper manufacturing unit as directors in M/s Nav Bharat Duplex Limited having installed capacity of 10000 MTPA. The paper mill is already running successfully.

Weaknesses
The installed capacity of the unit is 19800 MTPA and thus there is a threat of competition from units having larger capacity in the area.

Mitigants
The directors are experienced to take care of market competition

Opportunity:
The unit is established in Kashipur, Distt. Udham Singh Nagar, Uttarakhand. Central and State Governments are providing a number of financial and non-financial benefits to the units being established in this area. The company has an opportunity to tap these advantages in its favour. The unit is established with the latest Plant & Machinery and apparatus with the matching equipments. So the cost of production in the unit will be lower than the other similar units in the area and the company has an opportunity to capture further market share.

12.3 SECURITY For working capital limits FBWC limits

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1st charge over entire current assets, by way of hypothecation of raw material, stock in process, finished goods & goods in transit, whether lying in companys godown/ warehouse or otherwise and entire receivables/ book debts, loans & advances. Thus all the current assets of the company (present & future) shall remain hypothecated/ charged to the Bank.

Non Fund Based/ LG limits

a) Fixed Deposit Receipt for 10% of Bank Guarantee. b) Counter Indemnity from the company. c) 1st charge on current assets of the company.

For Term Loans (Existing/ Proposed)

1st charge on entire block assets (present & future) of the company, by way of (i)hypothecation of machinery and equipment & other fixed assets and (ii)EM of lessee rights of factory land (period 29 years 11 months) measuring 1.967 hectares (mortgage of original title deeds with ownership rights also to be extended) and building constructed thereon. WDV of block assets as at 31.03.2011 is Rs.1905.62 lakh for existing total term loans of Rs.1105.17 lakh [PNB Rs.1088.53 lakh (term loans Rs.1070.28 lakh & car loans 18.25 lakh) and ICICI Bank Car Loan Rs.16.61 lakh).

Personal/ Corporate Guarantee Name of Guarantor 1. Sh. Bhagwat Prasad 2. Sh. Rajesh Agarwal 3. Dr. Veena Agarwal 4. Sh. Ankit Aggarwal Total 5. M/s Jay Bharat Tissues Ltd. Relation with borrower Director Director Director Close relative Corporate Guarantee

(Rs. in lakh)

Net Worth IPs Date of CRs (Including IPs) Prev. Present Prev. Present Prev. Present (31.3.10) (30.6.11) (31.3.10) (30.6.11) 278.19 284.37 85.00 85.00 10.7.10 11.7.11 178.82 81.55 290.37 828.00 66.19 * 189.77 99.50 300.50 874.14 69.11 ** 77 12.00 68.00 290.17 455.00 15.00 68.00 300.00 10.7.10 11.7.11 10.7.10 11.7.11 10.7.10 11.7.11

468.00 10.7.10 11.7.11

Security Margin ( Fixed Asset Coverage Ratio for term loans)

(Rs. in lakh) Nature
Book Value Existing Term FACR Loans 1.72 1.18 2.90 Proposed Additions Book Term FACR Book Value Loans Value 469.10 300.00 300.00 1.56 Proposed FACR on Term project Loans 1.35 0.93 2.28

completion

Primary 1905.62 1105.17 Collater 1300.00 1105.17 al 3205.62 1105.17 Total

1901.79 1405.17 1300.00 1405.17 3201.7 1405.1 9 7

469.10 300.00 1.56

Security Coverage Ratio (for all credit facilities)

(Rs. in lakh) For proposed exposure Rs. 2485.46 FACR

As on 31.3.11 as on date of proposal Nature Existing Proposed For (for exposure Rs. (exposure Rs. 2655.17 exposure 2155.17 lacs) lacs) Rs. 1985.46 Book Value/r ealizabl e value Primary 1905.62 Collater 1300.00 al Total 3205.62 FACR Book Value/realiz able value 1901.79 1300.00 3674.72 FACR on project complet ion 0.72 0.49 1.21 FACR

0.88 0.60 1.48

0.96 0.65 1.61

0.77 0.52 1.29

12.4 PRESENT PROPOSAL

The proposal is for: Enhancement of FBWC limits from Rs.1050 lakh to Rs.1250 lakh and renewal of NFB limits of Rs.50 lakh with overall ceiling of Rs.1250 lakh (existing Rs.1050 lakh). Fresh sanction of Term Loan of Rs.300 lakh. Review/ continuation of existing 3 term loans having present O/s of Rs.916.15 lakh. Approval of 25% relaxation in applicable Processing Fee for FBWC limits and Upfront Fee for proposed Term Loan of Rs.300 lakh and 50% relaxation in applicable Review Charges for existing Term Loans.
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 Continuation of 100% relaxation in applicable Inter-SOL charges. Approval of other issues.

Facilities Recommended

Nature Fund Based Working Capital (FBWC) CC(H) Sub-limit CC(BD) FBWC Ceiling Non Fund Based (NFB)

Existing Proposed Secured/Unsecured

1050.00 1250.00 650.00 780.00

Secured

1050.00 1250.00

LG (workable within FBWC limits) 50.00 NFB Ceiling 50.00

50.00 50.00

Ceiling for FBWC and NFB 1050.00 1250.00 limits Term Loans Term Loan I Term Loan II Term Loan III Term Loan IV Term Loans Total Car Loan - I Car Loan - II Car Loan III Car Loan - IV 1501.00 9.00 5.00 5.00 5.00 916.15 5.16 4.72 4.82 4.61
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Sanctioned O/s 808.00 370.00 323.00 438.70 235.36 242.09

O/s 438.70 235.36 242.09 300.00 1216.15 5.16 4.72 4.82 4.61

Car Loans - Total

24.00

19.31 935.46

19.31 1235.46

Total Term & Car 1525.60 Loans Total Commitment

1985.46 2485.46

Cost of Project Item Building & civil Work Plant & Machinery Interest during Construction Period Margin money Working Capital Total Already incurred up to 30.06.2011 88.72 55.68 -

(Rs. in Laces) To be incurred 107.38 217.32 23.97 55.63 404.30 Total 196.10 273.00 23.97 55.63 548.70

for 144.40

Means of Finance Item Already incurred up to 30.06.2011 To be incurred 94.47 94.47 Total 94.47 85.78 180.25

Capital ( including share premium) Internal Accruals -Total ( including accruals) 85.78

Capital 85.78 internal

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Unsecured loans Term loan Total

58.62 144.40

9.83 300.00 404.30

68.45 300.00 548.70

Renewal of Working Capital Limits Nature FB NFB Total

(All amt in Rs. in lakh)

Existing Proposed 1050.00 50.00 1050.00 1250.00 50.00 1250.00

The calculation of working capital has been done on the basis of second method of Tandon Committee i.e
CALCULATION OF PBF PARTICULARS a) b) c) d) e) f) g) h) i) j) Chargeable Current Assets Other Current assets Total Current Assets (TCA) (a+b) Less: Other Current Liabilities Working Capital Gap (c-d) Minimum Stipulated NWC (25% of TCA as per `c above) Projected NWC PBF I (Item `e `f) PBF II (Item `e - `g) MPBF (lower of `h & `i)

2011 -12 PROJ./ 1909.74 108.83 2018.57 185.34 1833.23 504.64 583.23 1328.59 1250.00 1250.00

2012.13 Proj. 1900.39 162.91 2063.30 182.80 1880.50 515.82 630.50 1364.68 1250.00 1250.00

For Term Loan Fresh sanction of Term Loan of Rs.300 lakh as under:
Purpose Modernization involving construction of building (including civil work) and installation of Plant & Machinery 81

Cost of Project Total Debt Promoters Contribution Proposed TL (our share) DER DER (Quasi) Repayment Period Door to Door Tenor

548.70 300.00 248.70 300.00 2.04:1 1.21:1 58 Months 68 Months

ii) Review/ continuation of existing 3 term loans having present O/s of Rs.916.15 lakh.

Repayment Schedule
20 graduated quarterly installments wef. June 2012 as detailed hereunder:

8 quarterly installments of Rs.10 lakh each wef. June 2012. 12 quarterly installments of Rs.18.33 lakh each (last installment to be of Rs.18.37 lakh) wef. June 2014. Interest during the implementation period and thereafter to be repaid as & when levied.

Technical and Economical Viability

The average DSCR ratio of projections from 31.3.12 to 31.3.17 is 2.67, which is quite acceptable. In sensitivity analysis when sales has reduced to 5% it has been found that profit after tax is positive and is in increasing order, average DSCR is also 1.70 which is satisfactory In sensitivity analysis when expenses are increased by 5% it has been observed that profit after tax is positive and average DSCR is 2.06 which is quite satisfactory.
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In sensitivity analysis when expenses are increased by 5% and sales are reduced by 5% it has been found that profit after tax is positive in long run and average DSCR is 1.09 which is acceptable.

Keeping in view the present industry scenario and state of competition in the market and the present and future scenario of the project it is ascertained that the project is technically feasible and economically viable.

12.6 RECOMMENDATIONS
On examining the request of the Company, the following were observed: The Management of the company is well experienced. The Company has been in operation for past 40 years and has been earning profits continuously. The company has good track record in dealing with Banks. The overall financial position of the company is satisfactory. Keeping in view the increasing profitability and financial position of the company, the following are recommended: Enhancement of FBWC limits from Rs.1050 lakh to Rs.1250 lakh and renewal of NFB limits of Rs.50 lakh with overall ceiling of Rs.1250 lakh (existing Rs.1050 lakh). Fresh sanction of Term Loan of Rs.300 lakh. Review/ continuation of existing 3 term loans having present O/s of Rs.916.15 lakh.
Approval of 25% relaxation in applicable Processing Fee for FBWC limits and

Upfront Fee for proposed Term Loan of Rs.300 lakh. 25% relaxation in applicable Review Charges for existing Term Loans.

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CHAPTER 13 CONCLUSION & RECOMMENDATIONS

CONCLUSION
The study at PNB gave a vast learning experience to me and has helped to enhance my knowledge. During the study I learnt how the theoretical financial analysis aspects are used in practice during the working capital finance and term loan assessment. I have realized during my project that a credit analyst must own multi-disciplinary talents like financial, technical as well as legal know-how. The credit appraisal for business loans has been devised in a systematic way. It is a process of appraising the credit worthiness of loan applicants. Thus it extremely important for the lender bank to assess the risk associated with credit; thereby ensure the security for the funds deposited by the depositors. There are clear guidelines on how the credit analyst or lending officer has to analyze a loan proposal. It includes phasewise analysis which consists of 6 phases: 1. Financial statement analysis 2. Working capital and its assessment techniques 3. Techno Economic Feasibility Analysis 4. Credit risk assessment 5. Documentation 6. Loan administration Punjab National Banks adoptions of the Projected Balance Sheet method (CMA) of assessment procedures are based on sound principles of lending. This method of assessment has certain flexibility required to avoid any rigid approach to fixing quantum of finance. The PBS method have been rationalized and simplified to facilitate complete flexibility in decision-making. To ensure asset quality, proper risk assessment right at the beginning, is extremely important. That is why Credit Risk Management system is an essential ingredient of the Credit Appraisal exercise. PNB has formulated a Credit Risk Rating model, PNB Trac. It considers important parameters like profitability, repayment capacity, efficiency of the unit, historical / industry comparisons etc depending on the industry. PNB Trac is one of the best rating models present till date.

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FINDINGS
After completing the entire project at Punjab National Bank the following key findings as mentioned below were observed. At Punjab National Bank, Circle Office the priority to appraise a proposal was given to new or fresh clients over the existing clients presenting proposals for renewal. Ratings, as being performed at PNB, are done once a year. Therefore, the ratings do not take into account short term drastic changes like price level changes (which are an issue with any method based on accounting statements, since annual reports are based on historical cost basis of accounting and other changes like sudden mishap/ of the counterparty are not readily accounted for by the rating system due to long lag between repeat ratings on the same account. Some of the parameters in Business and industry evaluation are based on the information provided by company, which in some cases may not be sufficient. No specific guidelines are followed in such cases. Also, some of the parameters here may be rendered redundant in some cases and may push up/ push down the rating needlessly in these cases. The present risk rating model does not have any mechanism to prioritize certain sectors of the economy. There are certain sector in the economy where risk spread is low and certain sectors where spread of risk is high like real estate. Also, there are certain infrastructural projects which need to be prioritized. The risk rating model is not flexible to incorporate all these issues. With the deregulation of the financial sector, the ability of the banks to service the credit requirements of the SME sector depends on the underlying transaction costs, efficient recovery processes and available security. There is an immediate need for the banking sector to focus on credit and finance requirements of SMEs.

RECOMMENDATIONS
The Credit Department at PNB Circle Office Meerut, works at its full potential and the staff is highly experienced and has a very strong intuitive sense. So, there is no such recommendation on the entire process. However to make the process more flexible and efficient, an electronic database should be designed carrying all the available and important information related to the proposals accepted, and it should be easily
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accessible to the Credit Department. This will help reduce paperwork and loss of information.

LIMITATIONS
Like any other study this study too is not free from limitations. The major limitations of the study are listed below: 1. The major limitation of this study shall be data availability as the data is proprietary and not readily shared for dissemination.
2. Also the geographical scope of the project was limited to PNB Circle Office and

the loans studied were of solely of businesses established majorly in NCR. 3. The credit appraisal decision are more of intuition and experience and since the time period was limited, hence best efforts were made to grasp the process as much as possible.
4. Due to ever changing environment, many risks are unexpected and the remedial

measures available are based on general experience from the past. Therefore risks can only be minimized cannot be erased completely. Hence, out of the various ways in which risks can be managed, none of the methods is perfect and may be very diverse even for the work in a similar situation in the future.

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REFERNCES

PNB Journals (For internal circulation only)

Credit Management & Risk Policy for the year 2008-09 Book of Instructions on Loans, March 2005 Loans & Advances Circulars on
Base Rate

Project Finance Industry Rating Loaning Powers and Guidelines for exercising such powers

RBI Circulars and Guidelines

Guidelines on Credit Appraisal Basel I Accord Basel II Accord Base Rate

__________________________________________________________ _

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