The Banking Tutor

CAIIB Notes - Advanced Bank Management

Module D – Credit Management

001. Bank Credit can be either fund based or non-fund based.

002. in fund based credit, there is actual transfer of money from bank to
the borrower.

003. in non fund based credit, there is no transfer of money, but the
commitment by the bank on behalf of the client, may result in future
transfer of money to the beneficiary of such commitment.

004. a non fund based credit always has a possibility of getting converted
into a fund based credit.

005. Bank guarantees, letters of credit, o-acceptance of bills, forward

contracts and derivatives are various forms of non fund based credit.

006. the fund based credit is divided based on period (term or tenor) as
short term credit or long term credit.

007. credit also can be classified based on purpose like working capital
finance, project finance, export finance, agriculture finance etc.

008. Banks classify their credit portfolio based on customer type like
Corporate, Retail, Agriculture, International, Institutional etc.

009. the formulation of loan policy (credit policy) is influenced by various

factors such as market conditions, policies of competitors , bank’s own
SWOT analysis; RBI guidelines; exposure limits for borrowers; exposure
limits to sectors; discretionary powers at various levels.

010. Credit Appraisal Relates to examine character, capacity, purpose ,

risks involved, securities offered, government guidelines, feasibility of the
proposed activity, credit history of the applicant (proposed borrower), risk
grade of the borrower/activity.

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011. credit delivery relates to legal aspects of documentation, creation and
registration of charge over securities and procedures for disbursement of
the loan sanctioned.

012. control and monitoring relates to ensuring end use of the loan funds
and also safety of the loan.

013. credit default is possible due to genuine problems or due to

intentional (wilful) default.

014. refinance assumes importance in times of tight liquidity position.

015. even if bank avails refinance for eligible loans, the risk remains with
the bank only. therefore this aspect does not affect bank’s decision on a
credit proposal.

016. Priority Sector (Revised wef 04-09-2020) - The categories under

priority sector are as follows:

i. Agriculture // ii. Micro, Small and Medium Enterprises // iii. Export Credit
// iv. Education // v. Housing // vi. Social Infrastructure // vii. Renewable
Energy// viii. Others

017. The targets and sub-targets set under priority sector lending, to be
computed on the basis of the ANBC/ CEOBE as applicable as on the
corresponding date of the preceding year, are as under:

Categories Domestic commercial banks

Total Priority Sector 40 % of ANBC or CEOBE whichever
is higher.
Agriculture 18 % of ANBC or CEOBE, whichever
is higher; out of which a target of
10 percent is prescribed for Small
and Marginal Farmers (SMFs) #
Micro Enterprises 7.5 % of ANBC or CEOBE,
whichever is higher.
Weaker Sections 12% of ANBC or CEOBE,
whichever is higher.

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# Revised targets for Agriculture and SMFs will be implemented in a
phased manner.

018. Small and Marginal Farmers (SMFs)- For the purpose of computation
of achievement of the sub-target, Small and Marginal Farmers will include
the following:

i. Farmers with landholding of up to 1 hectare (Marginal Farmers).

ii. Farmers with a landholding of more than 1 hectare and up to 2 hectares

(Small Farmers).

019. Education - Loans to individuals for educational purposes, including

vocational courses, not exceeding ₹ 20 lakh will be considered as eligible
for priority sector classification. Loans currently classified as priority sector
will continue till maturity.

020. Housing Loans to individuals up to ₹35 lakh in metropolitan centres

(with population of ten lakh and above) and up to ₹25 lakh in other centres
for purchase/construction of a dwelling unit per family provided the
overall cost of the dwelling unit in the metropolitan centre and at other
centres does not exceed ₹45 lakh and ₹30 lakh respectively. Existing
individual housing loans of UCBs presently classified under PSL will
continue as PSL till maturity or repayment.

021. Housing loans to banks’ own employees will not be eligible for
classification under the priority sector.

022. Repairs & Renovation : Loans up to ₹10 lakh in metropolitan centres

and up to ₹6 lakh in other centres for repairs to damaged dwelling units
conforming to the overall costof the dwelling unit as prescribed.

023. Renewable Energy Bank loans up to a limit of ₹30 crore to borrowers

for purposes like solar based power generators, biomass-based power
generators, wind mills, micro-hydel plants and for non-conventional
energy based public utilities, viz., street lighting systems and remote
village electrification etc., will be eligible for Priority Sector classification.
For individual households, the loan limit will be ₹10 lakh per borrower.

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024. Definition of MSME ( with effect from 01-07-2020)

Classification of Enterprises :

An enterprise shall be classified as a Micro, Small or Medium Enterprise on

the basis of the following Composite Criteria of Investment in Plant &
Machinery or Equipment (PME) and Turnover.

(i) a Micro Enterprise is one where the investment in PME does not exceed
Rs 1 Crore and turnover does not exceed Rs 5 Crores.

(ii) a Small Enterprise is one in which the investment in PME does not
exceed Rs 10 Crores and turnover does not exceed Rs 50 Crores and

(iii) a Medium Enterprise is one in which the investment in PME does not
exceed Rs 50 Crores and turnover does not exceed Rs 250 Crore.

025. Retail and Wholesale Trade are included under the Micro Small and
Medium Enterprises (MSMEs) category from July 2, 2021.

026. Common guidelines for Priority Sector advances

Banks should comply with the following common guidelines for all
categories of advances under the priority sector.

(i) Rate of interest: The rates of interest on bank loans will be as per
directives issued by Department of Regulation (DoR), RBI from time to
time.

(ii) Service charges: No loan related and ad hoc service charges/inspection

charges should be levied on priority sector loans up to ₹25,000. In the case
of eligible priority sector loans to SHGs/ JLGs, this limit will be applicable
per member and not to the group as a whole.

(iii) Receipt, Sanction/Rejection/Disbursement Register: A register/

electronic record should be maintained by the bank wherein the date of
receipt, sanction/rejection/disbursement with reasons thereof, etc. should
be recorded. The register/electronic record should be made available to
all inspecting agencies.

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iv) Issue of acknowledgement of loan applications: Banks should provide
acknowledgement for loan applications received under priority sector
loans. Bank Boards should prescribe a time limit within which the bank
communicates its decision in writing to the applicants.

027. Inter-Bank Participation Certificates (IBPCs) is a short-term money

market instrument whereby the banks can raise money/deploy short-term
surplus. In the case of IBPC the borrowing bank passes/sells on the loans
and credit that it has in its book, for a temporary period, to the lending
bank

The Reserve Bank of India (RBI) has allowed private and foreign banks' to
treat their investments in inter-bank participatory certificates (IBPCs)
issued by public sector banks as direct lending to the priority sector. In
banking parlance, this arrangement is called inter-bank participation
certificate (IBPC).

028. Priority Sector Lending Certificates is a tool for promoting

comparative advantages among banks while they meet their priority
sector lending obligations in India.

The PSLC are issued by banks that have overreached their priority sector
lending targets (to the extent of their over lending to the stipulated
sectors) and bought by those banks who could not meet their priority
sector lending targets.

029. Credit exposure is a measurement of the maximum potential loss to

a lender if the borrower defaults on payment. .

030. RBI's prudential exposure norms mandate that a bank exposure to a

single borrower should capped to 20% of a lender's tier -I capital base and
to 25% limit to a group of connected entities with effect from April 1, 2019.

031. Base rate is the minimum rate set by the Reserve Bank of India below
which banks are not allowed to lend to its customers. Description: Base
rate is decided in order to enhance transparency in the credit market and
ensure that banks pass on the lower cost of fund to their customers.

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032. Benchmark Prime Lending Rate (BPLR) is the rate at which
commercial banks charge their customers who are most credit worthy.
According to the Reserve Bank of India (RBI), banks can fix the BPLR with
the approval of their Boards.

033. Marginal Cost of Funds based Lending Rate (MCLR) is the

minimum lending rate below which a bank is not permitted to lend. MCLR
replaced the earlier base rate system to determine the lending rates for
commercial banks. RBI implemented MCLR on 1 April 2016 to determine
rates of interests for loans.

034. RLLR (Repo-Linked Lending Rate) is an external benchmark,

wherein, the RBI's repo rate is used by commercial banks to calculate the
retail loan interest rate. RLLR of all banks comprises the prevailing repo
rate, tenure premium and pre-set spread or margin maintained for
adequate revenue generation.

035. MCLR is calculated internally by the bank on the basis of four

components – Marginal Cost of Funds, Cash Reserve Ratio (CRR), Tenure
Premium and Operating Costs.

036. In case of RLLR, the reset period is of 3 months.

037. The volatility or the frequency at which floating loan rates change
can be determined by whether they are linked to RLLR or MCLR. As per
RBI guidelines, the interest rates linked to RLLR are subject to revisions
every 3 months. In other words, any change in the repo rate will reflect in
a change in the RLLR of commercial banks every 3 months. The MCLR-
linked loan rates, on the other hand, are revised once every 6 or 12
months. Hence, the volatility of the loan rates linked to RLLR is more
compared to the volatility under the MCLR regime.

038. Reset Period: In case of MCLR linked home loans, the rest period is
usually 6 months or 12 months. This means that banks would revise their
MCLR every 6 or 12 months. A change in MCLR would accordingly change
the home loan interest rates and subsequently the housing loan EMIs.
Such a long reset period gives a time-lag to MCLR-linked loans.

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039. In case of RLLR, the reset period is of 3 months. This implies that your
interest rate of RLLR-linked loans would help to revise the EMIs every 3
months. This way, the borrowers would be able to enjoy the benefit of the
repo rate cut. However, in case of a rise in the repo rate, the loan rates will
also increase quickly.

040. Both Statutory Requirements and Regulatory Requirements are

those requirements that are required by law. These requirements are non-
negotiable and must be complied with. Failure to comply a legal
requirement may result in a fine or penalty and possibly a custodial
sentence for the person or persons responsible or organization for such
failure.

“Statutory refers to laws passed by a state and/or central government,

while regulatory refers to a rule issued by a regulatory body appointed by
a state and/or central government.”

Statutory requirements are those requirements which are applicable by

virtue of law enacted by the government. These are enacted by passing
the law in the legislative assembly or parliament. A regulatory requirement
can be termed as administrative legislation that

041. Statutory Restrictions on Credit

A) In terms of the Banking Regulation Act, 1949, a bank cannot grant any
loans and advances on the security of its own shares.

B) The Banking Regulation Act, 1949 also lays down the restrictions on
loans and advances to the directors and the firms in which they hold
substantial interest. (see next para for exceptions to this restriction).

However, the following are exceptions to the above Restriction.

i) loans or advances against Government securities, life insurance policies

or fixed deposit..

ii) such loans or advances as can be made to its director was an employee
of the bank on the same terms and conditions as would have been
applicable to him as an employee of that banking company.

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iii) such loans or advances to its Director who was not an employee of the
bank for purpose of purchasing a car, personal computer, furniture or
constructing/ acquiring a house for his personal use and festival advance,
with the prior approval of the RBI and on such terms and conditions as
may be stipulated by it;

C) In terms of provisions of the Companies Act, 2013, companies are

permitted to purchase their own shares or other specified securities out of
their (a) free reserves, or (b) securities premium account, or (c ) the
proceeds of any shares or other specified securities, subject to compliance
of various conditions specified therein. Therefore, banks should not
provide loans to companies for buy-back of shares/securities.

042. Steps banks follow in case of stressed assets

(a) Exit from the Account

(b) Reschedule/Restructure
(c ) Rehabilitation
(d) Compromise (OTS)
(e) Legal Action (Suit filing, DRT, SARFAESI Action)
(f) Write-off

043. Special Mention Accounts are those assets/accounts that shows

symptoms of bad asset quality in the first 90 days itself or before it being
identified as NPA. But some 'Special Mention' assets are identified on the
basis of other factors that reflect sickness/irregularities in the account
(SMA -NF).

044. A resolution plan is a proposal that aims to provide a resolution to

the problem of the corporate debtor’s insolvency and its consequent
inability to pay off debts.

045. TEV Techno Economic Viability

046. JLF Joint Lenders Forum

047. CDR – Corporate Debt Restructure.

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048. SDR – Strategic Debt Restructuring.

049. CAP – Corrective Action Plan.

050. JLF – EG - Joint Lenders’ Forum Empowered Group.

051. IEC – Independent Evaluation Committee.

ICRA (Master Circular of RBI dt 01-10-2021)

052. In line with the international practices and as per the

recommendations made by the Committee on the Financial System
(Chairman Shri M. Narasimham), the Reserve Bank of India has
introduced, in a phased manner, prudential norms for income recognition,
asset classification and provisioning for the advances portfolio of the
banks so as to move towards greater consistency and transparency in the
published accounts.

053. The policy of income recognition should be objective and based on

record of recovery rather than on any subjective considerations. Likewise,
the classification of assets of banks has to be done on the basis of
objective criteria which would ensure a uniform and consistent application
of the norms. Also, the provisioning should be made on the basis of the
classification of assets based on the period for which the asset has
remained non-performing and the availability of security and the
realisable value thereof.

054. An asset, including a leased asset, becomes non performing when it

ceases to generate income for the bank. Non performing asset (NPA) is a
loan or an advance where;

i. interest and/ or instalment of principal remains overdue for a period of

more than 90 days in respect of a term loan,

ii. the account remains ‘out of order’ as indicated at paragraph 2.2 below,
in respect of an Overdraft/Cash Credit (OD/CC),

iii. the bill remains overdue for a period of more than 90 days in the case
of bills purchased and discounted,

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iv. the instalment of principal or interest thereon remains overdue for two
crop seasons for short duration crops,

v. the instalment of principal or interest thereon remains overdue for one

crop season for long duration crops,

vi. the amount of liquidity facility remains outstanding for more than 90
days, in respect of a securitisation transaction undertaken in terms of the
Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021.

vii. in respect of derivative transactions, the overdue receivables

representing positive mark-to-market value of a derivative contract, if
these remain unpaid for a period of 90 days from the specified due date
for payment.

055. In case of interest payments, banks should, classify an account as NPA

only if the interest due and charged during any quarter is not serviced fully
within 90 days from the end of the quarter.

056. ‘Out of Order’ status

An account should be treated as 'out of order' if the outstanding balance

remains continuously in excess of the sanctioned limit/drawing power for
90 days. In cases where the outstanding balance in the principal operating
account is less than the sanctioned limit/drawing power, but there are no
credits continuously for 90 days as on the date of Balance Sheet or credits
are not enough to cover the interest debited during the same period,
these accounts should be treated as 'out of order'.

057. ‘Overdue’ Any amount due to the bank under any credit facility is
‘overdue’ if it is not paid on the due date fixed by the bank.

058. The policy of income recognition has to be objective and based on

the record of recovery. Therefore, the banks should not charge and take
to income account interest on any NPA. This will apply to Government
guaranteed accounts also.

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059. Interest on advances against Term Deposits, National Savings
Certificates (NSCs), Indira Vikas Patras (IVPs), Kisan Vikas Patras (KVPs) and
Life policies may be taken to income account on the due date, provided
adequate margin is available in the accounts.

Fees and commissions earned by the banks as a result of renegotiations

or rescheduling of outstanding debts should be recognised on an accrual
basis over the period of time covered by the renegotiated or rescheduled
extension of credit.

060. Reversal of income - If any advance, including bills purchased and

discounted, becomes NPA, the entire interest accrued and credited to
income account in the past periods, should be reversed if the same is not
realised. This will apply to Government guaranteed accounts also.

In respect of NPAs, fees, commission and similar income that have accrued
should cease to accrue in the current period and should be reversed with
respect to past periods, if uncollected.

061. Leased Assets - The finance charge component of finance income

[as defined in ‘AS 19 Leases’)] on the leased asset which has accrued and
was credited to income account before the asset became non performing,
and remaining unrealised, should be reversed or provided for in the
current accounting period.

062. Appropriation of recovery in NPAs - Interest realised on NPAs may

be taken to income account provided the credits in the accounts towards
interest are not out of fresh/ additional credit facilities sanctioned to the
borrower concerned.

063. Interest Application - On an account turning NPA, banks should

reverse the interest already charged and not collected by debiting Profit
and Loss account and stop further application of interest. However, banks
may continue to record such accrued interest in a Memorandum account
in their books.

064. For the purpose of computing Gross Advances, interest recorded in

the Memorandum account should not be taken into account.

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Asset Classification - Categories of NPAs

065. Banks are required to classify non performing assets further into the
following three categories based on the period for which the asset has
remained non performing and the realisability of the dues:

(i) Substandard Assets

(ii) Doubtful Assets
(iii) Loss Assets

066. Substandard Assets - with effect from March 31, 2005, a

substandard asset would be one, which has remained NPA for a period
less than or equal to 12 months. Such an asset will have well defined credit
weaknesses that jeopardise the liquidation of the debt and are
characterised by the distinct possibility that the banks will sustain some
loss, if deficiencies are not corrected.

067. Doubtful Assets - With effect from March 31, 2005, an asset would
be classified as doubtful if it has remained in the substandard category for
a period of 12 months. A loan classified as doubtful has all the weaknesses
inherent in assets that were classified as substandard, with the added
characteristic that the weaknesses make collection or liquidation in full, –
on the basis of currently known facts, conditions and values – highly
questionable and improbable.

068. Loss Assets - A loss asset is one where loss has been identified by
the bank or internal or external auditors or the RBI inspection but the
amount has not been written off wholly. In other words, such an asset is
considered uncollectible and of such little value that its continuance as a
bankable asset is not warranted although there may be some salvage or
recovery value.

Guidelines for classification of assets

069. Classification of assets into Standard & NPA categories should be

done taking into account the degree of well-defined credit weaknesses.

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070, Appropriate internal systems for proper and timely identification of
NPAs Banks should establish appropriate internal systems (including
technology enabled processes) for proper and timely identification of
NPAs,.

071. The availability of security or net worth of borrower/ guarantor should

not be taken into account for the purpose of treating an advance as NPA
or otherwise, except to certain exemptions.

072. Accounts with temporary deficiencies

The classification of an asset as NPA should be based on the record of

recovery. Bank should not classify an advance account as NPA merely due
to the existence of some deficiencies which are temporary in nature such
as non-availability of adequate drawing power based on the latest
available stock statement, balance outstanding exceeding the limit
temporarily, non-submission of stock statements and non-renewal of the
limits on the due date, etc.

073. Banks should ensure that drawings in the working capital accounts
are covered by the adequacy of current assets, since current assets are
first appropriated in times of distress. Drawing power is required to be
arrived at based on the stock statement which is current.

074. Stock statements relied upon by the banks for determining drawing
power should not be older than three months. The outstanding in the
account based on drawing power calculated from stock statements older
than three months, would be deemed as irregular.

075. A working capital borrowal account will become NPA if drawings are
permitted based on stock statement which is older than three months for
a continuous period of 90 days even though the unit may be working or
the borrower's financial position is satisfactory.

076. Regular and ad hoc credit limits need to be reviewed/ regularised

not later than three months from the due date/date of ad hoc sanction. In
case Regular and ad hoc credit limits need to be reviewed/ regularised not
later than three months from the due date/date of ad hoc sanction.

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In case of constraints such as nonavailability of financial statements and
other data from the borrowers, the branch should furnish evidence to
show that renewal/ review of credit limits is already on and would be
completed soon. In any case, delay beyond six months is not considered
desirable as a general discipline. Hence, an account where the regular/ ad
hoc credit limits have not been reviewed/ renewed within 180 days from
the due date/ date of ad hoc sanction will be treated as NPA.

077. Upgradation of loan accounts classified as NPAs - If arrears of

interest and principal are paid by the borrower in the case of loan accounts
classified as NPAs, the account should no longer be treated as non-
performing and may be classified as ‘standard’ accounts.

078. Accounts regularised near about the balance sheet date The asset
classification of borrowal accounts where a solitary or a few credits are
recorded before the balance sheet date should be handled with care and
without scope for subjectivity. Where the account indicates inherent
weakness on the basis of the data available, the account should be
deemed as a NPA. In other genuine cases, the banks must furnish
satisfactory evidence to the Statutory Auditors/Inspecting Officers about
the manner of regularisation of the account to eliminate doubts on their
performing status.

079. Asset Classification to be borrower-wise and not facility-wise

080. It is difficult to envisage a situation when only one facility to a

borrower/one investment in any of the securities issued by the borrower
becomes a problem credit/investment and not others. Therefore, all the
facilities granted by a bank to a borrower and investment in all the
securities issued by the borrower will have to be treated as NPA/NPI and
not the particular facility/investment or part thereof which has become
irregular.

081. If the debits arising out of devolvement of letters of credit or invoked

guarantees are parked in a separate account, the balance outstanding in
that account also should be treated as a part of the borrower’s principal
operating account for the purpose of application of prudential norms on
income recognition, asset classification and provisioning.

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082. The bills discounted under LC favouring a borrower may not be
classified as a Non-performing assets (NPA), when any other facility
granted to the borrower is classified as NPA.

083. However, in case documents under LC are not accepted on

presentation or the payment under the LC is not made on the due date by
the LC issuing bank for any reason and the borrower does not immediately
make good the amount disbursed as a result of discounting of concerned
bills, the outstanding bills discounted will immediately be classified as NPA
with effect from the date when the other facilities had been classified as
NPA.

084. Advances under consortium arrangements should be based on

the record of recovery of the individual member banks and other aspects
having a bearing on the recoverability of the advances. Where the
remittances by the borrower under consortium lending arrangements are
pooled with one bank and/or where the bank receiving remittances is not
parting with the share of other member banks, the account will be treated
as not serviced in the books of the other member banks and therefore, be
treated as NPA.

085. Accounts where there is erosion in the value of security/frauds

committed by borrowers

086. In respect of accounts where there are potential threats for recovery
on account of erosion in the value of security or non-availability of security
and existence of other factors such as frauds committed by borrowers it
will not be prudent that such accounts should go through various stages
of asset classification. In cases of such serious credit impairment, the asset
should be straightaway classified as doubtful or loss asset as appropriate:

a) Erosion in the value of security can be reckoned as significant when the

realisable value of the security is less than 50 per cent of the value assessed
by the bank or accepted by RBI at the time of last inspection, as the case
may be. Such NPAs may be straightaway classified under doubtful
category.

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b) If the realisable value of the security, as assessed by the bank/ approved
valuers/ RBI is less than 10 per cent of the outstanding in the borrowal
accounts, the existence of security should be ignored and the asset should
be straightaway classified as loss asset.

087. Banks should normally provide for the entire amount due to the bank
or for which the bank is liable (including in case of deposit accounts),
immediately upon a fraud being detected.

088. Banks shall make suitable disclosures with regard to number of frauds
reported, amount involved in such frauds, quantum of provision made
during the year and quantum of unamortised provision debited from
‘other reserves’ as at the end of the year.

089. Advances against term deposits, NSCs eligible for surrender, IVPs,
KVPs and life policies need not be treated as NPAs, provided adequate
margin is available in the accounts. Advances against gold ornaments,
government securities and all other securities are not covered by this
exemption.

090. The assessment of working capital requirement of a borrower shall

generally be made under any one of the following 3 methods:

(i) Turnover method ; (ii) MPBF System (iii) Cash Budget System

091. Turnover method - The idea of the turnover method is originated

in the P R Nayak Committee Recommendations which was again
reviewed by the Vaz Committee. Under this method, the working capital
limit shall be computed at 20% of the projected gross sales turnover
accepted by the Bank.

Under this method, the eligible Fund based credit limit shall be computed
at 20% of the projected gross annual sales turnover accepted by the Bank
ensuring maintenance of minimum margin of 5% on the projected gross
annual sales turnover accepted by the Bank.

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If the available NWC in the system exceeds stipulated 5% minimum
margin, the same shall be reckoned for assessing the extent of Bank
finance and limits will be determined accordingly.

However, borrowers can opt for MPBF/Cash budget system and Bank can
employ it if the same is more suitable and appropriate for assessing their
working capital needs.

Actual drawings will be based on drawing power computed.

As the working capital requirements are linked to projected turnover,

branches should satisfy themselves about the reasonableness of the
projected annual turnover of the applicant. This should be done with
reference to the past performance of the units, as reflected in the audited
financial statements, the orders on hand, installed capacity of the units,
power, availability of raw materials and other inputs and infrastructural
facilities.

In the case of new units, branches should ensure that the projections made
are realistic by analysing the installed capacity, availability of
infrastructural facilities, marketability of the product and performance of
similar units in the industry, background of the promoter etc., and such
other factors relevant to a particular unit.

092. MPBF (Maximum Permissible Bank Finance) Method

Under this method, the assessment of Working Capital finance

requirement is made based on the overall study of the borrower‘s business
operation, the operating cycle of the industry which results in estimation
of a reasonable build up of current assets supported by Bank finance.
Here, proper classification of current assets and current liabilities shall be
made on the lines given in the CMA (Credit Monitoring Arrangement)
data format and Method II of lending will be applied . Current ratio of 1.33
shall be insisted subject to specific relaxations.

The levels of inventory and receivables shall be based on past trend,

operational needs, ability to absorb the carrying costs, inter-firm
comparisons, industry trend and related market developments, etc.

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However, borrowers can opt for MPBF/Cash budget system and Bank can
employ it if the same is more suitable and appropriate for assessing their
working capital needs. The tolerance level of 10% is permissible on the
assessed MPBF.

093. Cash Budget System :

Under this method, the Working Capital needs of the borrowers are
assessed on the basis of projected cash flow and the estimate of cash
deficit. This Method is applicable to those ....

a) Borrowers seeking / enjoying Fund based credit facilities of over Rs. 25

crore.

b) Specific industries / seasonal activities such as software development,

construction, tea and sugar.

c) Traders, Merchants, Exporters, others etc., who are not having a

predetermined manufacturing / trading cycle if the same is found to be
more appropriate.

094. Early warning signals (EWS) of tipping points are vital to anticipate
system collapse or other sudden shifts. However, existing generic early
warning indicators designed to work across all systems do not provide
information on the state that lies beyond the tipping point.

095. Early Warning Signals in Operative Accounts.

1) Frequent Cheque Bouncing:

2) Delays in payment of statutory dues
3) Invoices without of TAN, GSTIN etc.
4) Frequent request for Ad-hoc Limits.
5) Borrowers resorting to frequent change in scope of business only to
keep seeking unjustifiable extension of time for completion of the project.
6) Sales proceeds are not routed through consortium / member bank/
lender bank.
7) High value RTGS receipts & payment to unrelated parties.
8) Dis-proportionate Increase in borrowings.
9)Frequent change in the management.

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096. A Red Flagged Account (RFA) is one where a suspicion of fraudulent
activity is thrown up by the presence of one or more Early Warning Signals
(EWS). The threshold for EWS and RFA is an exposure of Rs 50 Cr. or
more.

Financial statements

097. Financial statements (or Financial Reports) are formal records of the
financial activities and position of a business, person, or other entity.

098. Fnancial Statements represent a formal record of the financial

activities of an entity. These are written reports that quantify the financial
strength, performance and liquidity of a company. Financial Statements
reflect the financial effects of business transactions and events on the
entity.

099. Relevant financial information is presented in a structured manner

and in a form which is easy to understand. They typically include four
basic financial statements accompanied by a management discussion and
analysis.

1) A Balance Sheet, (or Statement of Financial Position), reports on a

company's Assets, Liabilities and Owners’ Equity at a given point in time.
The Balance Sheet displays the company’s assets, liabilities, and
Shareholders’ Equity. As commonly known, assets must equal liabilities
plus equity. The asset section begins with Cash and Equivalents , which
should equal the balance found at the end of the Cash Flow statement.
The balance sheet then displays the changes in each major account. Net
income from the Income Statement flows into the Balance Sheet as a
change in retained earnings (adjusted for payment of Dividends )

2) An Income Statement - or Profit and Loss Account (P&L report), or

Statement of Comprehensive Income, or Statement of Revenue &
Expense—reports on a company's Income, Expenses and Profit (or Loss)
over a stated period. A Profit and Loss Statement provides information on
the operation of the enterprise. These include sales and the various
expenses incurred during the stated period.

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Often, the first place an investor or analyst will look is the income
statement. The Income Statement shows the performance of the business
throughout each period, displaying Sales Revenue at the very top. The
statement then deducts the cost of goods sold (COGS) to find Gross Profit.
From there, the gross profit is affected by other operating expenses and
income, depending on the nature of the business, to reach Net Income at
the bottom – “the bottom line” for the business.

3) Cash Flow Statement : The cash flow statement then takes net income
and adjusts it for any non-cash expenses. Then, using changes in the
balance sheet, usage and receipt of cash is found. The cash flow statement
displays the change in cash per period, as well as the beginning balance
and ending balance of cash.

Cash Flow Statement, presents the movement in cash and bank balances
over a period. The movement in cash flows is classified into the following
segments:

a) Operating Activities: Represents the cash flow from primary activities of

a business.

b) Investing Activities: Represents cash flow from the purchase and sale of
assets other than inventories (e.g. purchase of a factory plant).

c) Financing Activities: Represents cash flow generated or spent on raising

and repaying share capital and debt together with the payments of
interest and dividends.

4) Statement of Changes in Equity, also known as the Statement of

Retained Earnings, details the movement in owners' equity over a period
is derived from the following components:

a) Net Profit (loss) during the period as reported in the Income Statement
b) Share capital issued or repaid during the period
c) Dividend payments
d) Gains or losses recognized directly in equity (e.g. revaluation surpluses)
e) Effects of a change in accounting policy or correction of accounting
error

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A statement of changes in equity or statement of equity, or statement of
retained earnings, reports on the changes in equity of the company over
a stated period.

For large corporations, these statements may be complex and may include
an extensive set of footnotes to the financial statements and management
discussion and analysis. The notes typically describe each item on the
balance sheet, income statement and cash flow statement in further detail.
Notes to financial statements are considered an integral part of the
financial statements.

100. Methods of Financial Statement Analysis

There are two key methods for analyzing financial statements - Horizontal
Analysis and Vertical Analysis.

Horizontal Analysis is the comparison of financial information covering a

series of reporting periods. Horizontal analysis is also known as Trend
Analysis.

Vertical Analysis is the proportional analysis of a financial statement,

where each line item on a financial statement is listed as a percentage of
another item.

This means that every line item on an income statement is stated as a

percentage of gross sales, while every line item on a balance sheet is
stated as a percentage of total assets.

Thus, horizontal analysis is the review of the results of multiple time

periods, while vertical analysis is the review of the proportion of accounts
to each other within a single period.

Another method for analyzing financial statements is the use of many

kinds of ratios. Ratios are used to calculate the relative size of one number
in relation to another. After a ratio is calculated, you can then compare it
to the same ratio calculated for a prior period, or that is based on an
industry average, to see if the company is performing in accordance with
expectations.

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The Basics of Balance Sheet

101. A Balance Sheet comprises Assets, Liabilities, and Equity. The three
important sections of any balance sheet are:

102. Assets – Anything that has value and owned by a company

103. Liabilities – This provides a list of debts a company owes to others

104. Capital or Equity- This is the amount invested by the Shareholders

105. In a Balance Sheet Assets are equal to the Sum of liabilities and equity.

106. Assets are the tools with the help of which , income in a business is
earned.

107. Assets are also known as Application or Use of Funds and these have
debit balance. They are the resources of the company that have future
economic value.

108. The Assets are grouped into current and long-term assets to reflect
the ease of liquidating each asset.

109. The Assets are also categorized into tangible and intangible assets.

110. The tangible assets are further bifurcated into current, long term and
other assets, to reflect the ease of liquidating each asset.

111. The non tangible assets are trademark, copyrights, goodwill to

mention a few.

112. Current assets include the cash, accounts receivable, prepaid

expenses and all that can be converted into cash within a year.

113. Long term assets are also called fixed assets and include land,
buildings, machinery, that are used in connection with the business. These
are also known as Block Assets.

114. Liabilities are debts owed by the business. These are claims of the
creditors against the assets of the business.

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115. Liabilities are classified into current and long term liabilities.

116. Current liabilities are accounts payable, accrued expenses, taxes

payable, the current due within one year portion of long term debt and
any other obligations due within a year.

117. Long term liabilities are debts that must be repaid by the business in
more than one year from the date of the balance sheet.

118. Net worth (Owner’s Equity): Owner’s equity (called when it’s sole
proprietorship) sometimes is also referred to as the book value of the
company because owner’s equity is equal to the reported asset minus the
reported liability.

119. Liabilities and owners' equity: This includes all debts and obligations
owed by the business to outside creditors plus the owners' equity. Often
this side of the balance sheet is simply referred to as "liabilities."

120. A Banker, basically, make use of Balance Sheet to know the following
important indicators:

a) Liquidity Group : Current Ratio ; Quick Ratio ; NWC (Net Working

Capital); Working Capital Gap (WCG).

b) Solvency (or Leverage ) Group : Debt Equity Ratio; Net Worth ; TNW
(Tangible Networth)

c) Activity Ratios : Stock TO Ratio; Debtor Velocity Ratio; Creditor Velocity

Ratio.

121. Current Ratio = Curent Assets / Curent Liabilities

122. Quick Ratio (also known as Acid Test Ratio) = Quick Assets /
Curent Liabilities

123. Net Working Capital (NWC) = Current Assets – Current Liabilities

( or Long Term Funds – Long Term Uses).

124. Working Capital Gap = CA – CLOBB (i.e CL other than Bank

Borrowings)
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125. Net Worth = Capital + Reserves

126. Tangible Net Worth = Net Worth – Intangible Assets.

127. Stock Turnover Ratio = Net Sales / Stock Value

128. Debtor Velocity Ratio : Debtors x 12 (months) / Net Sales

129. Creditor Velocity Ratio : .Creditors x 12 (months) / Purchases

130. Debt Equity Ratio (DER) : . Long Term Debt / Tangible Networth

131. Stock Turnover Ratio = Net Sales / Stock = 11.70 (approxmately 12

times)

132. LTU = Fixed Assets after Depreciation + Intangible Assets

133. Plese note the difference between Pre-paid Expenses and Pre-
operative Expenses. We find both these on Assets side.

Prepaid expenses are future expenses that have been paid in advance.
These are treated as Current Asset.

Preoperative expenses are those expenses incurred by a company before

commencement of commercial operations; or before starting to earn
income. These are distinct from preliminary expenses or formation
expenses.

Preliminary expenses (also known as Formation Expenses) are those that

are incurred before incorporation of a company or commencement of
business.

Preliminary expenses (Formation Expenses) and Pre-operative expenses

are treated as Intangible Assets.

134. In Balance Sheet, though original value of Fixed Assets is furnished

(this is known as Gross Block), while computing Value of Assets, we take
into account Value of Fixed Assets after deducting Depreciation. This
Depreciated Value of Fixed Assets is known as Net Block .

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135. Please note that a Vehicle used by the Firm for transporting its goods
is a fixed asset, though it is mobile (not fixed).

136. Interpretation of Current Ratios

If Current Assets > Current Liabilities, then Ratio is greater than 1.0 -> a
desirable situation to be in.

If Current Assets = Current Liabilities, then Ratio is equal to 1.0 -> Current
Assets are just enough to pay down the short term obligations.

If Current Assets < Current Liabilities, then Ratio is less than 1.0 -> a
problem situation at hand as the company does not have enough to pay
for its short term obligations.

A current ratio of 1 is safe because it means that current assets are more
than current liabilities and the company should not face any liquidity
problem. A current ratio below 1 means that current liabilities are more
than current assets, which may indicate liquidity problems. In general,
higher current ratio is better.

A rising current ratio is not necessarily a good thing and a falling current
ratio is not inherently bad. A very high current ratio may indicate existence
of idle or underutilized resources in the company. This is because most of
the current assets do not earn any return or earn a very low return as
compared to long-term assets. A very high current ratio may hurt a
company’s profitability and efficiency.

137. Relation between Current Ratio (CR) and NWC (Net Working Capital)

1) When CR is 1 – NWC is zero

2) When CR is above 1 – NWC is positive.
3) When CR is less than 1 – NWC is negative.

138. Seasonality & Current Ratio - It should not be analyzed in isolation

for a specific period. We should closely observe this ratio over a period of
time – whether the ratio is showing a steady increase or a decrease.

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Current ratios should be analyzed in the context of relevant industry. Some
industries for example retail, have very high current ratios. Others, for
example service providers such as accounting firms, have relatively low
current ratios because their business model is such that they do not have
any significant current assets.

Further, it is quite possible for two companies to have same current ratios
but vastly different liquidity position for example when one company has
a large amount of obsolete inventories.

A more meaningful liquidity analysis can be conducted by calculating

Quick Ratio (also called Acid-test Ratio) and Cash Ratio. These ratios
remove the illiquid current assets such as prepayments and inventories
from the numerator and are a better indicator of very liquid assets.

139. Debt Equity Ratio - DER is included under gearing ratios. Gearing
ratios are a metric used to demonstrate the funding of an entity’s
operations i.e. whether it was covered through debt or the investment
made by shareholders.

This is the ratio between debt and equity. i.e., debt / equity. It indicates
the relation-ship between the loan capital and capital raised by way of
equity. In the numerator we take only Long Term Outside Liabilities as
Debt.

140. A company's capital structure refers to how it finances its operations

and growth with different sources of funds. Capital structure is sometimes
referred to as "financial leverage" . There are two main forms or sources
of capital for a capital structure: equity capital and debt capital (loan
capital).

141. The main difference between loan capital and equity is that the
interest payable on the loan capital has prior charge and has to be paid
before any dividend can be declared. While there can be no dividend
without profits, interest may have to be paid even if there is no profit.

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142. In the calculation of the ratio, debt is defined as the outside liabilities.
As per the definition, the debt would include debentures, current liabilities,
and loans from banks and financial institutions.

However, the inclusion of current liability is controversial because debt to

equity ratio is all about long-term financial solvency and current liability is
a short-term liability and the amount of current liability fluctuates far and
wide over the year.

Further, current liabilities are taken care of in liquidity ratios (such short-
term ratio and quick ratio) and the interest on them is not so huge. In view
of the above in calculation of DER, Debt represents long term outside
liabilities.

'Equity' refers to tangible net worth.

As the debt to equity ratio expresses the relationship between external

equity (liabilities) and internal equity (stockholder’s equity), it is also
known as “external-internal equity ratio”.

If a unit has more debt and less capital, it may be in a disadvantageous

position as the servicing of loan, i.e., payment of instalments and interest,
may be a problem, in the event of its failure to earn sufficient profit.

Debt/equity ratio may misguide the potential investors as well since a low
debt to equity ratio can be a result of the company not appropriately using
technology available. This is an indication of technical inefficiency which
would result in lower returns even if the debt/equity ratio is low.

Though, the optimal debt/equity ratio is 1:1, it cannot be applied to all

situations. In respect of traders, loans from friends and relatives received
on a long term basis, subordinated to the Bank can be treated as equity.

A capital-intensive entity may have a high debt/equity ratio indicating that

net assets have been regularly maintained and financed through the debts
obtained which would increase returns in the future due to higher
production.

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However, a low-capital industry doesn’t need to invest in factories and
types of equipment hence its optimal ratio should be around 1:1. This is
one of the major limitations of the debt/equity ratio since it can only
compare similar companies’ financial performance.

On the other hand, if the unit obtains all its needs of long term funds by
floating equity capital, it will have no worry as there is no legal need of
payment of dividends and the capital will be repaid only in the event of
the liquidation of the unit. Conversely, the shareholders of a unit stand to
gain considerably if a part of these funds is obtained by borrowings.

Turnover Ratios

143. Turnover Ratios are also known as Activity Ratios.

These ratios basically measure the efficiency with which assets are being
utilized or managed. This is why they are also known as productivity ratio,
efficiency ratio or more famously as turnover ratios.

These ratios show the relationship between sales and any given asset. It
will indicate the ratio between how much a company has invested in one
particular type of group of assets and the revenue such asset is producing
for the company.

The following are the different kinds of Activity Ratios that measure the
effectiveness of the funds invested and the efficiency of their performance

1) Stock Turnover Ratio and Inventory Holding Level

2) Debtors Turnover Ratio and Debtors Holding Level
3) Creditors Turnover Ratio and Creditors Holding Level

144. Stock Turnover Ratio :

This ratio focuses on the relationship between the cost of goods sold and
average stock. So it is also known as Inventory Turnover Ratio or Stock
Velocity Ratio.

It measures how many times a company has sold and replaced its
inventory during a certain period of time.

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Inventory turnover ratio is computed by dividing the cost of goods sold
by average inventory at cost. The formula/equation is given below:

Two components of the formula of inventory turnover ratio are cost of

goods sold and average inventory at cost.

Cost of goods sold is equal to cost of goods manufactured (purchases for

trading company) plus opening inventory less closing inventory. Average
inventory is equal to opening balance of inventory plus closing balance of
inventory divided by two.

If cost of goods sold is not known, the net sales figure can be used as
numerator and if the opening balance of inventory is unknown, closing
balance can be used as denominator. For example if both cost of goods
sold and opening inventory are not available in the data provided, the
formula would be as follows: Inventory turnover ratio = Sales / Inventory

It allows Management to figure out their inventory reordering schedule,

by indicating when all the stock will run out. It also helps them analyze
how efficiently the stock and its reordering is being managed by the
purchasing department.

The inventory holding levels measure the average length of time required
to sell inventory.

Its usefulness lies in its comparison to past years or to similar companies.

145. Debtors Turnover Ratio

This Ratio measures the efficiency with which Receivable are being
managed. Hence it is also known as ‘Receivable Turnover ratio’. Definition:

Debtor’s turnover ratio or accounts receivable turnover ratio or velocity

ratio indicates the velocity of debt collection of a firm.

In simple words, it indicates the speed of collection of credit sales.

It is computed by dividing the net credit sales during a period by average

receivables.

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Accounts receivable turnover ratio simply measures how many times the
receivables are collected during a particular period. It is a helpful tool to
evaluate the liquidity of receivables.

Two components of the formula are “net credit sales” and “average trade
accounts receivable”. It is clearly mentioned in the formula that the
numerator should include only credit sales. In case this information not
available in the data provided, the total sales should be used as numerator
assuming all the sales are made on credit.

Average receivables are equal to opening receivables (including notes

receivables) plus closing receivables (including notes receivables) divided
by two. But sometimes opening receivables may not be available in the
data provided. In that case closing balance of receivables should be used
as denominator.

The higher the value of debtor’s turnover the more efficient is the
management of debtors or more liquid the debtors are. Similarly, low
debtors turnover ratio implies inefficient management of debtors.

146. Average Collection Period : Debtors Holding Level

This ratio is significant in managing the debtors of a company. This

is also known as Debtors’ Velocity Ratio and it indicates the time it takes
for a business to receive payments owed by its clients in terms of accounts
receivable. Companies calculate the average collection period to make
sure they have enough cash on hand to meet their financial obligations.

The average collection period is calculated by dividing the average

balance of accounts receivable by total net credit sales for the period and
multiplying the quotient by the number of days in the period.

Average collection periods are most important for companies that rely
heavily on receivables for their cash flows.

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The Formula to arrive at Average Collection Period is .......>

Average Book-debts
Months = ------------------------------ x 365 (for days) or (12) for months
Net Sales

147. Creditors Turnover Ratio (also known as Accounts Payable Turnover

Ratio)

Accounts payable turnover ratio indicates the creditworthiness of the

company. A high ratio means prompt payment to suppliers for the goods
purchased on credit and a low ratio may be a sign of delayed payment.

Accounts payable turnover ratio also depends on the credit terms allowed
by suppliers. Companies who enjoy longer credit periods allowed by
creditors usually have low ratio as compared to others.

A high ratio (prompt payment) is desirable but company should always

avail the credit facility allowed by the suppliers.

It measures the number of times, on average, the accounts payable are

paid during a period. It is calculated by using the following formula :

In above formula, numerator includes only credit purchases. But if credit

purchases are not known, the total net purchases should be used.

Average accounts payable are computed by adding opening and closing

balances of accounts payable and dividing by two. If data related to
opening balance of accounts payable is not available , the closing balance
of Creditors should be used.

148. Creditors’ Velocity or Creditors’ Payment Period : Average Payment

Period: Credtors Holding Level

Average Creditors
Months ------------------------------ x 365 (for days) or (12) for months
Purchases

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The Account Payable turnover ratio shows the speed at which a company
pays its suppliers.

Investors can use the accounts payable turnover ratio to determine if a

company has enough cash or revenue to meet its short-term obligations.

Creditors can use the ratio to measure whether to extend a line of credit
to the company.

A decreasing Account Payable turnover ratio indicates that a company is

taking longer to pay off its suppliers than in previous periods.

When the Account Payable Turnover Ratio is increasing, the company is

paying off suppliers at a faster rate than in previous periods. An increasing
ratio means the company has plenty of cash available to pay off its short-
term debt in a timely manner. As a result, an increasing accounts payable
turnover ratio could be an indication that the company managing its debts
and cash flow effectively.

However, an increasing APT Ratio over a long period could also indicate
the company is not reinvesting back into its business, which could result
in a lower growth rate and lower earnings for the company in the long
term.

149. “Gross Working Capital” or “Working Capital “ mean investment

in total current assets.

150. Working Capital Gap - This represents excess of current assets over
current liabilities excluding bank borrowings. A part of the Current Assets
are financed by Current Liabilities (other than bank borrowings). The
remaining portion of current assets which requires financing is called as
working capital gap. Banks do not grant advance to the full extent of
working capital gap. It is a well established rule that the borrower has to
finance a part of working capital gap out of either capital or long term
sources.

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151. Net Working Capital - Excess of current assets over total current
liabilities is known as Net Working Capital (NWC). Further, NWC
represents promoters’ contributon in the business which is brought-in
from long term sources. As such, NWC also represents excess of Long
Term Sources over Long Term Uses. It indicates the margin or long term
sources provided by the borrower for financing a part of the current assets.

152. Operating Cycle or Working Capital Cycle - The process involved

in the utilisation of working capital is cyclic one. The cycle starts from
getting Raw Material either on cash basis or on credit and ends with
realization of sale proceeds and make payment to creditors.

In respect of trading concerns, operating cycle represents the period

involved from the time the goods and services are purchased and the
same are sold and realised.

In the case of manufacturing concerns, it is the time involved in the

purchasing of raw materials, converting them into finished goods and the
same are finally sold and proceeds are realised.

The Basics of Profit & Loss Account

152. The P&L statement is one of three financial statements , other two
are Balance Sheet and Cash Flow Statement.

153. The profit and loss (P&L) statement summarizes the revenues and
expenses incurred during a specified period, usually a fiscal quarter or
year.

154. The P&L statement is also known as Income Statement, Statement of

Profit and Loss, Statements of Operations, Statement of Financial Results
or Income Earnings Statement or Expense Statement.

155. The P&L Statement provide information about a company's ability

to generate profit by increasing revenue, reducing costs, or both.

156. Revenue (Net Sales) : This entry represents the value of goods or
services a company has sold to its customers. Commonly sales are
presented net of different discounts, returns, etc.

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157. Cost of Goods Sold. This element measures the total amount of
expenses, related to the product creation process, including the cost of
materials, labor, etc. Costs of goods sold include direct costs and overhead
costs. Direct costs (materials; parts of product purchased for its
construction; items, purchased for resale; labor costs; shipping costs, etc.)
are the expenses that can be actually associated with the object and its
production. Overhead costs (labor costs, equipment costs, rent costs, etc.)
are the expenses that are related to the business running process, but
cannot be directly associated with the particular object of production.

158. Gross profit is net revenue excluding costs of goods sold.

159. Operating Expenses. Operating expenses include selling and

administrative expenses. Selling expenses are the expenses, which relate
to the process of generating sales by a company, including miscellaneous
advertisement expenses, sales commission, etc. All the expenses
connected with company’s operation administration, such as salaries of
the office employees, insurance, etc., refer to the administrative expenses.

160. Operating Income. Operating income is gross profit excluding

operating expenses.

161. Other income or expense. This entry contains all the other income or
expense values that weren’t included to any of the previous entries. It may
be dividends, interest income, interest expense, net losses on derivatives,
etc.

162. Income Before Income Taxes. Income before income taxes is

operating income including (or excluding) other income or expense.

163. Income Taxes. This entry includes all state and local taxes, which are
based on the reported profit of an enterprise.

164. Net Income. Net income is the amount of money remaining after
taking the net sales of a business and excluding all the expenses, taxes
depreciation and other costs. In other words, this entry reflects the basic
goal of an enterprise functioning – its profit. It is also often referred as net
profit or net earnings.

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Interpretation of Profitability Ratios :

[Link] income statement of the firm contains information that can be

used for computation of certain financial ratios, which measure firm’s
performance and position over the reporting period. Depending on the
ratio, it can be a measure of firm’s profitability or financial sustainability.

166. There are two types of profit ratios viz., gross profit and net profit
ratio.

167. Gross Profit = Sales - Cost of goods sold

168. When gross profit ratio is expressed in percentage form, it is known

as gross profit margin or gross profit percentage. The formula of gross
profit margin or percentage is given below:

Gross Profit
GP Margin = -------------------- x 100
Net Sales

This indicates the efficiency and competence with which the unit is being
managed. A high GP ratio implies that the cost of production is relatively
low and margin of profit consequently high.

169. GP ratio may increase due to the following :

a. A higher sale price while cost of production remaining constant.

b. Lower cost of goods sold while sale price remaining constant.

170. GP ratio may decline due to the following :

a. Fall in prices of products

b. Increase in input costs not compensated by matching price increase

c. Decline in efficiency in production

d. Idle capacity

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171. Net Profit Ratio - Also known as Net Profit Margin ratio, it establishes
a relationship between net profit earned and net revenue generated from
operations (net sales).

172. Net profit ratio is a profitability ratio which is expressed as a

percentage hence it is multiplied by 100.

Net Profit
Net Profoit Margin = -------------------- x 100
Net Sale
173. Net Profit = Operating Income – (Direct Costs + Indirect Costs)

174. Net Sales = (Cash Sales + Credit Sales) – Sales Returns This ratio is
the main indicator of a firm’s profitability, a trend analysis is usually done
between two different accounting periods to assess improvement or
deterioration of operations.

High – A high ratio may indicate low direct and indirect costs which will
result in a higher net profit of the organization. This ratio is the overall
measure of the firm's ability to turn each rupee of sales into profit. A firm
with a high net profit ratio would be in an advantageous position in the
face of fall in sale prices, rise in cost of production or decline in the
demand for the product as it would be able to absorb the market
fluctuation to a certain extent.

Low – A low ratio may indicate unnecessarily high direct and indirect costs
which will result in a lower net profit of the organization, thus reducing
the numerator to lower than the desired number.

175. The following contribute to a decline in net profit ratio :

a. The incidence of fixed costs may lead to a decline in profit when
turnover falls.
b. Expenses not entirely pertaining to current year
c. Presence of idle assets, accumulated inventory, debtors posing difficult
of realization.
d. Expenses not resulting in revenue.
e. Lack of control over fixed assets.

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176. Operating Income = GP – Overheads (also known as Operating
Expenses)

177. Operating Expenses include wages & salaries, utilities such as power,
water, logistics, Rent, depreciation.

178. Net Profit = Operating Income – Interest – Taxes

179. P&L management refers to how a company handles its P&L

statement through revenue and cost management.

180. DSCR is a ratio of cash available to cash required for debt servicing.
In other words, it is the ratio of the sufficiency of cash to repay the debt.
It measures a company’s ability to service its current debts by comparing
its net operating income with its total debt service obligations.

This ratio indicates whether the earnings are adequate to meet the burden
of fixed financial charges. A borrowing concern is required to pay interest
on the loan as also to pay the stipulated instalments. It must, therefore,
have sufficient earnings to enable it to meet thesefinancial commitments.

181. Calculation of DSCR is very simple. Debt service coverage ratio is

calculated as follows :

Net profit after tax + depreciation + interest on term loans

DSCR = -----------------------------------------------------------------------
interest on term loans + principal repayment instalment

Sometimes, these figures are readily available but at times, they are to be
determined using the financial statements of the company/firm.

182. Profit after tax (PAT) - PAT is generally available readily on the face of
the Profit and loss account. It is the balance of the profit and loss account
which is transferred to the reserve and surplus fund of the business.
Sometimes, in an absence of the profit and loss statement, we can also
find it on the Balance Sheet by subtracting the current year P/L account
from the previous year’s balance, which is readily available under the head
of reserve & surplus.

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183. Interest - The amount which is payable for the financial year under
concern on the loan is taken.

184. Noncash expenses expenses are those expenses which are charged
to the profit and loss account for which payment has already been done
in the past years.

185. Following are the noncash expenses:

a) Writing off of preliminary expenses, pre-operative expenses etc,

b) Depreciation on the fixed assets.

c) Amortization of the intangible assets like goodwill , trademark, patent ,

copyright etc,

d) Provisions for doubtful debts,

e) Deferment of expenses like an advertisement, promotion etc.

186. Depreciation is added back to the operating profit in the funds flow
analysis in order to arrive at true funds from operations or real funds from
operations. Depreciation is a non-cash charge and it does not reflect any
actual out go of funds. It is generally entered in the books in order to
satisfy certain accounting conventions and sometimes to provide for
replacement of the assets. Since depreciation does not reflect any actual
outgo of funds it is added back to the operating profit in order to arrive
at the real funds from operation. This would apply to any other non-cash
charge debited before the operating profit stage.

187. Principal amount is the amount payable on the loan for the financial
year under review. It includes the payment towards principal for the
financial year.

188. Lease Rental is the amount of lease rent paid or payable for the
financial year.

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189. Interpretation of Debt Service Coverage Ratio

Higher this Ratio, better is the debt serving capacity.

If the ratio is less than 1, it is considered bad because it simply indicates

that the cash of the firm are not sufficient to service its debt obligations.

The acceptable norm for a DSCR is between 1.5 to 2.

190. Funds Flow Statement & Cash Flow Statement.

Funds flow analysis is aimed at identifying the various sources and uses of
funds. It helps in analyzing the interaction between short term and long
term funds.

Increase in Reserves is due to profit earned and decrease in Fixed Assets

is due to depreciation. Decrease in Term Loan is due to repayment of
instalments.

It compares the two balance sheets by analyzing the sources of funds

(debt and equity capital) and the application of funds (assets).

It helps to understand where the money has been spent and from where
the money is received.

191. Analysis of movement of funds

In order to find out changes in the funds flow pattern comparison of a

minimum of two financial statements is to be done.

Any increase in a liability item would be a source of funds and any increase
in asset would represent use of funds.

Any decrease in liability would be a use and decrease in assets would be

a source.

The long term sources and uses are identified/bifurcated. If the long term
sources are found to be more than long term uses, it shows that the excess
or difference has gone to short term uses.

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Where the short term sources are found to be more than the short term
uses and the difference being utilized for long term uses, this state would
lead to a decline in the current ratio and a decline in the net working
capital. If a portion of the current liabilities (short term source) is diverted
to long term uses (investment in fixed or non current assets), it would
result in current liabilities going up, while the current assets do not
increase proportionately. This would mean a reduction in working capital.
Hence, whenever there is a diversion, there is a reduction in the net
working capital.

If the long-term source is not increased during the period and term
liability is reduced or non-current assets are increased it indicates that
short-term source is utilized for long term source. In bankers parlance
using short-term source for long term use is the diversion of funds which
has the dire consequence towards the operation of the entity.

Bankers, normally, analyse Funds Flow Statement to see whether the Firm
has resorted to divert Short Term Funds to meet Long Term Uses. If such
situation is observed Banker has to initiate corrective steps.

Funds flow analysis is also useful in determining whether the unit has
adopted a wise policy in the matter of raising funds from various sources
and whether the funds so obtained are properly deployed.

192. Difference between Funds Flow and Cash Flow :

The Cash Flow Statement is prepared on a cash basis, whereas , The Fund
Flow Statement is prepared on an accrual basis. Funds flow would take
into account all the changes in the pattern of economic resources,
whereas, a cash flow statement would represent only the effect of cash
transactions.

Basically, any change in the assets and liabilities may result in the inflows
and outflows of funds, but not always, as in case of depreciation or
revaluation of assets, there is no inflow or outflow of funds. Hence, only
those assets or liabilities will become a part of the statement, which
actually leads to the flows of the fund to/from the business.

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Funds flow statement is also called by various other names such as
“Sources and Application of Funds”; “Where came in and Where gone out
Statement”; “Where got, Where gone Statement” ; “Movement of Funds
Statement”; “Funds Generated and Expended Statement”; etc.

For the purpose of appraisal of a term loan proposal, an analysis of funds

flow is made, as the funds flow takes into account all transactions whether

193. The main components of financial statements are

1. Balance Sheet
2. Income Statement (or Profit and Loss Account)
3. Statement of Changes in Owners’ Equity (or Retained Earnings):
4. Statement of Changes in Financial Position. (Funds Flow Statement
& Cash Flow Statement).

194. The following concepts are to be understood to analyse Financial

Statements in a proper way.

1. Return on Equity. (RoE)

2. Return on Investment (or Capital Employed - ROCE) (RoI)
3. Operating Profit Ratio
4. Fixed Asset Coverage Ratio.(FACR)
5. Loan Life Ratio.

195. Return on Equity (ROE) : is a measure of financial performance.

ROE is expressed as a percentage and is calculated as under:

Net Profit
Return on Equity = -------------------------------- x 100
Tangible Net Worth

196. Return on Investment (ROI) (aka ROCE) is the ratio of a profit or loss
made in a fiscal year expressed in terms of an investment. It is expressed
in terms of a percentage of increase or decrease in the value of the
investment during the year in question.

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 Net Profit
Return on Investment = ------------------------------ x 100
Total Investment

197. RoI vs RoE

Although both the metrics define the health of investment, result of both
might not always go in the same direction. It is possible that a company
might have higher ROE but poor ROI or vice versa. The main difference is
Debt is included while arriving at Return on Investment (ROI) and whereas
outside debt is not taken into account while calculating Return on Equity
(ROE).

198. Operating Profit Ratio : This Ratio indicates the margin of profit on
the main operations revealing the operational efficiency of the Unit. The
Ratio is calculated to see that the main activity remains viable for long
time, as under

Operating Profit
Operating Profit Ratio = ----------------------------- x 100
Net Sales

199. Fixed Assets Coverage Ratio (FACR)

The asset coverage ratio determines a company’s capacity to pay its debt
through its assets. The ratio indicates specifically how much of these assets
will be needed for the company to settle its debts. To what extent do fixed
assets provide protection for long term creditors is assessed by calculating
this ratio.

Net fixed assets (i.e., after providing for depreciation)

FACR = --------- -------------------------------------------------------
Long term debts secured by fixed assets.

This ratio indicates number of times the value of fixed assets covers the
amount of the loan. Generally the ratio should be 1.33 : 1.

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200. Loan Life Ratio (LLR) (also known as Loan Life Coverage ratio (LLCR))

LLCR is similar to the Debt Service Coverage Ratio (DSCR), but it is more
commonly used in project financing because of its long-term nature. The
DSCR captures a single point in time, whereas the LLCR addresses the
entire span of the loan.

201. Loan Life Ratio is a concept which is used in project financing activity.

202. LLR can be used to arrive at the sustainable debt in a restructuring

exercise.

203. A bench-mark LLR of 1.25, which would give a sufficient cushion to

the amount of loan to be serviced, may be considered adequate.

204. Purpose of Analysis will be served only if the all the related
statements are studied (Balance Sheet, P&L Account and Funds Flow
Statements) together. Further, the results are to be compared with
previous years’ results and also with that of Industry. Then only One can
arrive at correct decisions. Studying each Ratio seperately excluding
other items, may not yield desired results.

Important concepts related to preparation of Balance Sheet

205. Entity Concept is a business for which a separate set of accounting

records is maintained. ... The accounting entity concept is used to establish
the ownership of assets and obligation for liabilities, as well as to
determine the profitability of a specific set of economic activities

206. Money Measurement Concept states that a business should only

record an accounting transaction if it can be expressed in terms of money.
... Examples of items that cannot be recorded as accounting transactions
because they cannot be expressed in terms of money include: Employee
skill level. Employee working conditions

207. Stable Monetary Unit Concept assumes that the value of the Rupee
is stable over time. This concept essentially allows accountants to
disregard the effect of inflation -- a decrease, in terms of real goods, of
what a dollar can purchase

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208. Going Concern Concept - is an accounting term for a company that
has the resources needed to continue operating indefinitely until it
provides evidence to the contrary. ... If a business is not a going concern,
it means it's gone bankrupt and its assets were liquidated.

209. Cost Concept refers to the amount of payment made to acquire any
goods and services. In a simpler way, the concept of cost is a financial
valuation of resources, materials, undergone risks, time and utilities
consumed to purchase goods and services.

210. Conservatism Concept refers to the idea that expenses and

liabilities should be recognised as soon as possible in a situation where
there is uncertainty about the possible outcome and in contrast record
assets and revenues only when they are assured to be received.

211. Dual Aspect Concept states that every business transaction requires
recordation in two different accounts. This concept is the basis of double
entry accounting, which is required by all accounting frameworks in order
to produce reliable financial statements.

212. Accounting Period Concept An accounting period is a period of

time that covers certain accounting functions, which can be either a
calendar or fiscal year, but also a week, month, or quarter, etc. Accounting
periods are created for reporting and analyzing purposes, and the accrual
method of accounting allows for consistent reporting.

213. Accrual Concept - Accrual accounting is an accounting method

where revenue or expenses are recorded when a transaction occurs versus
when payment is received or made. The method follows the matching
principle, which says that revenues and expenses should be recognized in
the same period.

214. Realisation Concept - The concept of realisation states that revenue

is realized at the time when goods or services are actually delivered. In
short, the realisation occurs when the goods and services have been sold
either for cash or on credit. It also refers to inflow of assets in the form of
receivables.

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215. Matching Concept - The matching concept is an accounting practice
whereby firms recognize revenues and their related expenses in the same
accounting period. Firms report "revenues," that is, along with the
"expenses" that brought them. The purpose of the matching concept is to
avoid misstating earnings for a period.

216. Projected financial statements incorporate current trends and

expectations to arrive at a financial picture that management believes it
can attain as of a future date. At a minimum, projected financial
statements will show a summary-level income statement and balance
sheet.

217. Purpose of Analysis of Financial Statements by Bankers

a) Assessment of Performance & Financial Position

b) Projection for Future Performance
c) Detecting Danger Singnals
d) Assessment of credit requirements
e) Examine Funds Flow
f) Cross Checking

218. Working Capital finance to the Information Technology and

Software Industry.

Reserve Bank of India has framed guidelines for extending working capital
finance to the Information Technology and Software Industry, based on
the recommendations of the National Taskforce on Information
Technology and Software development. However, said guidelines
prepared by the central bank are not mandatory for lenders.

In terms of RBI guidelines, the working capital credit proposal of an IT

company is appraised just like all other types of credit proposals such as
sanctioning the limits based on the track record of the promoters’ group
affiliation, the composition of the management team, and their work
experience as well as the infrastructure.

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The turnover method (Nayak Committee recommendation) can be applied
in the case of borrowers with working capital limits of up to Rs 2 crore i.e.
assessment may be made at 20 percent of the projected turnover.
Alternatively, MPBF can be considered on the basis of the monthly cash
budget system. For the borrowers enjoying working capital limits of Rs 10
crore and above from the banking system, the guidelines regarding the
loan system would be applicable.

Purchase / Discount & Negotiation :

219. If no credit is to be provided to the buyer, a demand bill is drawn.

If Bank extend finance against Demand Bill , it is known as Purchase.

220. If credit is provided on the sales, the bill of exchange called usance
bill is drawn on the purchaser. If Bank extend finance against Usance Bill ,
it is known as Discount.

221. If Bank extend finance against Bill under LC (whether Demand or

Usance Bill), it is known as Negotiation.

222. TReDS is an electronic platform for facilitating the financing /

discounting of trade receivables of Micro, Small and Medium Enterprises
(MSMEs) through multiple financiers. These receivables can be due from
corporates and other buyers, including Government Departments and
Public Sector Undertakings (PSUs).

223. Following are Non Fund Based Working Capital facilities

Bank Guarantees
Letters of Credit
Co-acceptance of Bills

224. Irrevocable Payment Commitment (IPC) means irrevocable

confirmation issued by the custodian bank in favour of a stock exchange
/ clearing corporation of a stock exchange on behalf of its customers, to
meet the payment obligation arising out of a 'buy' transaction".

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225. RBI prohibited Banks from negotiating unrestricted LCs of non-
constituent.

226. The confirmation bank is not specified, which means that the exporter
can show the bill of exchange to any bank and receive a payment on an
unrestricted LC. Transferrable — The exporter has the right to make the
credit available to one or more subsequent beneficiaries.

227. Commercial paper is a money-market security issued by large

corporations to obtain funds to meet short-term debt obligations (for
example, payroll) and is backed only by an issuing bank or company
promise to pay the face amount on the maturity date specified on the
note.

228. Factoring is a type of financing in which one company buys another

company's accounts receivable, i.e., its invoices (money it is owed).

229. Forfaiting is a method of trade finance that allows exporters to obtain

cash by selling their medium and long-term foreign accounts receivable
at a discount on a “without recourse” basis. ... “Without recourse” or “non-
recourse” means that the forfaiter assumes and accepts the risk of non-
payment.

[Link] break-even point (BEP) indicates the volume of sales which the
unit must achieve in order to cover its total costs.

231. Contribution is difference of Selling Price (SP) and Variable Cost (VC).
It is also known as Marginal Income.

232. Contribution or marginal income = SP – VC

233. Margin of safety is the percentage of excess sales over those at the
break-even point to the actual sales. It indicates as to what extent the sales
may decline before the unit starts incurring losses.

234. COGS = Opening Stock + Purchases + Direct Expenses – Closing

Stock

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235. Net Sales = Cash Sales + Credit Sales – Sales Return

236. Capital Employed = Equity share capital, Reserve and Surplus, Deben-
tures and long-term Loans

237. Capital Employed = Total Assets – Current Liability

238. PERT / CPM - The Project Evaluation and Review Technique,

abbreviated as PERT or Critical Path Method, abbreviated as CPM helps
the management in performing all these functions more efficiently. PERT
/ CPM is a method of budgeting and scheduling resources so as to
accomplish a predetermined job.

239. PERT / CPM is based on a simple concept called the `Network Logic'.
The network is drawn taking into account the sequencing and inter-
dependence of various activities that constitute the project. Such a
network, then, becomes the basis for planning and controlling the project.

240. Critical path : The longest path which determines the earliest
expected time of the network ending event is referred as the critical path.
It is the most time consuming path of activities from beginning to the end
of the network.

241. In exceptional cases, Banks provide Term Loan s for current assets.
This is called Working Capital Term Loan.

242. If the enterprises is not able to bring in the required amount of Net
Working Capital, it will feel liquidity crunch and business operations will
be affected. In such cases, Banks may provide WCTL.

243. Certificates of Deposit (CDs) is a negotiable money market instrument

and issued in dematerialised form or as a Usance Promissory Note, for
funds deposited at a bank or other eligible financial institution for a
specified time period.

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244. Bailout : Providing money and/or resources (also known as a
capitalinjection) to a failing company is known as Bailout. These actions
help to prevent that Entity’s potential downfall which may include
bankruptcy and default on its financial obligations.

Inland Bank Guarantees (BG)

245. There are three parties to a guarantee. The person who gives the
guarantee is called the ‘Surety’ or ‘Guarantor’, the person on whose behalf
the guarantee is given is called the ‘Principal Debtor’ and the person in
whose favour the guarantee is given is called the ‘Creditor’ or
‘Beneficiary’.

246. The liability of the surety/guarantor is co-extensive with that of the

principal debtor, unless it is otherwise provided in the Agreement of
Guarantee itself.

247. Advance Payment Guarantees are issued where the parties (principal
borrowers) seek ‘advance payment’ from their principals to meet part of
the expenses for execution of contracts or to meet a part of the working
requirements.

248. Guarantees should not be issued for a period of more than 10 years
irrespective of the fact that such guarantees are backed with 100% cash
margin or not, within Branch Powers.

249. Automatic renewal clause is considered to be onerous. Normally,

guarantees containing automatic renewal clause carry an additional risk
of being required to be renewed at the request of the beneficiary with
or without specific request from the borrower. Branches can issue the
guarantees containing onerous clauses only after obtaining permission
from the competent sanctioning authority.

250. Guarantee issued on behalf of Joint Stock Companies should be

supported by appropriate resolutions of the Board of Directors.

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251. Guarantees of Rs.50,000/- and above have to be signed jointly by an
Officer who is an authorised signatory and Senior Manager/Manager.

252. If the claim period is not mentioned in the protective clause in the
guarantee, the beneficiary will have right to claim the amount by taking
legal action within 30 years if the beneficiary is the government. In case 0f
Others within 3 years, they can initiate legal action.

253. Claim Period is the time that the beneficiary is permitted after the
expiry of the period of the guarantee, to demand payment from the
guarantor bank, on failure of the party to perform the contract.

254. Every guarantee should contain a standard protective clause. A

protective clause is one that determines and restricts the amount of
guarantee and period of enforceability of the claim against Bank.

255. In case of Guarantees with Interest Clause, while limiting the liability
of the Bank in the protective clause, notional interest should also be taken
into account and commission should be charged on the amount including
the interest component specified in protective clause. For all purposes
guarantee amount and interest constitute guarantee liability.

256. In addition to sending Bank Guarantee in paper form, a separate

advice of the Bank Guarantee shall be sent to the advising bank through
SFMS by interfacing Flexcube Corporate through Middleware i.e, XMM
package, after which the paper Bank Guarantee could become operative.
A Clause has to be incorporated in the 'Bank Guarantee' that the Bank
Guarantee issued in paper form shall become operative only when the BG
advice transmitted through SFMS is advised to the beneficiary by the
advising bank. Such clause is known as SFMS Clause.

257. Advance Payment Guarantees and LCs for purchase/import of Raw

Materials are Non Fund Based Working Capital Limits.

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NFB Term Loans - DPG & BCA

258. DPG and BCA are normally involved in purchase of heavy plant and
machinery only. This system is also advantageous to the Bank as no
outflow of funds is involved. These two products are of much helpful to
Banks in adverse Credit-Deposit Ratio (CD Ratio) situations.

259. Deferred Payment Guarantees (DPG)

Issuance of deferred payment guarantees favouring suppliers arise where

machineries are supplied on credit and the payment is to be made by way
of instalments. The manufacturers will agree to supply the same only if
such instalments are guaranteed by the bank.

In the event of non-payment of instalment dues by the buyer, i.e., principal

debtor, banker issuing the deferred payment guarantee will have to make
the payment.

260. Bills Co-acceptance (BCA) means “an undertaking from the third
party (Bank) to make payment to the drawer of the bill (seller) on due date
even if the buyer fails to make the payment on that date”.

Thus, in the Co-acceptance of the bills, the bank which stands as co-
accepter undertakes to make timely payment to the seller even if the buyer
fails to make payment on due date.

In terms of RBI regulations, the co-acceptance limits should be sanctioned

only to the borrowers of the bank who enjoy other credit facilities with the
bank.

261. Main Difference between DPG & BCA - In case of both DPG & BCA,
Suppliers are sure of receipt of payments. However, Suppliers who are
cash rich may prefer DPG as yhey may not in need of funds immediately.
In case of BCA, since Coaccepted Bill is available, Suppliers who are in need
of funds, can get them discounted with their Bank. As such, Cash Rich
Suppliers may prefer DPG and Suppliers who need immediate funds may
prefer BCA.

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262. A takeout loan or takeout funding refers to long-term financing
that the lender assures to provide on a specific date or when specific
project completion criteria are met. It is quite common in property
development. Loans for takeovers are commonly used in the development
of properties.

263. Inter-institutional guarantees: Banks may issue guarantees favouring

other banks/ Fls/ other lending agencies for the loans extended by the
latter, subject condition that the guaranteeing bank should assume a
funded exposure of at least 10% of the exposure guaranteed.

264. Policy for financing the acquisition of the promoters’ shares in

an existing company, which is engaged in implementing or operating an
infrastructure project in India. Subject to following conditions (RBI Master
Direction of 2015)

(i) The bank finance would be only for acquisition of shares of existing
companies providing infrastructure facilities. Further, acquisition of such
shares should be in respect of companies where the existing foreign
promoters (and/ or domestic joint promoters) voluntarily propose to
disinvest their majority shares in compliance with SEBI guidelines, where
applicable.

(ii) In order to ensure that the borrower has a substantial stake in the
infrastructure company, bank finance should be restricted to 50% of the
finance required for acquiring the promoter's stake in the company being
acquired.

(iii) Finance extended should be against the security of the assets of the
borrowing company or the assets of the company acquired and not
against the shares of that company or the company being acquired. The
shares of the borrower company / company being acquired may be
accepted as additional security and not as primary security. The security
charged to the banks should be marketable.

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(iv) The tenor of the bank loans may not be longer than seven years.
However, the Boards of banks can make an exception in specific cases,
where necessary, for financial viability of the project.

(v) The banks financing acquisition of equity shares by promoters should

be within the regulatory ceiling of 40 per cent of their net worth as on
March 31 of the previous year for the aggregate exposure of the banks to
the capital markets in all forms (both fund based and non-fund based).

265. Partial Credit Enhancement (PCE) is a method whereby a borrower

or a bond issuer attempts to improve its debt or credit worthiness by
providing an additional comfort to the lender. Credit enhancement is a
strategy for improving the credit risk profile of a business, usually to obtain
better terms for repaying debt. In the financial industry, credit
enhancement may be used to reduce the risks to investors of certain
structured financial products.

266. In the context of project financing, the amount of capital expenditures

or funding above the original estimate to complete the project is known
as Financing of Cost Overruns.

267. Infrastructure Development Finance Company (IDFC) is a finance

company that offers finance and advisory services for infrastructure
projects, asset management and investment banking. The company has
now entered the banking industry with its venture, IDFC Bank.

268. Kinds of Charges:

Type of Charge Is created on

I Mortgage Immovable property

II. Pledge Movable goods or property
III. Hypothecation Movable goods or property
IV. Lien Paper security
V. Personal Liability Is nothing but personal guarantee

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Consortium, Syndication; MBA & JLA

269. Credit Limits can be availed in any of the following methods as

required by the borrower:

(a) Sole Banking

(b) Multiple Banking Arrangement (MBA)
(c) Consortium arrangement.
(d) Syndication.
(e) Joint Lending Arrangement (JLA)

270. Sole Banking :

Under Sole Banking, the entire credit requirements of the borrower are
met by one Bank only.

271. Consortium Advances:

The necessity of consortium arises when the amount involved is very large
and beyond the permissible resources of a single bank or beyond what a
bank would like to risk under ordinary circumstances on a single borrower
beyond the prudential exposure norms.

Borrowers having multi divisions/multi product companies are to be

treated as one single unit, unless there is more than one published balance
sheet for each division/unit. Therefore, more than one bank financing each
division of the company with only one published balance sheet without
the formation of Consortium / MBA would not be in order.

Under the consortium arrangement, more than one lending institution

including banks may participate in consortium to share the advances upto
the total assessed requirement of a borrower, on agreed proportions.

272. Multiple Banking Arrangement (MBA)

Borrowers can avail any credit facilities (both FB & NFB) from any number
of banks without a formal consortium arrangement.

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So long as the total credit limits enjoyed by a borrower from the bank are
within the permissible resources of a single bank, or within the prudential
exposure norms, such facilities can be extended by the individual banks
without a formal consortium under MBA.

To strengthen the sharing information about the status of borrowers

enjoying credit facilities under MBA., following guidelines shall be adhered
to:

1. Where the borrowers enjoy credit facilities from more than one bank,
obtain declaration about the credit facilities already enjoyed by them from
other banks from the borrower. Also, obtain declaration each time any
fresh facilities/ enhancements are sought or limits are renewed.

2. Branches shall obtain full details of all credit facilities including

temporary/adhoc facilities availed by such borrowers from the banking
system, duly certified by their auditors every time the credit facilities are
renewed/ fresh facilities/ enhancements are permitted.

Under Consortium financing, several banks finance a single borrower with

a common appraisal, common documentation, joint supervision and
follow up exercises, but in multiple banking, different banks provide
finance and other banking facilities to a single borrower without having a
common arrangement.

273. Loan Syndication

A syndicated credit is an agreement between two or more lending

institutions to provide the borrower credit facility using common loan
documentation.

Bank shall obtain a mandate from the project sponsor and act as a Lead
Manager / Mandated Bank to arrange credit on its behalf.

Wherever Bank is appointed as Lead Manager / Mandated Bank, the Bank

shall follow the general guidelines laid down for syndication of loan.

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Wherever any Bank wants to participate in loan syndication, the
information memorandum prepared by the lead manager / mandated
bank shall be evaluated and the matter be placed before appropriate
authority for decision.

While loan syndications typically work across borders and may handle
financing in different currencies, consortiums typically occur within the
boundaries of a given nation.

The managing bank in a loan syndication is not necessarily the majority

lender, or "lead" bank. Any of the participating banks may act as lead or
assume the responsibilities of the managing bank depending on how the
Credit Agreement is drawn up.

Under Consortium all the banks acts as a supervisor whereas under loan
syndication there is a lead bank or syndicate agent who looks after all the
issues.

Consortium is within a country's boundary whereas under syndication

institutions from different countries pool there resources to provide for
the required amount.

While a loan syndication also involves multiple lenders and a single

borrower, the term is generally reserved for loans involving international
transactions, different currencies, and a necessary banking cooperation to
guarantee payments and reduce exposure. A loan syndication is headed
by a managing bank that is approached by the borrower to arrange credit.
The managing bank is generally responsible for negotiating conditions
and arranging the syndicate. In return, the borrower generally pays the
bank a fee.

Loan syndication is a process where borrower approach a single bank /

financial institution and that bank sanction a part of the loan and get the
rest of the part sanctioned from other banks. (Sometimes the bank may
not provide the loan itself and may get it sanctioned from other banks).
Banks do this for a fee and also to diversify the risk.

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In case of consortium , borrower approach different banks and get them
at one platform, generally the bank having largest share of loan act as
leader of consortium.

274. Joint Lending Arrangement (JLA)

With a view to inculcate the required financial discipline in the borrowers

and to enable financing banks to take informed decision on credit matters
and as a risk mitigant, the ground rules governing Joint Lending
Arrangement (JLA) has been introduced.

(i) The scheme shall be applicable to all lending arrangements, with a

single borrower with aggregate credit limits (both Fund Based and Non-
Fund Based) of 150 Crore and above involving more than one Public
Sector Bank.

(ii) Borrowers having Multiple Banking Arrangement (MBA) below 150

crore may also be encouraged to come under JLA.

(iii) Banks/Consortia shall treat borrowers having multi-division/ multi-

product companies as one single unit, unless there is more than one
published balance sheet.

Credit Monitoring Tools

275. Monitoring and Follow-up

Monitoring and follow-up are closely related. Monitoring gives more

emphasis on ensuring proper end-use and follow-up gives more
emphasis on timely recovery of advances.

By Monitoring we mean to have a proper control over the borrowers’

operation to ensure the end use of funds. It includes adequate
arrangement by bank for maintaining close contact with the borrower and
his activities in order to remain well informed about the position and
progress of the project financed and to offer appropriate guidance to the
borrower, where necessary.

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Follow-up includes efforts to ensure that the terms and conditions of the
advance at different stages (Pre-disbursement, Disbursement, Post-
disbursements and Recovery stages) are complied with and money lent is
repaid as per schedule of repayment. It also includes efforts to regularize
the irregular advances. Recovery of advances largely depends on effective
follow-up. Follow-up is the systematic process through which these
activities are carried out. Success depends on how effectively the branch
ensures supervision and follow-up of the advances.

276. Important Credit Monitoring Tools : Balance Sheet; Stock Statements,

Unit Visits, Monthly Select Operational Data (MSOD),QOS, HOS, Progress
Reports in case of Bank Guarantees; PIPR in case of Term Loans.
Branches/Offices are obtaining these, but no proper review is done, they
are being used only for Attendance purpose. Please make use of these
tools properly.

277. Important Followup Tools : Unit Visits, Reminders for submission of

feedback data, for repayment, for compliance with Terms & Conditions.
Though, branches are contacting Borrowers (Coobligants/Guarantors)
frequently , no record is kept with respective files. If there is no proper
record we may be forced to conclude that there is no followup action from
Branch. Please keep a record of your followup action.

Credit Rating

278. Credit Rating reflects the payback abilities of individuals or

companies. Credit rating is a numerical representation of the
creditworthiness of an individual or a business.

279. A credit rating is an assessment of the creditworthiness of a borrower

in general terms or with respect to a particular debt or financial obligation.
It can be assigned to any entity that seeks to borrow money — an
individual, corporation, state or provincial authority, or sovereign
government.

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280. Evaluating the creditworthiness of an instrument comprises of both
qualitative and quantitative assessments, making credit rating far from a
straightforward mathematical calculation. A credit rating agency (CRA)
provides independent evidence and research-based opinion on the ability
and willingness of the issuer to meet debt service obligations.

281. In India, CRAs are regulated by SEBI. The Securities and Exchange
Board of India tightened disclosure standards for credit rating agencies
while assigning ratings to companies and their debt instruments. The
regulator directed that rating agencies must now disclose the liquidity
position of a company being rated. If the rating is assigned on the
assumption of cash inflow, the agencies would need to disclose the source
of the funding. Rating agencies must disclose their rating history and how
the ratings have transitioned across categories. Credit rating firms will also
have to analyze the deterioration of liquidity and also check for asset
liability mismatch.

The following are some of important CRAs registered under SEBI.

282. CRISIL (formerly Credit Rating Information Services of India Limited)

is an Indian analytical company providing ratings, research, and risk and
policy advisory services and is a subsidiary of American company S&P
Global.

283. CARE (Credit Analysis and Research Limited Ratings) - The company
was promoted by major Banks/ FIs (financial institutions) in India. In the
global arena CARE Ratings is a partner in ARC Ratings, an international
credit rating agency.

284. SMERA (Small and Medium Enterprises Rating Agency) . It is a joint

enterprise by SIDBI, Dun & Bradstreet Information Services India Private
Limited (D&B), and some chief banks in India.

285. ONICRA (Onida Individual Credit Rating Agency of India) has been
promoted by well known ‘ONIDA’ group. It is also known as Onicra Credit
Rating Agency.

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286. Fitch (India Ratings & Research) – Ind-Ra –(India Ratings and
Research) is a 100% owned subsidiary of the Fitch Group. Fitch Group is a
global leader in financial information services with operations in more
than 30 countries. Fitch Group is majority owned by New York based
Hearst Corporation. Fitch Ratings Inc. is an American credit rating agency
and is one of the "Big Three credit rating agencies", the other two being
Moody's and Standard & Poor's.

287. ICRA Limited (formerly Investment Information and Credit Rating

Agency of India Limited) was set up in 1991 by leading
financial/investment institutions, commercial banks and financial services
companies as an independent and professional investment Information
and Credit Rating Agency. The ultimate parent company of international
Credit Rating Agency Moody’s Investors Service is the indirect largest
shareholder of ICRA.

288. BWR (Brickwork Ratings) was established in 2007 and is promoted by

Canara Bank. It offers ratings for bank loans, SMEs, corporate governance
rating, municipal corporation, capital market instrument, and financial
institutions. It also grades NGOs, tourism, IPOs, real estate investments,
hospitals, IREDA, educational institutions, MFI, and MNRE. Brickwork
Ratings is recognised as external credit assessment agency (ECAI) by
Reserve Bank of India (RBI) to carry out credit ratings in India.

289. IVRPL (Infomerics Valuation and Rating Private Limited) is a full-

service rating agency. It provides rating services for the entire range of
money market & capital market instruments and borrowing programmes.
Infomerics also rates various schemes of Mutual Funds and Alternative
Investment Fund.

290. Acuite Ratings & Research Limited is an institutionally promoted

organisation with a unique combination of country's leading public &
private sector banks along with a global data & analytics company as its
shareholders.

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291. “The Big 3 Credit Agencies”-Globally The following 3 known as “The
Big 3 Credit Rating Agencies” - Fitch - Fitch Ratings ; Moody’s - Moody's
Investors Service ; S&P Global Ratings

292. Fitch - Fitch Ratings is a leading provider of credit ratings,

commentary and research. It provides value beyond the rating through
independent and prospective credit opinions.

293. Moody’s - Moody's Investors Service, often referred to as Moody's, is

the bond credit rating business of Moody's Corporation, representing the
company's traditional line of business and its historical name. Moody's
Investors Service provides international financial research on bonds issued
by commercial and government entities

294. S&P Global Ratings (previously Standard & Poor's and informally
known as S&P) is an American credit rating agency (CRA) and a division
of S&P Global that publishes financial research and analysis on stocks,
bonds, and commodities. S&P is considered the largest of the Big Three
credit-rating agencies.

Credit Information Companies

295. Due diligence is exercised in evaluating the credit worthiness of the

customer before extended any offer of loan or a credit card. This process
of evaluation is assisted by the services of Credit Information Companies
(CIC), which assist the banks in determining the credit worthiness of the
customers who applied for a loan or a credit card.

296. CIC or Credit Information Company is an independent third party

institution that collects financial data regarding loans, credit cards and
more about individuals and shares it with its members. Banks, Non-
Banking Financial institutions are usually the customers of Credit
Information Companies. The Credit Card Company collects financial
information about all these individuals and forms a credit report based on
their financial history.

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297. Credit Information Companies comply public data, credit transactions
and payment histories of individuals and companies. The data is collected
from various authentic sources and the companies form a credit report
based on the collected data. The credit companies also create a score
based on the credit report of an individual or an organisation.

298. The credit report and credit score plays a very important rule in an
individual’s financial journey as banks refer to this report and score to
decide the creditworthiness of an individual before granting a loan or
credit card.

299. Credit Information Companies in India are licensed by the Reserve

Bank of India and governed by the Credit Information Companies
Regulation Act, 2005 and various other rules and regulations issued by the
Reserve Bank of India.

300. The actions of Credit Information Companies is regulated by the

Credit Information Companies Regulation Act, 2005, enacted by the
Government of India. Following the CIC Act of 2005, the RBI and the
Government of India followed up with the Credit Information Companies,
Regulations and Rules Act, 2006.

301. In India we have the following four CICs as of now - CIBIL - The Credit
Information Bureau Limited; Equifax; Experian ; High Mark Credit
Information Services.

302. CIBIL - The Credit Information Bureau Limited or CIBIL was founded
in the year 2000. It is also the first Credit Information Company of India.
The company issues a score derived from this data known as CIBIL score.
The CIBIL score plays a very important role when it comes to the approval
of loan and credit cards.

303. Equifax - Equifax is a CIC that was founded in the year 1899 in
Atlanta. It is one of the oldest CIC as of now. Equifax got its ‘Certificate of
Registration’ in India in the year 2010 by the Reserve Bank of India. The
company has a separate bureau dedicated to address the growing lending
and regulatory needs of the Microfinance Institutions.

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304. Experian - Experian Credit Information Company was established
as a joint venture with several banks and financial institutions in India in
the year in 2006. It was named as one of the ‘World’s most innovative
companies’ by Forbes magazine in the year 2014. Experian prepares credit
reports of individuals based on the information provided by banks and
other financial institutions about the financial history of the individual.

305. High Mark Credit Information Services - This Company not only
provides credit reports to customers, but also caters to borrower
segments such as SME, commercial borrowers and retail borrowers. It was
established in 2005 in Mumbai. The company charges a nominal fee for a
credit report.

306. NARCL has been incorporated under the Companies Act and has
applied to the Reserve Bank of India for a license as an Asset
Reconstruction Company (ARC). As per the Ministry, NARCL has been set
up by banks to aggregate and consolidate stressed assets for their
subsequent resolution.

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