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The joy of ingenuity!!! This is doubtlessly what this project is about. Before getting to brass tacks of things. I would like to add a heartfelt word for the people who have helped me in bringing out the creativeness of this project. To commence with things I would like to take this opportunity to gratefully and humbly thank to Mr. Sumit Saxena, Project guide, State bank of India, Bareilly for being appreciative enough by giving me right guidance to undertake this project. Respected Mr Sanjay Medhavi, Faculty, Department of Business Administration, University of Lucknow for his undeterred guidance for the completion of the report. My parents need special mentions here for their constant support and love in my life. I also thank my friends and well wishers, who have provided their whole hearted support to me in this exercise. I believe that this Endeavor has prepared me for taking up new challenging opportunities in future.


In India, our environment hitherto was totally regulated and directed with reference to our industry, banking etc. High tariff walls due to shortage of foreign exchange and forced restriction on imports, protected indigenous Industries and created a suppliers' market, where the consumer had no or very limited choice. Similarly Banks operated in an atmosphere where everything was directed and controlled externally (albeit either by RBI or Finance Ministry), the need for studying risk was never felt. Lack of product-quality in Industry or poor service and lack of efficiency in service-centers were never felt seriously, as there was no competition and no alternative choice before the consumer. But with dismantling of State control over every sector of economy, with deregulation (i.e. supply, demand and prices) to shape on the basis of market forces, Indian Industry and Indian Banking have now come to face a new challenge. Competition results in the survival of the fittest. In the liberalized environment, competing with the hightech new generation Banks, the erstwhile commercial banks have to re-orient themselves to the changed situation. Lending which was the primary function of banking has gained lot of importance as it determines the profitability of the bank. A bank can lend successfully only when a borrowers credit worthiness is accurately assessed. The method of analysis required varies from borrower to borrower. It also varies in function of the type of lending being considered. The lending can differ in the way credit given to retail customers or corporate customers, secured or unsecured, long term or short term etc. For financing a project, bank would look at the funds generated by the future cash flows to repay the loan, for asset secured lending, bank would look at the assets and for an overdraft facility, it would look at the way the account has been run over the past few years. In this project the appropriate methods of analysis for lending to companies, known as corporate credit is being detailed. This project is about the credit analysis in banks. The process of lending, the various analysis involved in giving credit to a customer are detailed. Focus is on financial ratio analysis, non financial analysis and different models used by banks in the lending process.


The significant transformation of the banking industry in India is clearly evident from the changes that have occurred in the financial markets, institutions and products. While deregulation has opened up new vistas for banks to augment revenues, it has entailed greater competition and consequently greater risks. Cross-border flows and entry of new products, particularly derivative instruments, have impacted significantly on the domestic banking sector forcing banks to adjust the product mix, as also to effect rapid changes in their processes and operations in order to remain competitive in the globalize environment. These developments have facilitated greater choice for consumers, who have become more discerning and demanding compelling banks to offer a broader range of products through diverse distribution channels. The traditional face of banks as mere financial intermediaries has since altered and risk management has emerged as their defining attribute. Currently, the most important factor shaping the world is globalization. Integration of domestic markets with international financial markets has been facilitated by tremendous advancement in information and communications technology. But, such an environment has also meant that a problem in one country can sometimes adversely impact one or more countries instantaneously, even if they are fundamentally strong. There is a growing realization that the ability of countries to conduct business across national borders and the ability to cope with the possible downside risks would depend, interalia, on the soundness of the financial system. This has consequently meant the adoption of a strong and transparent, prudential, regulatory, supervisory, technological and institutional framework in the financial sector on par with international best practices. All this necessitates a transformation: a transformation in the mindset, in the business processes and finally, in knowledge management. This process is not a one shot affair; it needs to be appropriately phased in the least disruptive manner. The banking and financial crises in emerging economies have demonstrated that, when things go wrong with the financial system, they can result in a severe economic downturn. Furthermore, banking crises often impose substantial costs on the exchequer, the incidence of which is ultimately borne by the taxpayer. The World Bank Annual Report (2002) has observed that the loss of US $1 trillion in banking crisis in the 1980s and 1990s is equal to the total flow of official development assistance to developing countries from 1950s to the present date. As a consequence, the focus of financial market reform in many emerging economies has been towards increasing efficiency while at the same time ensuring stability in financial markets. From this perspective, financial sector reforms are essential in order to avoid such costs. It is, therefore, not surprising that financial market reform is at the forefront of public policy debate in recent years. Financial sector reform, through the development of an efficient financial system, is thus perceived as a key element in raising countries out of their 'low level equilibrium trap'. As the World Bank Annual Report (2005) observes, a robust financial system is a precondition for a sound investment climate, growth and the reduction of poverty .

Financial sector reforms were initiated in India two decade ago with a view to improving efficiency in the process of financial intermediation, enhancing the effectiveness in the conduct of monetary policy and creating conditions for integration of the domestic financial sector with the global system. The first phase of reforms was guided by the recommendations of Narasimhan Committee. The approach was to ensure that the financial services industry operates on the basis of operational flexibility and functional autonomy with a view to enhancing efficiency, productivity and profitability'.

The second phase, guided by Narasimham Committee II, focused on strengthening the foundations of the banking system and bringing about structural improvements. Further intensive discussions are held on important issues related to corporate governance, reform of the capital structure, (in the context of Basel II norms), retail banking, risk management technology, and human resources development, among others. Since 1992, significant changes have been introduced in the Indian financial system. These changes have infused an element of competition in the financial system, marking the gradual end of financial repression characterized by price and non-price controls in the process of financial intermediation. While financial markets have been fairly developed, there still remains a large extent of segmentation of markets and non-level playing field among participants, which contribute to volatility in asset prices. This volatility is exacerbated by the lack of liquidity in the secondary markets. The purpose of this paper is to highlight the need for the regulator and market participants to recognize the risks in the financial system, the products available to hedge risks and the instruments, including derivatives that are required to be developed in the Indian system. The financial sector serves the economic function of intermediation by ensuring efficient allocation of resources in the economy. Financial intermediation is enabled through a four-pronged transformation mechanism consisting of liability-asset transformation, size transformation, maturity transformation and risk transformation.

INDUSTRIAL PROFILE HISTORY OF BANKING IN INDIA Without a sound and effective banking system in India it cannot have a healthy economy The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factors. For the past three decades Indias banking system has several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. This is one of the main reasons for Indias growth. The governments regular policy for Indian bank since 1969 has paid rich dividends with the nationalization of 14 major private banks of India. The first bank in India, though conservative, was established in 1786. From 1786 till today, the journey of Indian Banking System can be segregated into three distinct phases. They are as mentioned below: Early phase from 1786 to 1969 of Indian Banks. Nationalization of Indian Banks and up to 1991 prior to Indian. Banking sector Reforms. New phase of Indian Banking System with the advent of Indian. Financial & Banking Sector Reforms after 1991.

Phase I The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank of India was established which started as private shareholders banks, mostly European shareholders. In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935. During the first phase the growth was very slow and banks also experienced periodic failures between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline the functioning and activities of banks, mostly small. To streamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers for the supervision of banking in India as the Central Banking System. During those days public has lesser confidence in the banks. As an aftermath deposit mobilisation was slow. Abreast of it the savings bank facility provided by the Postal department was comparatively safer. Moreover, funds were largely given to traders.

Phase II Government took major steps in this Indian Banking Sector Reform after independence. In 1955, it nationalised Imperial Bank of India with extensive banking facilities on a large scale specially in rural and semi-urban areas. It formed State Bank of India to act as the principal agent of RBI and to handle banking transactions of the Union and state government all over the country. Seven banks forming subsidiary of State Bank of India was nationalised in 1960 on 19th July 1969, major process of nationalisation was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country were nationalized.Second phase of nationalisation Indian Banking Sector Reform was carried out in 1980 with seven more banks. This step brought 80% of the banking segment in India under Government ownership. The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country: 1949: Enactment of Banking Regulation Act. 1955: Nationalisation of State Bank of India. 1959: Nationalisation of SBI subsidiaries. 1961: Insurance cover extended to deposits. 1969: Nationalisation of 14 major banks. 1971: Creation of credit guarantee corporation. 1975: Creation of regional rural banks. 1980: Nationalisation of seven banks with deposits over 200 crores.

After the nationalization of banks, the branches of the public sector bank India raised to approximately 800% in deposits and advances took a huge jump by 11000%. Banking in the sunshine of Government ownership gave the public implicit faith and immense confidence about the sustainability of these institutions.

Phase III This phase has introduced many more products and facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name, which worked for the Liberalization of Banking Practices. The country is flooded with foreign banks and their ATM stations. Efforts are being put to give a satisfactory service to customers. Phone banking and net banking is introduced. The entire system became more convenient and swift. Time is given more importance than money. The financial system of India has shown a great deal of resilience. It is sheltered from any crisis triggered by any external macroeconomics shock as other East Asian Countries suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital account is not yet fully convertible, and banks and their customers have limited foreign exchange exposure.

In todays changing world, retail trading, SME financing, rural credit and overseas operations are the major growth drivers for Indian banking industry. The scene has changed since the adoption of financial sector restructuring programme in 1991. The reform in the financial sector in India along with the overall second generation economic reforms in Indian economy has transformed the landscape of banking industry and financial institutions. GDP growth in the 10 years after reforms averaged around 6 %.

With the introduction of the reforms especially in financial sector and successful implementation of them resulted into the marked improvement in the financial health of the commercial banks measured in terms of capital adequacy, profitability, asset quality and provisioning for the doubtful losses.

risk management has become the key to success in which adoption of the state-of-the-art technology and latest rating and management skills turn out to be the significant aid for better risk management. The ability to gauge the risks and take appropriate position will be the key to successful financing in the emerging Indian banking scenario. Risk-takers will survive, effective risk mangers will prosper and risk-averse are likely to perish.

In this context, Indian banks have to ensure:

1. Risk management has to trickle down from the corporate office to branches. They should be made more accountable and responsible towards their duties. 2. As audit and supervision shifts to a risk-based approach rather than transaction oriented, the risk awareness levels of line functionaries also will have to increase. 3. There is a growing need for banks to deal with issues relating to `reputational risk' to maintain a high degree of public confidence for raising capital and other resources.

The SMEs sector is considered to be an untapped market for financial institutions in India. We just need to combat certain obstacles. The hurdles which need to be removed are:1. Minimization of probabilities of skewed returns from SMEs by better risk management 2. Eradicate inconsistency in the knowledge of SMEs business. For example, entrepreneurs may possess more information about the nature and characteristics of their products and processes than potential financiers. 3. Absence of managerial and technical expertise of intermediaries whose role is to evaluate and monitor companies 4. Lack of international infrastructure and expertise in SME financing SMALL and MEDIUM enterprises (SMEs) play a catalytic role in the development of any country. They are the engines of growth in developing and transition economies. In India they account for a significant proportion in manufacturing, exports and employment, and are major contributors to GDP. Considering the growth potential of Indian SMEs, the Government of India has asked public sector banks to achieve a minimum 20 per cent year-on-year growth in the funding of SMEs that will lead to double the flow of credit to the sector from Rs 67,000 crore in 2004-2005 to Rs 1, 35,000 crore by 2009-2010. The Importance of Small and Medium Enterprises (SMEs) in any economy cannot be overlooked as they form a major chunk in the economic activity of nations. They play a key role in industrialization of a developing country like India. They have unique advantages due to:Their size Their comparatively high labor-capital ratio Need a shorter gestation period Focus on relatively smaller markets Need lower investments Ensure a more equitable distribution of national income Facilitate an effective mobilization of resources of capital and skills which might otherwise remain unutilized and Stimulate the growth of industrial entrepreneurship.

According to a UNIDO report, 4 supports for SMEs are generally based on three assumptions. It sustains a broad and diversified private sector and creates employment and thus benefits the country as a whole Second, a strong SME sector will not emerge without support from the state, but they suffer disadvantages in the markets because of their size The programs aimed at smallest enterprises, have been justified more in terms of their welfare impact than their economic efficiency.

In India, SME sector accounts for around 95% of the industrial units, 40% of the value added in the manufacturing sector output,

34% of exports and provides direct employment to 20 million persons in around 3.6 million registered SME units. The SME sector in India contributes to about 7% of Indias GDP during 2002-03.

In developing countries like India, making the SMEs more competitive is particularly pressing as trade liberalization and deregulation increase the competitive pressures and reduce the direct subsidies and protection that Governments offer to SMEs. If our SMEs are to be competitive enough to withstand and fight back the foreign MNC products, they have to be nurtured.