1 credit management overview - nikkie
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CREDIT MANAGEMENT-
OVERVIEW AND PRINCIPLES
OF LENDING
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What is Credit Credit isdefined as confidence in
borrowers ability & intentions to repay the loan extended
to him by the creditor. Credit has become an integral partof modern industrialization economies. It has been
considered as oil of the commerce. It contributes to the
industrial growth and economic development.
What is Credit Management Credit Management
usually deals with the credit vetting of the customers,
allocation of available funds to different sectors/segments
of the economy, diversifying the applicable risk in
extending credit, internal funds movements &
reconciliation, as also maintaining relations with the
customers
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Goals of Credit Management in Banks
1. Optimize the mix of Banks assets2. Minimize bad debt loss
3. Analyze customer credit risk
4. Maintain financial flexibility
5. Be responsive to individual customer
6. Respect overall corporate financial constraints
7. Credit Managers must become strategic partners in
business operations
8. Credit Managers should learn how to manage
people of different culture
9. A Credit system is a foundation stone of modern
economy
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Credit Management has two facets :
Credit Appraisal
Credit Monitoring
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Credit Appraisal deals with the evaluation of credit needs of the
borrower, his worthiness, his ability, his risk, policy regarding
extension of credit to the borrowers, terms and conditions of the
credit, sanctioning process of the Bank and involves a decision
whether to extend the credit or not to the customer- pre sanction
stage. Once a decision to extend the credit is taken, the borrower is
asked to complete all the formalities of the terms and conditions,
signing of the documents etc.(Pre disbursal stage). After which the
credit is disbursed to the borrower.
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Credit Monitoring This is a post disbursal period and is very
important for the banker since the health of the unit is determined
during this phase. Banks are required to keep constant watch onthe unit vis--vis the loan account after disbursal of the loan, to
ensure that the amount disbursed to the unit is safe, is being utilised
for the purpose extended (ensuring end use of funds), generates
income and does not turn out to be sick.
There are three types of follow up that constitutes credit monitoring
a) Financial follow up
b) Physical follow up
c) Legal follow up
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Warning Signals
The loan account by itself would indicate explicitly the quality of the
loan. There are bound to be warning signals before an account
goes bad viz.,
(i) Reductions in credits (deposit entries) in the loan account if it is
a working capital account.
(ii) Issuing cheques to the creditors by the borrower in excess ofthe limit/Drawing Power (DP) available in the account, thereby
frequent returning of these cheques.
(iii) Delays and defaults in repaying the interest/ installments.
(iv) Non-submission/Delay in submission of the stock statements
and/or financial data to the Bank.
There is a need to identify these signals emanating from a loan a/c.
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If the Bank does not take prompt follow up action, it could result in
further defaults, thereby leading to a further degeneration in the
quality of the loan and create problem loans.
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Basic Requirement of Lending
Capital (register)
Credit Monitoring
Documentation Legal Remedy
Risk Management
Credit Information
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Documentation
The Banker grants financial facility to its customer under a valid
contract, the terms and conditions of the financial assistance areenumerated. Further, the terms of repayment as well as the
consequences in the event of breach of conditions are enumerated.
As a part of initial exercise, during the post sanction phase, the
bank obtains certain documents from the borrower/competent
authority of the borrowing Company duly signed so as to bind the
borrower legally and enforce charge.
The importance of the documents lies in the fact that with properdocumentation in force, there will not be any problem in enforcing a
claim by the bank in case of a default by the borrower.
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LEGAL REMEDY
In case of persistent default by the customer, where all other
measures taken by the banker including reviving of the unit are not
successful, the recourse open to the bank is
i. Enforce the repayment or enforce the security available through
the Court of Law. A common complaint of the banks and financial
institutions had been that they were facing enormous bottlenecks
in the recovery of loans through the Civil Courts. In view of this
the Government took initiative and established Debt Recovery
Tribunals (DRTs). However, even after establishment of DRTs,
enforcing security is still a time consuming process.
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(ii) To enter into a compromise proposal with the defaulting
borrower.
(iii) On recommendations of Narsimahan Committee for the purpose
of examining Banking Sector reforms, the GOI promulgated
Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Ordinance 2002 (SARFAESI)which was later on replaced by an Act . The provisions of this act
will enable Banks and Financial Institutions to exercise power in
taking over the possession of the securities, sell them and reduce
their non-performing assets.
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The Act provided three alternative methods of recovery of non-
performing assets:
Securitization
Asset Reconstruction
Enforcement of Security without the intervention of Court
The provisions of this act are applicable to NPA loans with
outstandings above Rs. 1 lac. NPA loan accounts where the amount
is less than 20% of the principal and interest are not eligible to be
dealt with under this Act.
Non performing assets should be backed by securities charged to
the Bank by way of hypothecation or mortgage or assignment.
Security interest by way of pledge, lien, hire purchase, lease are not
liable for attachment under this act.
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The act empowers the banks
To issue demand notice to the defaulting borrower and guarantor,
calling upon them to discharge their dues in full within 60 days from the
date of notice.
To give notice to any person who has acquired any of the secured
assets from the borrower to surrender the same to the Bank.
To ask any debtor of the borrower to pay any sum due or becoming due
to the borrower.
CAUTION: ANY SECURITY INTEREST CREATEDOVER AGRICULTURAL LAND CAN NOT BE
PROCEEDED WITH.
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If on receipt of demand notice, the borrower makes any
representation or raises any objection, Authorised officer shall
consider such representation or objection carefully and if he comes
to the conclusion that such representation or objection is not
acceptable or tenable, he shall communicate the reasons for non-
acceptance within one week of receipt of such representation orobjection.
A borrower/guarantor aggrieved by the action of the Bank can file an
appeal with DRT and then
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With DRAT, but not with any Civil court. The borrower/guarantor is
required to deposit 50% of the dues before filing the appeal.
If the borrower fails to comply with the notice, the Bank may take
recourse to one or more of these measures:
Take possession of the security
Sale or lease the right over the security
Manage the same or appoint any person to manage the same.
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Illustration:
Excel Bank Ltd. has sanctioned following credit limits to Andheri
Enterprises Ltd.:
Cash- Credit Rs. 20 cr
Bills Discounting Rs. 5 cr
Term Loan Rs. 0 cr
L/C Rs. 5 cr
The stock statement submitted by M/s.Andheri Enterprises as on
30/06/2010 is as follows :
Raw Material : 8 cr
WIP Rs.3 cr FG: Rs. 8 cr
Receivables: Rs.8 cr (including receivables of Rs. 2 cr which are
more than 6 months & excluding those included under Bills
Discounting Limit).
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The present outstanding as on 15/10/2010 in Cash-Credit account
are Rs.22 cr (including overdrawing) and the account has remained
continuously irregular since 14/09/2010
First Term Loan installment of Rs. 2cr and quarterly interestamounting to Rs.0.60 cr has also remained unpaid till date. Further,
Bills discounted limit is fully utilised, however, bills amounting to
Rs.1.60 cr due for retirement till date also remained unpaid.
The margins applicable to RM, WIP, FG, Receivables are 30%,
40%, 30%& 40%. 8 Cheques amounting to Rs.3.40 crs have been recently returned
for want of required DP in the account.
Question:
Calculate the amount of irregularity in the account as on date. What
action should the bank take under the circumstances.
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Risk Management :
Banks Traditional role is to mobilize the funds from thehousehold sector/surplus from the Corporates and
deploy it with the household and Corporate Sectorfor consumption/productive purpose. Its role is thatof intermediary. As such Banks are exposed tovarious risks.
The price at which the Banks mobilize and transferfunds depend on two parametersthe time forwhich the funds are made available and creditworthiness of the person to whom the funds aremade available. Considering long term loans are
priced higher than short term loans and a high riskborrower pays a higher price (interest), banks willhave to factor liquidity risk and/or credit
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credit risk to earn spreads. There is also a definite linkage between
the various risks faced by the banks. For example, if the bank
charges a client floating rate of interest, in case of increasing ratescenario, the banks interest rate risk will be lower. Consequently,
the payment obligations of the borrower increases. Other things
remaining constant, the default risk increases if the client is not able
to bear the burden of the rising rates. There are many instances
where the interest rate eventually leads to credit risk.
Top priority of the banks is to improve their asset quality by
minimizing and managing their credit risk.A robust credit riskmanagement framework with a proper risk management model
coupled with the sound/speedy legal framework improves the quality
of the assets.
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Another technique being employed by the Banks to reduce interest and
liquidity risk is Asset-Liability Management (ALM).ALM has both
macro and micro level implications.
At macro level it leads to the formulation of critical business policies,
efficient allocation of capital and designing of products with
appropriate pricing strategies.
At micro level, the objective is two foldit aims profitability through
price-matching and ensuring liquidity by maturity matching. Price
matching maintains spreads by ensuring deployments of liabilities is
at a rate higher than the cost. Similarly, grouping the
assets/liabilities based on their maturity profile ensures liquidity. The
gap is then assessed to identify the future financing requirements.
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Credit Information: Banks and lending institutions
have a traditional resistance, to share creditinformation because of confidential nature of
banker-customer relationship. To serve this
purpose and to make credit and other data
available specialised institutions known asCredit information bureaus have been set up.
They serve as repository of current & historical
data of the existing and potential customers.
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CREDIT INFORMATION BUREAU OF INDIA
LTD.(CIBIL)
CIBIL was promoted by SBI, HDFC, Dun & Bradstreet Information
services (P) Ltd. to provide credit information of clients to its
members. Presently, its shareholding pattern has been diversified to
include number of banks and finance companies.
CIBIL collects commercial and consumer credit-data and collatessuch data to create and distributes credit reports to its members.
CIBIL primarily gets information from its members and at
subsequent stage will supplement it with public domain information
in order to create a truly comprehensive snapshot of an entitys
financial track record.
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Credit Information Report(CIR)
Credit information reportis a factual record ofborrowers credit payment history. Its purpose is
to help credit grantors make informed lending
decisions-quickly and objectively. CIBIL caters
to both consumer and commercial sectors.Consumer Credit Bureau covers credit availed
by individuals while the Commercial Credit
Bureau covers credit availed by non-individuals
e.g. partnership firms, proprietary concerns,
Private and Public Ltd. companies etc.
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Type Of Information vailable OnBorrower1.Basic information
Name, Address, ID No., Passport ID, Voters ID, Date of birth,
Registration No., Date of incorporation, Legal Constitutions, Board of
Directors etc.1.Record of all the credit facilities availed by the borrower
2.Past Payment history
3.Amount overdue (if any)
4.Suit filed status
5.No. of enquiries made on that borrower by member
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INFORMATION NOT INCLUDED IN CIR
- Income/Revenue details- Details of deposits with the banks
- Details of the borrowers assets
- Value of assets mortgaged
- Details of investments
CIBIL itself does not classify any accounts as
defaults account. It merely reflects theinformation of Asset Classification as permembers record.
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LENDING DECISION: CIBIL CIR only provides available credit information and
does not provide any opinion, indication or comment pertaining whether
credit should or should not be granted.
The Credit grantors who have received an application for credit will make the
credit decision. CIBIL does not own any responsibility merely on the basis of
Credit information provided to the creditor.
RIGHT TO INFORMATION ACT 2005 IS NOT APPLICABLE TO CIBIL
CIBIL is not a public authority.
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CREDIT FACILITIES EXTENDED
BY THE BANKS:
1. RETAIL: Risk Assessment on Scoring Model
Personal Loans: Amount sanctioned: Multiple of Monthly Income/Annual
Income, Repayment 5-7 years, Documentation- Loan Application, Loan
Agreement, Demand Promissory Note (DP Note) Check-off facility (ifavailable), PDCs for EMIs or mandate to debit the account through ECS for
monthly repayments.
Consumer loans: To buy consumer goods, Margin Nil to 25%, Repayment
5-7 years, documents as in personal loan additionaly Hypothecation
agreement
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Vehicle Loans: Cars/ScootersMargin 5% to 25%, Period 5-7
years, Documents as above, Charge to be registered with RTO,
Comprehensive Insurance to include Bank clause
Home Loans: Home Loans against mortgage of property, Equitable
Mortgage is preferred, Credit extended may be 60% to 85% of the
cost of house/cost of construction, Period may range from 10 to 30
years depending upon income and age of the borrower. Title
Documents relating to property are called for verification of
ownership.
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Photocopies of these documents are sent to Banks Legal Advisor to
seek his opinion regarding ownership of the customer and also to
know if the valid equitable mortgage can be created against the
property. Sometimes, if necessary technical report from approved
valuer to know the market value of the property is also called for.
Documentation: Home Loan application, Loan agreement, personal
guarantee agreements from the acceptable guarantors, Personal
guarantee of the spouse/legal heir, Deposit of titles of the property
for equitable mortgage, independent letter to be sent by the
customer to the bank detailing the details of the property and his
independent acceptability to equitable mortgage the property,
Recital to be prepared by the Banker, PDCs or ECS mandate for
EMIs.
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Construction of house : Inspection, progressive payments on the
basis of architects certificate, if title deed is not available, obtain any
other acceptable security for the intervening period.
Education Loan:Admission must be granted by a Recognised
Institution, good academic track record of the student, Family
financial position, scoring model
MARGIN
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MARGIN :
Upto Rs 4 lakhs Nil
Above Rs. 4 lacs : Studies in India 5% Studies Abroad15%-
Scholarship/ assistantship to be included in margin.
Margin may be brought-in on year-to-year basis as and when
disbursements are made on a pro-rata basis.
Loan repayment to start as soon as the student gets
employment or within 6 months of the completion of the
course.
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SECURITY :
Upto Rs 4 lacsCo-obligation of parents.
No securityAbove Rs.4 lacs and upto Rs7.5 lakhsCo-obligation
of parents together with collateral security in the form of suitable
third party guarantee. The bank may, at its discretion, in
exceptional cases, waive third party guarantee if satisfied with
the net-worth / means of parent/s who would be executing the
document as joint borrower.Above Rs.7.5 lakhsCo-obligation of
parents together with tangible collateral security of suitable
value, along with the assignment of future income of the student
for payment of instalments Loan application, Loan agreement to
be signed by the student and parents, personal guarantee
agreements (if applicable)
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LOAN AGAINST SHARES OF THE LISTED
COMPANIES: Sanctioned both as demand loan or
Limit/DP in Current Account. Facility should be extended
only in case of listed companies. Amount sanctioned
should not be more than 50% of the average market
price of the share. Documents: Application form, DP
Note, Transfer deed duly signed by the shareholder. If
EMI-PDCS/ECS, Bullet Payment.
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LOAN AGAINST BANKS OWN FDRS/NSCs etc.
Sanctioned both as demand loan or Limit/DP in Current
Account. Margin25% Lien of Bank is noted (in case of
NSCs/ KVPs with the issuing Post Office) Documents:
FDR/NSCS/KVPs duly discharged by the customer,
Application for loan, DP Note.
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REVERSE MORTGAGE
It is a contract between the Home owner and the financier/bank,
which enables the Home owner to receive a stream of income
(monthly/quarterly), from the future realizable value of home.
It enables senior citizens/Old age (60 years & above) to get
independent income and live honourably
Normally banks will provide the stream of income to couple, till the
last of two live but may put maximum tenure to 15 years
The recovery of loan amount is effected through sale of house afterthe death of last of couple
Even if maximum tenure of income stream is fixed for 15 years,
couple can continue to live in the house till last of two is alive
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Legal heirs after death of couple can also pay the loan amount along
with interest and can acquire the house
In case if sale of house takes place, any surplus amount afterclearing loan balance is passed on to the legal heirs
In case if the sale amount falls short of the loan amount, loss is
borne by the bank
Valuation of the property is got done and equity value on which
annuity is paid to the couple may range from 60% to 90% of the
property valuation
Property valuation is revisited periodically and if couple requires
annuity value can be increased
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Amount of annuity paid to the couple is based on factors like current
valuation, projected appreciation, age of applicant, current interest
rates
Higher the age, valuation, more is amount available
Benefit to the Bank:
Bank will be able to get expected return on the principal invested
No risk of account becoming NPA
Provisioning and capital adequacy norms still not defined by RBI
More profitable to offer mortgage to older people because of less life
expectancy
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Risk factors for Bank
Life expectancy/mortality risk: May have to pay annuity for longer
period, if borrower or spouse live longer. Risk is mitigated by fixing
tenure to 15 years
Interest rate risk: When interest rates move up: Can be mitigated by
entering into floating rate contract
Real Estate market risk: Depreciation in valuation: Real Estate
values seldom depreciate in long run
Benefits to Borrower:
Supplement retirement income
Remain economical independent
With real estate values increasing, better equity left over for heirs
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No upper age prescribed. In fact more the age, more easy to get
loan
It is a non recourse loan. Bank can recover the amount only when
last of couple dies
Disadvantage
Non convential retirement tool
May disturb emotional attachment
Pricing is complex; based on future value, life expectancy, interest
rate risk
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If borrower have two or more spouses, reverse mortgage agreement
will include only one and bank will be entitled to sell property
accordingly
Closure and servicing cost is highupfront cost, servicing cost
(Insurance etc), closure cost (Margins due to life expectancy&
others)Recommendationsgo only for 15 years or fixed annuity
period
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2. COMMERCIAL CREDIT FACILITIES:
Credit Facilities are extended to proprietary firms, partnership firms,
SMES/SSIs, Private Ltd. and Public Limited Companies based on
their CRA. The credit facility extended may be either Funded
Facility or Non Funded Facility.
Funded Facilities
Non Funded Facilities
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EXPORT FINANCE
Pre-shipment Finance:
a) Export Packing Credit (EPC)
denominated in Rupees
b) Packing Credit in Foreign
Currency (PCFC)
denominated in Euro, Dollar, Pound,
Yen
Post Shipment Finance:
a) Foreign Bill discounting Limit
with or without L/C.
IMPORT CREDIT
Letter of Credit (L/c)
for import of machinery/material
etc.
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LETTER OF CREDIT
It is a financial instrument issued
by the bank on application of its
customer (importer/purchaser) in
favour of exporter/seller,
guaranteeing reimbursement of
drafts (Bills of exchange) drawn
by the exporter/seller for the
supplies upto certain amount and
within a specified period as per
terms enumerated in the L/c.
Part ies inv olved:
Applicant-Importer/Purchaser
Negotiating Bank
Confirming Bank
Opening Bank/Issuing Bank
Reimbursing Bank
Advising Bank
Beneficiary
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Types of L/cs
Revocable L/c & Irrevocable L/c,
Confirmed L/c & Unconfirmed L/c
Revolving L/c
Transferable L/c
Back to back L/c Deferred Payment L/c:
Allows Bank to make payment in predetermined
installments
Anticipatory L/c:Red clause letter L/c, Green Letter clause L/c
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Guarantees
Sec.126 of the Contract Act. A contract of guarantee is a contract to
perform the promise or discharge the liability of the third person in
case of his default. The person who gives the guarantee is called
surety; the person on whose behalf /default the guarantee is given is
called principal debtor and the person to whom the guarantee is
given is called creditor/beneficiary. The liability of a guarantor/ surety
comes into existence upon the failure of a debtor. If the surety
extinguishes the liability of a debtor, then the surety will acquire all
the rights of the creditor, known as right of subrogation.
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Types of Guarantees
Financial Guarantees
Bid/Tender Guarantee
Deferred Payment
Guarantee (DPG)
Performance Guarantee
Advance Payment
Guarantee (APG)
Performance Guarantee
(PG)
Retention Money
Guarantee (RMG )
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DPGis a Financial Guarantee and can be said to be a substitute of
Term Loan. Difference between the two is that in case of Term
Loan, the lender bank lays down funds to the extent loan extended
for the purchase of FA. In case of DPG the bank does not lays down
the funds for acquiring FA by the borrower but has to make sure that
the borrower has sufficient cash flows at the time of retirement of
bills drawn by the seller and got discounted by his bank on the
strength of the purchaser/importers bank. It is therefore necessary
that the various aspects of appraisal of the project viz. economics of
the project, its technical feasibility and economic viability etc. are
assessed in detail, as done in case of Term Loan.