CREDIT RATING

Based on changing scenario and the need to factor certain vital parameters like
Market Risk,Industry Risk, Management Risk, etc. so that important elements of the
rating process are given sufficient attention , a new rating model has been evolved.
Even though the main purpose of the rating system is to decide on “risk”, credit rating
is also used to ‘price the product’ in a scientific and transparent manner. Hence, apart
from analyzing the various risks, due weightage has been given to factors such as
volume of business, share of ancillary business, length of relationship with the bank ,
threat of loss of business due to competition , overall image / reputation of the
customer/group , etc., to decide the pricing.
Credit Ratings are carried out as under:
Type of Account
Aggregate fund based /non fund based
limits over Rs. 2 lakhs, but less than Rs. 1 crore.
Aggregate fund based /non fund based limits of Rs. 1 Crore
And above (except traders).

CREDIT RISK - MEASUREMENT & MANAGEMENT

In the global context, the concept of risk management in bank lending has become a
routine affair though it is still to catch up in the Indian market. Of all the risks banks
encounter in their intermediation processes, credit risk poses greater threat to their
vulnerability & sustainability.
Credit risk arises from the likelihood of borrowers’ inability to meet payment
obligations. Credit risk has got two distinct facets:
• risk from the macro credit portfolio management perspective; and
• risk inherent in the individual loan account.

1. Determinants of credit risk:

The word ‘risk’, be it at Corporate level or at branch level, refers to the variability of
expected return. The variability could be either due to non-fructification of expected
cash flows or rejection of the product by the market. Here again, the failure to honour
the commitments of repayment could arise from:
• economic and business risk
• industry risk; and
• firm level risk.
¬ Economic & Business/Industry Risk:
Economic risks are more influenced by factors like Government policies - monetary
and fiscal measures, investment climate, political happenings, incentives in the form
of tax exemptions, changes in import tariffs, etc.
Similarly, business/industry risk are also external in nature to the assisted unit. Factors
like state of economy, natural calamities, business cycles, industrial recession, excess
capacity creation in anticipation of increase in demand, newer and cheaper products
replacing the existing one, technology getting obsolete/replaced by cheaper and more
effective techniques, over-exposure to a particular industry/group, etc., affect the
functioning of the assisted unit, which in turn, inflicts financial damage to the bank
These are more of macro level perceptions affecting the credit portfolio of bank as a
whole.

Firm-level Risk:
The firm-level risk, which is unique to each loan proposal, can be segregated into:
financial risk
cost-based risk
fiduciary risk (off balance sheet items)
default risk
Default, owing to either of these two, results in:
o Write off of the asset, if not recovered - direct loss
o If recovered late - loss of opportunity for reinvestment and fall in value of money.
The happening or otherwise of these risks depends on two aspects:
• propensity of the borrower to pay; and
• ability of the borrower to pay.
Ability can be estimated at the unit level through financial appraisal techniques etc.,
but willingness to pay is likely to remain as a subjective assessment.

2. Credit Risk Evaluation

Economic and industry risks being more of a macro level perception influenced by
events external to the assisted unit as well as the banks, needs to be managed at the
corporate level by undertaking continuous research into various government policies,
general economy of the country, industry profile, etc. Based on such constant tab on
the market happenings, corporate offices formulate credit policy guidelines and
circulate the same to branches for compliance/to ensure that the risks are transferred/
minimized/ mitigated.
¬ At Corporate level:
Credit risk at corporate level is bound to vary between 0 and 1. It means, if the entire
loan portfolio is NPA, the risk is 1. On the contrary if there is no NPA, risk is 0. In
reality these two are absurd. Based on these probabilistic characteristics and assuming
that the existing levels of bad debts etc. are true representative of normal market
behaviour, we can work out a possible risk factor index of a bank’s loan portfolio as
under:
Risk factor Index of Loan portfolio at a given time =

Cumulative Int. Suspense (k) = cumulative provisions (t) + cumulative write off (t)
Outstanding loans (t) + cumulative write off (t)

Here as the denominator being the gross outstanding loans, the RFI will always be
more than zero but less than 1. This index can aid management in keeping risk
element at an acceptable level.

¬ Unit level risks are analyzed under the heads -

• Management competence;
• Commercial aspects;
• Technical aspects;
• Financial strength

Multivariate Sensitivity Analysis: Fluctuations in profit levels owing to changes in

critical parameters
Certainty Equivalent Method: By assigning several values to the expected cash flow
from a project/return on an investment with explicit probability attached thereto and a
mean value of the probability distribution arising from such alternative scenarios is
calculated. Such mean would amount to a fair “expected return”.
Adjusted Discount Rate Method: Pre-determined pay back ability.
Profitability: Price of lent assets (P)
Cost of Funds (C)
Burden of servicing (B)
Profit = P - (C +B)
To sum up, loan asset is created by picking up a reliable customer for an approved
purpose where capital can be used to advantage with a scope for repayment within a
reasonable period from trading receipts or known maturities due on given dates.

Credit Rating:
This is yet another technique of credit risk measurement and as a part of risk
management, price the product vis-à-vis the inherent risk. Of late, this technique has
almost become formalized among the banks in India though with a distorted focus on
financial ratios and operational aspects of the assisted unit.
However, in the international markets, credit rating measures are usually structured in
the following style to cover the whole gamut of assisted firms’ business arena.

SCORING MODEL

ASPECT RATING RANGE REMARKS

Industry Risk 10-0 Prospects
Managerial Competence 30.0 BOD, Structure, CEO
Commercial Aspects 20-0 Growth, Demand
Technical Strength 15-0 Location, Technology
Profitability 10-0 ROI, ROS
Gearing 5-0 NW. Outside Liabilities
Liquidity 5-0 CR, DT, CT
Growth 5-0 Production & Sales
Based on the score obtained, the units are classified into -
∗ Low Risk 90-100
∗ Moderate Risk 75- 90
∗ Average Risk 50- 75
∗ High Risk 30- 50
∗ Very High Risk 0- 30

SWOT ANALYSIS OF BANK OF INDIA

STRENGTHS:
Different options are avaible to cover the large segment of market by catching the
need of the ultimate customers. Bank of India has always tried to provide the best of
the customer service and as a result the customers are pretty satisfied with the services
provided by the Bank.
The new staff which is being recently given imphasis would prove beneficial for the
Bank.

WEAKNESSES:
Employee point of view- Employee donot have individual identity in the outside
World. Officers need to have proof that they are employees of the Bank.
Customer point of view- Improvement is unrest, in such a cut throat competition Bank
should be in a position to improve the services towards its customers.

OPPORTUNITIES:
The headline inflation has fallen sharply and recent trends suggest that it may move
negative. The decline in inflation should support consumption demand and reduce
input costs for corporates.
Large number of sectors requires push in demand is infrastructure, IT, fertilizers, iron
and steel and hence require huge investments. They will generate forward and
backward linkages with other sectors and facilitate growth and further investment.
This would increase bank credit substantially.

THREATS:
Growth of quality assets, which are normally low yielding, would be tied up unless
commensurate cost-effective CASA deposits are mobilised.
Internal failure cost due to rapid migration of the employees to other Banks offering
more exciting and eye catching salary packeges and benefits.
The inexperienced young staff generally works with a rapid pace. This may affect the
profit and the reputation of the Bank in the market.

CREDIT APPRAISAL
The process of credit appraisal would begin with the selection of the proponent. It
would involve appraising the background of the proponent/management, commercial,
technical and financial appraisal. Appraisal of credit facilities would comprise two
distinct segments:
- Appraising the acceptability of the customer.
- Assessment of the customer's credit needs.
Both the aspects need to be examined simultaneously at the time of the initial entry of
a customer to the Bank as also subsequent periodic renewals.
The appraisal would be different in respect of:
a) personal loans for consumer durables, houses etc ;
b) loans to tiny business enterprises ;
c) loans to agriculturists ; and,
d) Credit facilities to firms, corporates and others for business/trade/ industry.

DEFINING CREDIT APPRAISAL

Credit appraisal is a holistic exercise which starts from the time a prospective
borrower walks into the branch and culminates in credit delivery and monitoring with
the objective of ensuring and maintaining the quality of lending and managing credit
risk within acceptable limits. Details of it will be given under the title Credit Policy.
DIMENSIONS OF CREDIT APPRAISAL:
MANAGEMENT APPRAISAL
A lot of attention has to be paid to this area, for this is one of the long term factors
affecting the business of the concern. Does the management have enough experience
in the line? What is its track record? What are the antecedents? Introduced to us by
whom? These are some of the questions that need to be answered before we can take
up any kind of exposure.
TECHNICAL APPRAISAL
What is the status of technology used? Has a prototype been developed of the
product? What could be the possible economic life period of the present technology?
Is the venture technology feasible?
Technical appraisal of the project needs to be carried out for industrial activity
proposals beyond the cut-off limits prescribed from time to time. Where technical
appraisal is carried out by All India Financial Institutions, PSU Banks/other leading
banks having expertise in the area and the same may be accepted for an appraisal
purpose, after subjected to vetting by TAC/TAD.
Exemptions from fresh techno-economic appraisal shall be available in the following
categories:
a) Where appraisal has been carried out by all India Financial Institutions and relevant
portion of appraisal note made available for vetting of our TAD / TAC.
b) Where appraisal has been carried out by leader of WC consortium and the branch /
sanctioning authority observing no serious differences with such appraisal.
c) In case of AAA /AA rated accounts with other banks, where our bank proposes to
join the consortium and /or sanction limits under multiple banking arrangement for
the existing activity of the company/firm
d) In case of well conducted existing accounts with credit rating of AAA and AA
where only additional working capital limits are sought and diversification of the
project is not proposed
e) In case of well conducted existing accounts with credit rating of AAA and AA term
loan requirements upto Rs.10 crores, provided expansion is in the same product line
and without change in technology

COMMERCIAL APPRAISAL
The business has to be commercially viable for us to proceed further. Is there enough
demand in the market? Is the product accepted in the market? How many substitute
products are there? What about entry and exit barriers? Is there scope for further
growth?
The nature of the product, demand for the same, the existing and perceived
competition in the segment, ability of the proponents to withstand the same,
government policies governing the industry, etc. need to be taken into consideration.
The trade practices in respect of the product should be thoroughly understood.

FINANCIAL APPRAISAL
Does the promoter has the capacity to raise finance- both own equity and debt? What
are the sources of margin? Will the business generate sufficient funds to service the
debt and other stakeholders? Is the capital structure optimal?
Thorough scrutiny of the financial aspects of the request needs to be carried out.
Apart from ascertaining the need based character of the limits requested for, the
financial health of the proponents, ability to absorb unanticipated financial costs need
to be looked into. Ascertaining the need based character of the limits would include
scrutiny of the cost of the project, means of financing, financial projections etc. need
to be within acceptable parameters for that industries/ activities.
Where higher limits are considered, detailed analysis of the financial health would be
made and the following ratios computed:
i) Current ratio
ii) Total outside liabilities/equity ratio
iii) Profit before interest and taxes/interest ratio
iv) Profit before tax/Net sales ratio
v) Inventory + receivables/Sales ratio
vi) DSCR if the borrower enjoys any term loan with any bank/FI even if no TL is
being considered by our bank.
Assessment of working capital credit requirements hinges normally on the projected
sales and other financial figures.
All the above ratios would be compiled for the past two/three years including the
latest audited balance sheet. As the ratios would vary from industry to industry,
services, trade, etc. it is proposed not to stipulate any particular benchmark for the
above ratios. Besides the above factors, Bank need to reckon the exist¬ence, if any, of
negative factors that may adversely affect the con-tinued well being of a customer.

ECONOMIC APPRAISAL
What is the breakeven level? Will the business post positive net present value through
its economic life? What is the level of cost /benefit? What is the Internal Rate of
Return (IRR)? Will the cost of funding and operations be well below the IRR?
As a prudent Banker the following areas need to be particularly looked into:
¬ CHARACTER
- Antecedents-introduced by whom- Is it a takeover account? In which case, what
does the status report say? - Background Educational Professional Socio –economic,
Political- Initiative and Drive.
¬ CAPACITY
- Experience in the activity – track record – planning, budgeting and review handling
–production capacity - capacity utilization- professional capacity to handle men,
material, money and minutes – capacities to handle contingencies and crises.
¬ CAPITAL
- Extent of stake in business
- Ability to raise finance – both owned equity and debt
- Ability to inspire and sustain investor confidence
- Ability to absorb losses – expected and unexpected
- Structuring and budgeting capital.

¬ CONDITION
- Condition of economy – growing, stagnant or depressed
- Numbers of competitors
- Substitutes in the market
- Demand vs. Supply
- Government policies and regulations
- Status of technology
- Availability of manpower, material other resources
- Pollution control and effluent treatment
¬ COLLATERAL
- Risk perception and evaluation
- Financial parameters
• Debt/equity ratio
• Asset Cover
• Interest Cover
• DSCR
- Availability, suitability and chargeability of security –MAST principle
¬ CASH FLOW
- Pattern of cash generation
- Liquidity risk
- Break-even analysis
• DCF Technique
• NPV
• IRR
• PV Index

STAGES OF CREDIT APPRAISAL

1. Interview with the proponent and obtention of application on Bank’s prescribed

format.
2. Adherence of KYC norms stipulated by Reserve Bank of India.
3. Obtention and verification of documents/financial statements according to type of
credit facility/ies required as per Bank’s norms
4. Inspection: Pre sanction Inspection is done by Bank’s Officials viz. inspection of
borrower’s residence, making inquiries from his area and collect market reports,
inspection of proposed principal and collateral securities. In case of mortgage of
property proposed, a search report is obtained from Bank’s approved advocate for last
30 years regarding non-encumbrance of the property, dues on the property, and
genuineness of title, peaceful possession and marketability of property. To ensure the
market and distress sale value of the property, Valuation report of the property is also
needed from Bank’s approved Architect.
5. Preparation of credit proposal: The credit proposal contains the complete
information about the proponent’s background, appraisal of financial & managerial
status, technical and economic viability of the activity and future prospects. Financial
analysis is exercised to justify the required financial assistance/ to arrive maximum
permissible finance as per Bank’s norms. This Financial analysis is done according to
Bank’s/RBI norms for different kind of facility/ies. In specified cases SWOT analysis
(strength, weakness, opportunity and threats) is also done for the proponent’s and
Bank’s financial safeguard. It is responsibility of the processing officer to mention all
the facts relating to proponent, his/their financials, security proposed and all the terms
and conditions.
6. Sanction of credit proposal: The sanctioning authority goes through the credit
proposal and it is his responsibility to ascertain the facts of the proposal. If needed he
himself make physical inspection and change/modify the terms and conditions and
finally give sanction within stipulated time frame of the scheme.
7. A sanction letter is given to the proponent. The sanction letter contains the type and
size of facility and margin stipulated with all terms and conditions including rate of
interest and charges, Insurance of the proposed security and periodicity of inspections
etc. which is duly acknowledged by the proponent/s.
8. If the proponent agrees the terms and conditions stipulated by the bank,
he/authorized persons have to execute the security documents before the Bank’s
authorized officer and finally the account is opened to disburse the facility.
9. After disbursement post sanction inspections are carried out by the Bank’s official
from time to time (as stipulated per terms of sanction) to ascertain the utilization of
funds, for safeguard of the advance and Bank’s interest in the security.

PROCESS OF CREDIT APPRAISAL

General
The process of credit appraisal would begin with the selection of the proponent. It
would involve appraising the background of the proponent/management, commercial,
technical and financial appraisal. Appraisal of credit facilities would comprise two
distinct segments:
- Appraising the acceptability of the customer.
- Assessment of the customer's credit needs.
Both the aspects need to be examined simultaneously at the time of the initial entry of
a customer to the Bank as also subsequent periodic renewals.
The appraisal would be different in respect of:
a personal loans for consumer durables, houses etc ;
b loans to tiny business enterprises ;
c loans to agriculturists ; and,
d Credit facilities to firms, corporates and others for business/trade/ industry.

Background of the proponent/management

The identification of the borrower needs to be done properly through scrutiny of his
antecedents, experience, competence, integrity, initiative etc. This may be done by
obtaining status reports from previous bankers or meaningful assessment of his
dealings with bank. In case of corporates, the management structure, the background
of the top management, needs to be scrutinised. Bank should be careful if the names
of prospective borrowers/promoters appear in the list of defaulters published by RBI/
ECGC etc or in any other list of undesirable customers.

Wilful defaulters
In case of borrowers/promoters who have been identified as wilful defaulters by banks
and advised by RBI, there are certain penal provisions applicable.
Credit facilities may not be denied to any constituent merely on the ground that their
directors (Nominee of Professional) not connected with the day to day management
are appearing on the defaulters list of RBI. However, discrete enquiries may be made
about their existing status with the defaulting company. Additionally, it should be
ensured that directors of the borrowing company should not have been disqualified
due to provisions of Section 274(g) of Companies Act.