financial analysis for bank lenndinng -dsms

7/29/2019 Financial Analysis for Bank Lenndinng -Dsms

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Title: FINANCIAL ANALYSIS FOR BANK LENDING IN LIBERALISEDECONOMY AN ANALYSIS IN INDIAN PERSPPECTIVES.

Authored by:

Professor (Dr.) Debdas Ganguly

Head, Department of Management & Social Science

Haldia Institute of TechnologyP.O. HIT, Hatiberia, ICARE Complex

Haldia,

District: Midnapore (East), PIN-721657

West Bengal

E-mail Address: [email protected]

Mobile: 9433894726

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FINANCIAL ANALYSIS FORBANKLENNDING IN LIBERALISEDECONOMY AN ANALYSIS IN INDIAN PERSPPECTIVES.

Abstract: During last sixty years India has created a diversified industrial sector

maintaining average 5.3% annual growth rate in first three decades and 6.9 % annual

growth rate in next three decades. In this process of industrial growth in postindependence era, in first two decades lead was taken by public sectors and in last four

decades private sectors had massively come forward with subsequent capital investment.

Since the beginning of decade of ninety, because of enactment of several non regulatorypolicy by Government of India as well as change in global business environment,

opportunities of flexibilities was observed to be coming up on global basis leading to an

era of liberalized economy.

Also in this process, several systems and mechanisms had come up in industrial financingleading to availability of several sources of finance comprising of Government and

Private investors in this newly developed financial market. The cost of this finance also

varied widely, somewhere between an average cost of 10% to as high as 25% depending

upon terms and conditions of credit market. The public sector banks had been the mainplayer in this market.

The public sector banks with their policy of Bucket Filling source of finance had beenthe main and most trusted source of fund for the process of national industrial

development. Except several specific situation like high inflation etc. Indian nationalized

banks under the supervision of RBI had undertaken investment friendly credit policywith availability of low cost fund for individual investment purpose.

Investors seeking fund had been much analytic in nature over selection of source of

finance and there had been different purposes and methods of utilization of this fund. It

had been observed that public money offered to investors at a competitive rate(competition even with private financiers) had not been optimally utilized to generate

optimum national income by these investors. Return out of this public money, thus

invested, had not been maximized. Instead of satisfying the national interest, the investorshad satisfied their individual or organizational interest.

The public financing institutes, specially the banks need to suitably analyze each lending

activity and the lending activities in general so that it satisfies the national objective aswell as the financial objective for which bank lending process is encouraged by

Government in most efficiently satisfied keeping the eye towards the environment of

liberalized economy.

Key words: Liberalized economy, globalization, business environment, credit market.

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Introduction:

In fact the frame work of Indian economic policy was formulated by Pandit Nehru in

1950s in terms of democratic socialization. The chief planks of this policy were: i) thestate shall own and/or manage the heavy infrastructure and financial sectors of the

economy; ii) private sector actively shall be regulated by the state with respect to

investment, access to key inputs and credit production process, profit, wages and workingcondition, iii) eradication of poverty and social justice and iv) system of public

administration through bureaucrats who would be accountable to elected government.

In this context it may be useful to examine in general the expectations of the existingIndian industry from banks expressed on various occasions in recent years. The most

popular expectation is availability of easy and cheap credit from banks. Indian

industrialization has always explained against the national policies which they think are

aimed at dear and tight money.

Private Sector and Liberalization and Globalizing Policy:

With the advent of new policy of liberalization and globalization, particularly since 1991,

the Indian corporate sector has been subjected to an entirely new environment vis--visthe past era of strict commands and controls. In the preceding four and a half decades

they learnt to live as renters on the commands and favors of the political bosses andbureaucrats. Not only resource allocation and investment decisions, but also small details

like what, where, and how much to produce; how, when, where and whom to sell and at

what prices, were all were decided by the Government. This obviously resulted intocollapse of self confidence, stifling of initiative and decision making skills of Indian

corporate magnets, which are mostly family managed houses.

Role of Bank Credit:

It also follows that a large part of incremental bank credit both long term and short term,

will have to go to the newly growing segments of industry and the share of existing

industry will keep declining. However, in view of the mega character of infrastructureand the knowledge based industrial projects, demand of credit from banks would rise

faster and provide an entirely new and wide range of clientele to the banks and

syndication of mega loan. It is really a debatable issue whether it is possible in India forthe banks to lend at 7 to 9 percent and pay depositors only 3 to 5 percent interest when

inflation rate is likely to continue to be higher. Moreover, it is also interesting to find that

in recent years a company had been getting credit from banks at about 16% and at the

same time, it had also been getting money from inter-corporate market at about 22percent with provisions of a panel change of 3 percent if money is not returned within the

stipulated period of six months. This is a big anomaly and needs serious thinking and

plausible explanation.

Professionalization of Credit in Business The Delivery System

A big challenge for banks in coming days will be mobilizing more and more deposits atlower and lower costs. Banks need to prepare themselves to handle mega projects and

also to deal on day to day basis with mega corporations. Present system of consortium

may soon breakdown and multiple banking may become more popular. That would

provide sharper edge to competition.

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Indian banking is necessary to be transformed from highly regulated to fully liberalize

micro level operation. At the same time, it should also be seen as a learning process

where bankers learn that professionalism is based on a large measure of ethicalcommitment. Bankers need to be protected for their genuine errors of judgement. But let

there be no doubt about the fact that this protection would have to be earned and not

merely claimed.

Liberalized Era and New Focus of Bank Lending:

Liberalized banking necessitates a new focus in bank lending. During the last threedecades India has developed an impressive network of financial institutions, mainly in

public, cooperative and private sectors. Some of these are national level institutes while

others are state level and serving diverse economic sectors such as industry, agriculture,

small and tiny units, export housing and sick industries. These financial sectordevelopments since 1969 can be broadly divided into three related but distinct phases:

Expansion phase from 1969 to 1985; Consolidation and liberalization phase from 1985 to

1991, and Liberalization and financial sector reforms phase from 1991 onward.

Expansion phase (1969-1985) Due to strong impetus provided by the nationalization of14 major commercial banks in July 1969 and another six banks in April 1980, the sixteen

year period from 1969 to 1985 saw phenomenal expansion and diversification ofcommercial banking system in India. This is clear from following table:

Table-1: All Scheduled Commercial Banks of India

(Amounts in rupees)

June

(1969)

December

(1985)

March

(1991)

March

(1996)

1,Number of branches 8262 40,414

(10.13)

60,113

(6.50)

62,859

(0.90)

2.Aggregate deposits 4446 101.871(20.44). 192.542(10.63) 432,345(17.50)

3.Bank credit 3599 60,945

(18.58)

116.301

(10.80)

242,309

(15.80)

4.Priority sector credit 504 20,190

(25.06)

42,915

(15.14)

64,141

(10.57)

5.Credit deposit ratio 77.5 59.8 60.00 56.00

Figures in brackets denote annual compound rate of growth.

Banking industry in India witnessed spectacular growth during a decade and half after

nationalization of 14 banks in July 69. This is clear from the table that branch networkrecorded compounded growth of 10.03% per annum, deposits by 20.44% , credit by

18.58%, priority credit by more than 25% annually during this phase. During the second

phase (1985- 1991) of consolidation there was marked deceleration of growth on all thefour key performance areas of branch expansion(6.5%), deposits (10.6%), credit (10.8%),

and priority credit (15.4%). In the 3 rd phase there were some pick up in the growth of

deposits and credit as against 2nd phase, but compared to 1st phase the annual growth wasstill quite lower on all the four parameters.

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Innovation in Regard to Money Market:

A number of steps were taken to activate and develop money market in India. These,inter alias, include:

Introduction of 182 days Treasury bill on an auction basis.

Lowering of bill discounting rate. Setting up of Discount and Finance House of India (DFH), to develop active

secondary market instrument.

Introduction of inter-bank participation (a) with risk and (b) without risk.

Removal of interest rate ceiling on calls and notice money, inter-bank term money,

rediscounting of commercial bill.

Introduction of two new money market instruments, namely certificate of deposits (CD)and Commercial Paper (CP) the former to provide the market determined interest rate

on bulk deposits and later to enable prime borrowers to raise short term funds from

market at competitive rates.

Appraisal of Credit Worthiness and Credit Rating:Since 1975 credit appraisal in India aims at calculation need based maximum permissiblebank finance (MPBF) on the basis of certain norms for various chargeable current assets

and the agreed projected sales of borrowal units. But it is now found inadequate to cope

with the challenges thrown by the new policy of deregulation, liberalization and

globalization. It is increasingly felt that the new focus of the credit appraisal has to benow towards the following three critical factors:

1. Credit risk and credit worthiness- based rating system

2. Production differentiation3. Differential pricing policy.

Credit Rating Based on Risk and Credit Worthiness Analysis:Credit rating of a borrowed company relates to future which is uncertain, while

measuring the risk involved in lending, banker has to assess the chances of repayment of

the proposed loan with interest in time by the prospective borrowed company. It is a sort

of risk measuring exercise. In other words, risk measurement by a bank in regard to aprospective borrowed unit involves gathering information on the probability of that

prospective loan assets remaining standard and performing in nature. The collection of

such relevant data and information may entail detailed analysis of the following basicparameters:

A. Financial Parameters

i) Credit worthiness testii) Continued credit worthiness test

iii) Account policy and quality accountiv) Financial contingency plan and cash flow adequacy.

Continued Credit Worthiness Test:

Healthy ratios of previous year5s can not be taken as indicators of future continuedcreditworthiness of the company. Net worth of a company is a stock concept and profit

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is a flow concept. A company can continue to maintain its credit worthiness in future

only when it is able to maintain good profitability. The following profitability ratios may

be useful in this regards:

1. Margin Ratio = Operating Profit Before Interest and Taxes (OPBIT)/ Sales

2. Return on Investment = OPBIT/ Total Capital Employed (NWC+Total Outside

Liabilities)

3. Profitability Ratio =Net Profit Retained in Business / Net Profit After Tax

Price Differentiation: There can be differential pricing policy for various types of loan

products, based on some rational and transparent criteria. These criteria can be asfollows:

i) Credit Rating Criteria: The best rated clients such as blue chip corporate sectors can

be charged the lowest rate of interest, say prime rate plus tax, and successively lowerrated ones would be charged increasingly higher rates of interest due to loading of risk

premium, which would not be within the maximum prescribed based of interest from theprime rate of interest

ii) Conduct of the Account: There may be at least the following eight parameters relating

to financial discipline observed by the company for pricing loan products:

a) Punctual submission of information as per Quarterly Information System (QIS)

within the prescribed time and also submission of monthly stock statements.

b) Timely submission of renewal papers, latest within 12 months from the date of lastsanction/review/ renewal.

c) Achievement of net sales projected in last year.

d) Compliance of inventory norms.e) Timely repayment of term loan installments and interests.

f) Submission of complete audited balance sheet within 4 to 6 months from balance

sheet date.g) General compliance of term and conditions of sanction.

h) Retrial of bill/bills and IC/Invocation of bank guarantee fee.

iii) Repayment Period Criteria: Longer the duration of loan , higher may be the interest

rate of loading of risk premium for future uncertainties.

Conclusion:

A few things are evident from the foregoing discussion- i) the policy of economicliberalization and financial sector reforms have already releasing the forces of intense

competition for the banks in India. To survive and grow in this emerging scenario, they

have to develop a professional character like foreign banks, and inculcate among theirstaff a high sense of customer orientation. ii) they have to recognize and restructure their

credit department on suitable lines, iii) they have to computerize the selected branches

responsible for handling bigger advances and arm them with all modern gadgets, aids and

information technology.

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References

1. Iacocca Lee, Iacocca: An Autobiography, London, Sidgwick and Jackson, 1985.

2. Singh, S.P. and Bhattacharyya, B.N., Trends and Patterns of Financing inCorporate Sector, Pune, National Institute of Bank Management, 1989.

3. Singh, S.P., Managing Working Capital by Strategic Choice, Vilalpa, Jan.-

March, 1988.4. Singh, S.P.,Ideas on Bank Credit, Bank Lending, Bombay, National Institute of

Bank Management, 1975.

5. Weston, J.F. and Brigham, E.F., Managerial Finance, 1969, Ian W. Harrison,

Capital Investment Appraisal, McGraw- Hill Book Company (UK) Ltd.

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