Banking Credit Basics

  • Banks are formal financial institutions that accept deposits and provide loans/investments, playing a vital role in economic activities like agriculture, industry, and trade.
  • Lending is the primary source of profit for banks, through interest, commission, and processing charges.
  • The difference between interest earned on loans and paid on deposits is called the spread, crucial for a bank's profitability and health.
  • Loans facilitate economic growth by funding agriculture, industry, and other sectors, contributing to the country's GDP.
Sector Classification of Lending
  • Priority Sector Lending:
    • Loans for developmental activities prioritized by the Government of India, such as agriculture, MSMEs, education, housing, and micro credit.
    • RBI sets targets and regulations for banks under this segment.
  • Non-Priority Sector Lending:
    • Loans that do not fall under the priority sector, including consumption loans, large industrial and trading activities, purchase of consumer durables, and personal vehicles.
Purpose Classification of Lending
  • Term Loan:
    • Sanctioned for acquiring fixed assets like land, buildings, plant, machinery, and furniture.
  • Working Capital Loan:
    • Given to meet day-to-day industry/trade requirements such as raw materials, labor, electricity, and transportation.
    • Usually demand loans.
Period Classification of Lending
  • Demand Loans:
    • Payable on demand by the bank without installment facilities.
    • Examples: Loan on Deposits (LOD), Crop loans, Cash Credit, Temporary Overdraft (TOD), Overdraft (OD), Bills/Cheque purchase.
    • Repayment generally within one year, sometimes in lump sum.
  • Term Loans:
    • Repaid over a period in installments.
    • Medium Term Loans: Repaid in 3-5 years.
    • Long Term Loans: Repaid in installments over a longer period.
    • Equated Monthly Installments (EMI): Fixed monthly payments including installment and interest, common for Home Loans, Vehicle Loans, and Consumer Loans.
Security Classification of Lending
  • Secured Loans:
    • Loans backed by securities, which can be primary or collateral.
    • Primary Security: Asset created/purchased out of the loan (e.g., car for a Car Loan, house for a Housing Loan, stock for a Trading Loan).
    • Collateral Security: Additional security when primary security is weak or confidence in the borrower is low (e.g., house property for a trade advance, third-party guarantee for an Educational Loan).
  • Unsecured Loans:
    • Loans without security, typically for small amounts like consumption loans, salary loans, pension loans, and educational loans up to Rs 4 lacs.
Purpose Classification of Lending (Detailed)
  • Production Purpose Loans:
    • Given for activities generating income for the borrower (e.g., Agriculture Loan, Trade Loan, loan to a doctor for setting up a clinic).
  • Consumption Purpose Loans:
    • Given for purchasing consumer durables or other purposes without income generation (e.g., loans for purchasing consumable durables), enhancing people's standard of living.
Deployment of Bank's Funds
  • Fund Based Facilities:
    • Involve deployment of bank funds (e.g., working capital, home loan, bills purchased).
  • Non-Fund Based Facilities:
    • Do not involve immediate funds deployment (e.g., Bank Guarantee and Letter of Credit (LC)).
Segment Classification
  • Corporate Credit:
    • Loans to large corporate entities for business, trade, export etc.
    • Usually large quantum loans, subject to concentration risk.
  • Retail Credit:
    • Personal segment loans like Housing, Vehicle, Education, and loans for small traders and MSME sector.
    • Risk is spread, and profit margin is high, but operational cost is higher than corporate loans.
Features of Loan
  • Target Group:
    • Banks offer different types of loans to a specific group of people.
    • Agricultural loans targets agriculturalists, pension loan targets pensioners, trade loans target traders.
  • Purpose of the Loan:
    • All loans are given for some specific purpose, either for acquiring fixed assets, working capital needs, consumption purpose etc.
    • Banks cannot finance for purposes which are not allowed by Reserve Bank of India.
  • Quantum of Finance:
    • The amount of loan being financed calculated on the requirement of the borrower and his repayment capacity.
    • For housing loan, loan will be based on monthly NTHP criteria (as applicable).
    • For an MSME or business, this is fixed as 20% of the future sales or 75% of the working capital gap (difference between current assets and current liabilities).
    • Upper limit exists on borrowing.
  • Margin:
    • The amount contributed by the borrower (15-25% of the asset cost).
    • Certain loans are margin free, salary loan, pension loan, agriculture loan up to Rs 1.60 lac.
  • Security:
    • Banks insist on security, either primary or collateral.
    • Features of a security are:
      • Liquidity (convertible into cash easily)
      • Marketability (no legal or other constraints for selling)
      • Salable value (no deterioration in value)
    • Some advances do not require security such as consumption, salary, pension, or education loans (up to Rs 4 lacs).
  • Rate of Interest (ROI):
    • Bank is having Base Rate, BPLR (Old Loans), MCLR, and Repo Linked Rates.
    • Fresh Retail, MSME and renewal sanctions of MSME working capital loans are linked to repo rate.
    • Rural Banking Products are linked to MCLR.
    • The rate of interest is fixed by the bank depending on the nature of advance, risk factors, availability of security etc.
    • Lower ROI for Agricultural Loans, Export Finance, Loans given to people below the poverty line.
    • Non-priority loans have higher ROI.
  • Repayment Period:
    • Loans repaid in installments or in lump sum depending on demand loan or term loan.
    • Repayment is fixed depending on income generated.
    • Moratorium period (Holiday Period) is allowed (interest only during this period).
    • Repayment period also fixed on the economic life of the asset.
    • For crop loans, "cushion period" is given for marketing of the harvested produce, which succeeds the harvesting of the crop.
  • Charges for the Loan:
    • Processing fee, advocate fee, Engineer’s valuation fee, prepayment fee etc. charged on loans.
    • Depending on case to case basis concession/waiver may be allowed on such charges
Different types of fund based loan facilities offered by Bank:
  • Loan on Deposits:
    • 90% of the current value of the deposit is given as loan.
    • On maturity, the loan will be adjusted and the balance will be paid to the customer.
    • Banks charge 1% extra interest than the deposit on the loan raised.
    • No loan is given against deposits of the deceased, and special care is given for minor children deposits.
  • Loan on Gold Jewels:
    • Customers raise loan against security of jewels ranging from agriculture to consumption purpose.
    • The ROI applicable is as per the purpose.
    • A margin of 30%, 15% (Agri Jewel Loan up to 35 lakhs), 25%(OD against Jewel Loan) is kept on the market value of jewels.
    • Exercise caution to ensure that loan is not sanctioned against spurious jewels and stolen jewels.
  • Temporary Overdraft (TOD):
    • On the current account of the customers, for a very short period (one week) carrying higher interest rate.
    • Given on select cases only. Now allowed to Below Poverty Line (BPL) category of people under the financial inclusion plan also.
  • Over Draft:
    • Against the security of bank deposits, shares, government securities, property etc. to meet the working capital requirements of industry and trade.
    • The period of overdraft is for one year, which is to be renewed every year after review.
    • A margin ranging from 25% to 50% is stipulated depending upon the purpose and nature of security.
  • Open Cash Credit (OCC):
    • Against the security of stocks, insists margin of 25-30% on the value of the stocks for working capital requirement needs.
    • Sanctioned limit operates with credit and debit operations, unlike in term loan where only one-time debit is allowed and installments has to be remitted.
    • Assessment is made based on financial statement strength.
  • Term Loan:
    • For acquiring the fixed assets, purchase of house property, agriculture activities and consumable durables.
    • Repayable on installments varying from 3 years to 30 years.
    • Interest is charged on the principle balance outstanding after installments which is called diminishing balance method.
    • Margin ranges from 10 -25% of the value of assets insisted.
    • Loan to Value (LTV) is maximum 75% (margin 25% minimum).
  • Bills or Cheques purchased/discounted:
    • Facility extended to borrowers as a post sales finance.
    • The sales proceeds will be collected via bills purchase or bills discounted and cheque purchase facility.
    • Banks earn interest and commission on such transactions and such loans are liquidated automatically on due date
Different types of non fund based loan facilities offered by Bank:
  • Guarantee:
    • If the client defaults, bank’s guarantee pays the amount to the beneficiary.
    • The bank’s funds are not involved currently but may fall back on the bank in future with contingent liability of funds.
    • Banks earn commission by extending such facilities.
  • Letter of Credit (LC):
    • The bank makes good the payment in the default of the client under international trade terms.
    • Banks earn commission on LCs opened on behalf of their clients.
Steps in lending
  1. Take specified application form.
  2. Appraisal:
    • Pre-sanction survey by Personal discussion / Market report / Visit to office / factory /
      field.
    • Verify evidence of track record.
    • Verification of Assets & Liabilities report.
    • Preparation of Credit report.
    • Analysis of Project Cost - Promoter / Bank Loan / Other sources.
  3. Sanctioning of loans
  • Basics of Lending
    • 5 Cs
      • Character
      • Capacity
      • Capital
      • Collateral
      • Conditions
    • Borrower appraisal
      • 3 Ps
        • Person
        • Process
        • Product
      • 3 Ms
        • Men
        • Method
        • Market
    • Project / Activity appraisal
      • Managerial
      • Technical
      • Financial
      • Commercial
    • Security appraisal
      • Types
        • Personal
        • Tangible
        • Primary
        • Collateral
      • Characteristics
        • Marketability
        • Title
        • Value
        • Transferability
        • Yield

Selection and Appraisal of the Borrower:

  • Deposits and Advances are two sides of the Banking coin.

  • Banks have to pay back on demand the deposits with interest to the depositors.

  • Banks have to lend to the right person at right time for the right product and the right amount.

  • Lending should be in line with industrial benchmarking, with effective credit management to build a good portfolio.

  • Credit Management is vital step in clearing:

    • Credit Marketing and Selection of customer: Banks can do the right selection of customer only by going to the field.
    • KYC – Know Your Customer Details about the customer to be obtained. (i.e.,) Who, Where and What
      • Who are you?: Photo ID (Issued by employer, Aadhaar, Voter ID, Passport, Existing Bank Pass Book with photograph)
      • Where are you from?: Address Proof (Ration Card, Pass Port, Land line telephone bill, Driving License, LPG Bill)
      • What are you?: Assessing the status of the customer
    • Purpose and Repayment
      • The purpose of the loan
      • Source of repayment
      • Tenor of the Loan

  • Credit Portfolio segments and their products:

    • Large corporate
    • Mid corporate
    • Micro Small Medium Enterprises
    • Agriculture
    • Trade
    • Retail Segment

  • Product & Promoter Credit Appraisal consist of two important matrix points to be considered:

    • PRODUCT
    • PROMOTER

  • Product analysis: Product to be analyzed by considering the following points.

    • Promoter : Expertise and Experience
    • Process flow: Technology used, Availability of other infrastructure like skilled and semi-skilled labor, water, transport facilities, proximity to the raw materials, power etc.
    • Production : Capacity matching the market demand, storage (Fixed Assets, Technology, Other infrastructures like labor, power, proximity to raw materials, Government PolicyFinancial and Technical Viability)
    • Sales : Demand, Orders on hand
    • Price : In line with market conditions, Profit and profitability
    • Market : Business cycle, Competition, Pilot study, entry of substitutes
    • Viability : Financial, Technical, Commercial and Economic

  • Appraisal of the promoter:

    • Character - Priority to avoid frauds and willful defaults
    • Capacity - Experience and Expertise
    • Capital - Margin brought–owner’s contribution to the project
    • CIBIL, Equifax, Experian, CRIF HIGHMARK (CIC)

  • Management appraisal:

    • Skill in managing the project should be considered before financing.
    • Bank’s interest need to be safeguarded by collateral securities and guarantees.
    • Application to be in the bank’s appropriate format with unnecessary data avoided.

  • Types of Customers:

    • Individual
    • Sole Proprietor
    • Partnership
    • Private Limited Company
    • Public Limited Company
    • Trust

  • Asset and liabilities statement is important supporting document to the application:

    • Correct data to be furnished in customer’s A & L form with customer’s name, address, and his descriptions on lands, buildings, liquid assets, liabilities with full information

  • Credit report:

    • Reflect a realistic picture of customer’s position with the banker and his satisfaction of customer’s financial position.

  • Selection of Borrower and appraisal is more vital one where can avoid the probable Non Performing Asset.

Reading A Balance Sheet & Projections:

  • Product – Production Capacity, other infrastructures, technical know-how, Financial viability.

  • Promoter - Experience /Expertise.

  • Market - Segment (Buyers & Orders on hand)/ Competitors /Substitute.
    Process - Latest / necessary technology applied.

  • Marketing - How the product / brand is received by Market.

  • Price - Profit /Profitability.

  • To understand the balance sheet and reading the projections before making a judgement about the organization that seeks a loan from a bank.

  • What is Business:

    • Converting cash into non-cash items and again converting into better cash and the purpose of a business is to make profit.

  • What is balance sheet?

    • Equating sources and application of money in the business. A balance sheet is drawn (1) to assess whether the business has earned profit or incurred loss and (2) to know how the business is financed and where it is invested.

  • Components of the Balance sheet:

    • There are seven components in a balance sheet. On the Liabilities side, (a) Total Net worth (b) Term Liabilities and (c) Current Liabilities. On the Assets side, (a) Fixed assets (b) Non-current assets (c) Intangible assets and (d) Current assets

  • Fixed assets:

    • Assets with (i) Land & Building, (ii) Plant & Machinery, (iii) Furniture & Fixtures, ( iv) Vehicles, (v) Capital work in progress (vi) Railway siding.

  • Non Current assets:

    • The assets include, (i) Long term investments. (Property, Bonds, Shares Government Securities, Mutual Fund (held to maturity), (ii) Investment in subsidiaries and (iii) Security Deposits.

  • Intangible Assets:

    • Assets include, (i)Goodwill, (ii)Brands, (iii)Trademarks, (iv)Computer software, (v)Copy rights, (vi)Patents, (vii)License, (viii)Franchise, (ix)Preliminary expenses and (x) P & L debit balance.

  • Balance Sheet and Profit and Loss Accounts:

    • These are the basic financial statements of a Business Enterprise and Financial statements can provide valuable insights into a firm’s performance.

  • Balance Sheet reflects financial position of a firm as on a particular date.

  • Long Term assets are funded by long term liabilities (Capital, Term Liability etc.)

  • Contents of a Profit and Loss Accounts

    • All the expenditures are met out of the revenue earned, and there is a surplus, then the firm enjoys profit. This is carried over as retained earnings to the capital in balance sheet.

  • Funds Flow Statement.

    • A tool for analyzing the Balance Sheet. Two consecutive years balance sheet of a firm are to be compared to verify as to how the funds flow has taken place.

  • Some important Accounting Ratios:

    • Important tool for measuring the financial position of a firm. Ratios are a comparison of the numerator with the denominator.

  • Accounting Ratios can be categorized into the following areas:

    • Liquidity Ratios
    • Solvency Ratios
    • Leverage Ratios
    • Profitability Ratios and
    • Activity Ratios

  • Liquidity Ratios:

    • Higher the ratio, better the liquidity position of the Company.
      • Current Ratio = CurrentAssetsCurrentLiabilities\frac{Current Assets}{Current Liabilities}
      • Quick Ratio = CurrentAssets–Inventory(stock)CurrentLiabilities{Current Assets – Inventory (stock)}{Current Liabilities}

  • Solvency Ratios:

    • {Earnings before interest, Depreciation and Tax} / Interest
    • {Net Profit after Tax + Depreciation + interest on Term Loan} / {Interest on Term Loan + Installment on Term Loan}

  • Leverage Ratios:

    • Debt Equity Ratio (DER) = \frac{Long Term Debt}{Tanible Net Worth}
    • Total Indebtedness Ratio: TOL/TNW =. \frac{Total outside Liabilities}{Tanible Net Worth}
    • FACR = \frac{Net Fixed Assets}{Long Term Debts or Term Loan}

  • Profitability Ratios:

    • Gross Profit Margin =GrossProfit×100/ Net Sales{ Gross Profit \times 100} /{\text { Net Sales}}
      Net Profit Margin= NetProfit×100/Net Sales{Net Profit \times 100} /{\text{Net Sales}}

  • Activity Ratios: Stock Rotation

    • Evaluate the efficiency of the firm in rotating various assets to reach the level of sales.
      • Inventory Stock Turnover Ratio =${\text{Sales}} \over{\overline{\text{Average Inventory}}}}
      • Debtors Velocity = {\text{Receivables \times (12 or 52 or 365 in months, weeks or days)}}} / {\text{Average Monthly Credit Sales}}}
      • Creditors Velocity= { \text{Sundry Creditors \times 12 or 52 or 365 in months, weeks or days}} / {\text{Average Monthly Credit Purchases}}}

  • As per loan policy Bench Mark Values are given for the following ratios: Current Ratio; Debt Equity Ratio; TOL / TNW (Total Indebtedness Ratio); Debt Service Coverage Ratio; Interest Coverage Ratio; Fixed Assets Coverage Ratio.

Working Capital Assessment::

  • To introduce methods of assessment of Working Capital and confident to lend for Working Capital.

  • the Current Asset holding of an enterprise with the money required for the day to day functioning of a business. It is also sometimes called the Gross Working Capital.

  • Unit specific internal factors like operating efficiency, technology employed and the level of quality control may impact the size of working capital requirements major factors of production. External factors like Demand and Supply, nature of activity, availability of production inputs like Raw Material, Labour, Power and Fuel and availability of Credit also affect the requirement of working capital in a business
    *Every rupee invested in Current Assets at the beginning of the cycle comes back to the promoter with the profit element added, after a lapse of a specific period of time This length of time is popularly known as the Operating Cycle or the Working Capital Cycle

  • How to measure the Operating Cycle?

    • The operating cycle is generally measured in terms of days of average inventory held for every major category of working capital components.
    • The major activities are purchase of raw material, processing, finished Goods, and sundry debtors.
    • The are three methods of assessment of working capital are, 1.
      • Turnover Method
      • MPBF(Maximum Permissible Bank Finance) Method (Tandon Committee Second Method of Lending)
      • Cash Budget System

  • Turnover Method:

    • Presumed: the Working Capital requirement of the unit is 25% of the Projected Turnover and out of the 25%, 20% Bank Loan and 5% Margin, which is also known as Net Working Capital.

  • Maximum Permissible Bank Finance method - MPBF Method

    • MPBF = (Current Assets Less Other Current Liabilities) Less 25% of Current Assets.

  • Modified MPBF Method:

    • method will be applicable, where working capital facilities are secured by 100% collateral (Collaterals should be in the form of Liquid assets and Land and Buildings

Term loan appraisal comprises:

  • Management Appraisal

  • Technical Appraisal

  • Commercial Appraisal

  • Financial Appraisal

  • Economic Appraisal.

  • Technical parameters for technical appraisal:

    • Location, Environment production, Type of technology used etc

  • Commercial parameters for service or product appraisal:

    • product sustainability, competition, demand scope for diversification

  • Financial parameters for viability analysis:

    • Financial structure, sources of margin, generated from debt service
    • Various Ratios and other ratios

  • The goal of assessment is to ensure optimal capital structure.

  • Break even analysis.

    • Determining the point where total revenue equals product costs & is low fixed costs vs high or viability.

  • Payback period

    • Payback = \frac{\text{Total Investment}}{\overline{\text{Cash flow per annum}}}$$
    • If Payback low period project viable lesser than the life of the project itself.

  • Current ratio:

    • For short term viability
    • Current Ratio = \frac {(Current assets)}{Current Liabilities} \
      • 1.33:1

  • Debt Equity Ratio

    • {Total Term Liability /(Equity)}
    • 2:1 is normally accepted.
      *Net Present Value-Method (NPV)
      Present Value = \[\frac{ \text{Future sum}}{(1+i)^ eta}\]- if exceed the investment, the project is viable.

  • This ratio indicates the ability of the firm to meet liability and is derived as:
    { Total outside liability /Tangible Net Worth is 3:1
    Debt Service Coverage Ratio =( Net Profit after Tax+ Interest on Term Loan) /( Interest on Term Loan+ installment on Term Loan)= 1.50:1not below 1.25:1at any point of time
    *For Financial stability and better assessment with a SWOT analysis (Strength, Weakness,
    Opportunity and Threat).

Important Structured Loan Products

  • It is easy to remember any product, if you just know PQRSTMAI.

    • (Purpose, Quantum, Repayment, Security, Targeted beneficiary, Margin, Age limit, Insurance).

  • Personal Loans: CIBIL/CIC reports is to be checked before sanction, KYC to be updated and scoring is to be done, here are the following types of loans considered:

    • Pension Loan
    • Jewel Loan
    • Home Loan
      • PM-Surya Ghar
      • IB HOME IMPROVE.
      • IB HOME LOAN PLUS
      • LOAN FOR PURCHASE OF HOUSESITE
      • IB REVERSE MORTGAGE
      • IB RENT ENCASH
      • INDMORTGAGE
    • Education Loan
      • IBA SKILL LOAN SCHEME
    • Vehicle Loan
    • IB CLEAN LOAN TO SALARIED CLASS SCHEME (IBCLS)
    • LOAN AGAINST NSC / KVP / LIC / RBI BONDS
    • Credit Cards
      • VISA Global Gold, Platinum Cards, Rupay-Select, Platinum & Classic
      • Indian Bank customers having satisfactorily conducted accounts and KYC Compliance
      • Business Cards
      • Secure Cards
Trade finance

*It is the process of financing for trading activities both wholesale and retail (domestic and international). It is basically to improve their stock and book debts, in the form of working capital and non fund based limits & Term Loan for acquiring fixed assets for trade activity. The latest modification was done as Tradewell scheme

  • All Trading Units classified under MSME with 1 year experience / 75% collateral can apply with purpose for Working Capital needs/ Term Loan for acquisition of fixed asset, modernization of business place/office. Can get Fund Based facilities ranging from : OCC / EPC / Term Loan / Secured OD / IBN / FBN / FBP & Non-Fund Based: LC / BG.
  • To get the eligible TradeWell limit, assessment of Working Capital limits under MSME Policy to be complied with securities like Secured OD/ EM of properties/ Other Tangible Security i.e. Our Bank Deposits with personal guarantee, at ROIs based on immovable / liquid security
Rural Lending
  • To understand the agricultural activities done by the bank.
    To reach the rural market segments which are agriculture finance product are KCC, SHG, Govt. sponsored schemes. Jewel loan
  • RBI’s definition all farmers, tenant farmers and SHGs by KCC for short term and long term credit needs to buy Agri implements, farm maintenance, unforeseen family expenses with Govt’s subvention scheme, in addition Agri Jewel Loan Products are available.
    • Kisan Credit Card (KCC) Scheme:
      • Validity: 5 years subject to an annual review.
      • Rate of Interest (ROI): *Up to Rs.3.00 lakhs - 7%. *(Wherever Interest Subvention is available*).
      • Security: Hypothecation of crops up to card limits of Rs 1.60 lakh
        *The salient features of Allied KCC scheme are about KCC SHGs’ financial assistance to the participants in activities such as Poultry , fisheries, sericulture and mushrooms with term up to a period fixed by the District Level Technical Committee ..
        *Credit support of groups’ structure of SHG in the grading of groups from 1-4 times based on various criteria over a period time frame , such financial matrix and interest is charged by Bank
  • In all these, Government Sponsored Schemes give focus is on the economic growth, entrepreneurship. subsidy levels based on different criterions such as PMRY from 2008, Credit is through KVIC’s etc, ,PMEGP,DICCI etc . The salient are high incentives from central for MSME sector through collateral free funds
MSME Financing

  • Role in momentum for economic growth in overall GDP, 45 % of manufacturing output, provides employement opportunities and latest modification are GOI MSME Registration and including in Retail and Wholesale trades.

  • It includes Credit Guarantee Fund for Micro Units ( MUDRA ) for collateral free based for all NBFCs

  • It follows a range of Products from prime to collateral securities through Credit Guarantee Schemes such as Mudra loans, OD under PMJDY, SHG above 10 lakhs with categories Shishu , Kishor and Tarun
    Modified MPBF, Cash Budgets and the most successful Tradewell Loans 300 and Loan-Prime of MUDRA

  • RBI’s guidelines include General info on what happens on what not for documentation to avoid discrepancies
    *Under this are also important programs for micro-financing and loaning facilities for all areas.
    The various credit structure as well for general structure has some important areas for

  • Working Capital/Assess the property’s value with MSME guidelines for various clauses such as
    Loans and the like

  • It also includes a review process ,legal audits and many parameters and factors.