CREDIT ANALYSIS AND RISK RATING FOR MSME

For Vijaya Bank, Coimbatore

A Report on Project Work In Masters of Business Administration By G Pradeep Kannan 215112073

DEPARTMENT OF MANAGEMENT STUDIES NATIONAL INSTITUTE OF TECHNOLOGY TIRUCHIRAPPALLI 620015

SEPTEMBER 2013

DECLARATION This is to certify that the Summer Project Report titled CREDIT ANALYSIS AND RISK RATING FOR MSME is a bonafide record of the work done by, G Pradeep Kannan (215112073) studying Master of Business Administration (MBA) in the Department of Management Studies, National Institute of Technology, Tiruchirappalli, during the academic year 2012-14.

Dr. Senthil Arasu Internal Guide Departmental of Management Studies Studies National Institute of Technology Tiruchirappalli - 15

Dr.N. Thamaraiselvan Head of the Department Departmental of Management National Institute of Technology Tiruchirappalli 15

Project Viva-Voce held on ..

Internal Examiner

External Examiner

ACKNOWLEDGEMENT

I owe a great many thanks to a great many people who helped and supported me in the successful completion of my project. I would first like to extend my gratitude to Ms. S. Anitha (Relationship Manager), of Vijaya Bank, who was kind enough to be the guide for my project and was very helpful and encouraging. My deepest thanks to Dr. Senthil Arasu, Department of Management Studies, National Institute of Technology, Trichy for his encouragement and giving his precious time and support throughout this work without whose help the project would not have been completed. I also thank Dr. N. Thamaraiselvan (Head of Department), National Institute of Technology, Trichy who has been a constant source of motivation and support.

G Pradeep Kannan

Introduction The financial crises during 2008-09 have become the main cause for recession which was started in 2006 from US and was spread across the world. The world economy has been majorly affected from the crisis. The securities in stock exchange have fallen down drastically which has become the root cause of bankruptcy of many financial institutions and individuals. The root cause of the economic and financial crisis is credit default of big companies and individuals which has badly impacted the world economy. So in the present scenario analyzing ones credit worthiness has become very important for any financial institution before providing any form of credit facility so that such situation doesnt arise in near future again. Evaluation of the credit worthiness of the borrowers is known as Credit Analysis or Appraisal. In order to understand the credit appraisal system followed by the banks this project has been conducted. The project has analyzed the credit analysis procedure with special reference to Vijaya Bank which includes knowing about the different credit facilities provided by the banks to its customers, how a loan proposal is being made, what are the formalities that is to be satisfied and most importantly knowing about the various credit appraisal techniques which are different for each type of credit facility. The Indian Banking System: Banking in our country is already witnessing the sea changes as the banking sector seeks new technology and its applications. The best part is that the benefits are beginning to reach the masses. Earlier this domain was the preserve of very few organizations. Foreign banks with heavy investments in technology started giving some Out of the world customer services. But, such services were available only to selected few- the very large account holders. Then came the liberalization and with it a multitude of private banks, a large segment of the urban population now requires minimal time and space for its banking needs. Automated teller machines or popularly known as ATM are the three alphabets that have changed the concept of banking like nothing before. Instead of tellers handling your own cash, today there are efficient machines that dont talk but just dispense cash. Under the Reserve Bank of India Act 1934, banks are classified as scheduled banks and non-scheduled banks. The scheduled banks are those, which are entered in the Second Schedule of RBI Act, 1934. Such banks are those, which have paid- up capital and reserves of an aggregate value of

not less than Rs.5 lakhs and which satisfy RBI that their affairs are carried out in the interest of their depositors. All commercial banks Indian and Foreign, regional rural banks and state co-operative banks are Scheduled banks. Non Scheduled banks are those, which have not been included in the Second Schedule of the RBI Act, 1934. Structure of Indian Banking Industry The Indian banking industry has Reserve Bank of India as its Regulatory Authority. This is a mix of the Public sector, Private sector, Co-operative banks and foreign banks. The private sector banks are again split into old banks and new banks.

Reserve Bank of India [Central Bank]

Scheduled Banks

Scheduled Commercial Banks

Scheduled Co-operative Banks

Public Sector Banks

Private Sector Banks

Foreign Banks

Regional Rural Banks

Nationalized Banks

SBI & its Associates

Scheduled Urban Co-Operative Banks

Scheduled State Co-Operative Banks

Old Private Sector Banks

New Private Sector Banks

Commercial banks and its objectives A Commercial Bank is a financial institution that borrows money from the public and lends money to the public for productive purposes. The Indian Banking Regulation Act of 1949 defines the term Banking Company as "Any company which transacts banking business in India" and the term banking as "Accepting for the purpose of lending all investment of deposits, of money from the public, repayable on demand or otherwise and withdrawal by cheque, draft or otherwise". Commercial banks are the oldest, biggest and fastest growing financial intermediaries in India. They are also the most important depositories of public savings and the most important disbursers of finance. Commercial banking in India is a unique banking system, the like of which exists nowhere in the world. The truth of this statement becomes clear as one studies the philosophy and approaches that have contributed to the evolution of banking policy, programs and operations in India. The banking system in India works under constraints that go with social control and public ownership. The public ownership of banks has been achieved in three stages: 1995, july 1969 and April, 1980. Not only the public sector banks but also the private sector and foreign banks are required to meet the targets in respect of sectorial deployment of credit, regional distribution of branches, and regional credit deposit ratios. The operations of banks have been determined by lead bank scheme, Differential Rate of interest scheme, Credit authorization scheme, inventory norms and lending systems prescribed by the authorities, the formulation of credit plans, and service area approach. Commercial Banks in India have a special role in India. The privileged role of the banks is the result of their unique features. The liabilities of Bank are money and therefore they are important part of the payment mechanism of any country. For a financial system to mobilize and allocate savings of the country successfully and productively and to facilitate day-to-day transactions there must be a class of financial institutions that the public views are as safe and convenient outlets for its savings. The structure and working of the banking system are integral to a countrys financial stability and economic growth. It has been rightly claimed that the diversification and development of Indian Economy are in no small measure due to the active role banks have played financing economic activities of different sectors.

Major objectives of commercial banks

Banks play important role in economic development of a country, like: Banks mobilise the small savings of the people and make them available for productive purposes. Promotes the habit of savings among the people thereby offering attractive rates of interests on their deposits. Provides safety and security to the surplus money of the depositors and as well provides a convenient and economical method of payment. Banks provide convenient means of transfer of fund from one place to another. Helps the movement of capital from regions where it is not very useful to regions where it can be more useful. Banks advances exposure in trade and commerce, industry and agriculture by knowing their financial requirements and prospects. Bank acts as an intermediary between the depositors and the investors. Bank also acts as mediator between exporter and importer who does foreign trades. Thus Indian banking has come from a long way from being a sleepy business institution to a highly pro-active and dynamic entity. This transformation has been largely brought about by the large dose of liberalization and economic reforms that allowed banks to explore new business opportunities rather than generating revenues from conventional

streams (i.e. borrowing and lending). The banking in India is highly fragmented with 30 banking units contributing to almost 50% of deposits and 60% of advances. Importance of banking sector in a growing economy In the recent times when the service industry is attaining greater importance compared to manufacturing industry, banking has evolved as a prime sector providing financial services to growing needs of the economy. Banking industry has undergone a paradigm shift from providing ordinary banking services in the past to providing such complicated and crucial services like, merchant banking, housing finance, bill discounting etc. This sector has become more active with the entry of new players like private and foreign banks. It has also evolved as a prime builder of the economy by understanding the needs of the same and encouraging the development by way of giving loans, providing infrastructure facilities and financing activities for the promotion of entrepreneurs and other business establishments. For a fast developing economy like ours, presence of a sound financial system to mobilize and allocate savings of the public towards productive activities is necessary. Commercial banks play a crucial role in this regard. The Banking sector in recent years has incorporated new products in their businesses, which are helpful for growth. The banks have started to provide fee-based services like, treasury operations, managing derivatives, options and futures, acting as bankers to the industry during the public offering, providing consultancy services, acting as an intermediary between two-business entities etc. At the same time, the banks are reaching out to other end of customer requirements like, insurance premium payment, tax payment etc. It has changed itself from transaction type of banking into relationship banking, where you find friendly and quick service suited to your needs. This is possible with understanding the customer needs their value to the bank, etc. This is possible with the help of well-organized staff, computer based network for speedy transactions, products like credit card, debit card, health card, ATM etc. These are the present trend of services. The customers at present ask for convenience of banking transactions, like 24 hours banking, where they want to utilize the services whenever there is a need. The relationship banking plays a major and important role in growth, because the customers now have enough number of opportunities, and they choose according to their satisfaction of responses and recognition they get. So the banks have to play cautiously, else

they may lose out the place in the market due to competition, where slightest of opportunities are captured fast. Another major role played by banks is in transnational business, transactions and networking. Many leading Indian banks have spread out their network to other countries, which help in currency transfer and earn exchange over it. These banks play a major role in commercial import and export business, between parties of two countries. This foreign presence also helps in bringing in the international standards of operations and ideas. The liberalization policy of 1991 has allowed many foreign banks to enter the Indian market and establish their business. This has helped large amount of foreign capital inflow & increase our Foreign exchange reserve. Another emerging change happening all over the banking industry is consolidation through mergers and acquisitions. This helps the banks in strengthening their empire and expanding their network of business in terms of volume and effectiveness. Emerging scenario in the banking sector The Indian banking system has passed through three distinct phases from the time of inception. The first was being the era of character banking, where you were recognized as a credible depositor or borrower of the system. This era come to an end in the sixties. The second phase was the social banking. Nowhere in the democratic developed world, was banking or the service industry nationalized. But this was practiced in India. Those were the days when bankers has no clue whatsoever as to how to determine the scale of finance to industry. The third era of banking which is in existence today is called the era of Prudential Banking. The main focus of this phase is on prudential norms accepted internationally. NationalisationThe next significant milestone in Indian Banking happened in late 1960s when the then Indira Gandhi government nationalized on 19th July 1949, 14 major commercial Indian banks followed by nationalisation of 6 more commercial Indian banks in 1980. The stated reason for the nationalisation was more control of credit delivery. After this, until 1990s, the nationalised banks grew at a leisurely pace of around 4% also called as the Hindu growth of the Indian economy.After the amalgamation of New Bank of India with Punjab National Bank, currently there are 19 nationalised banks in India.

LiberalizationIn the early 1990s the then Narasimha rao government embarked a policy of liberalization and gave licenses to a small number of private banks, which came to be known as New generation tech-savvy banks, which included banks like ICICI and HDFC. This move along with the rapid growth of the economy of India, kick started the banking sector in India, which has seen rapid growth with strong contribution from all the sectors of banks, namely Government banks, Private Banks and Foreign banks. However there had been a few hiccups for these new banks with many either being taken over like Global Trust Bank while others like Centurion Bank have found the going tough. The next stage for the Indian Banking has been set up with the proposed relaxation in the norms for Foreign Direct Investment, where all Foreign Investors in Banks may be given voting rights which could exceed the present cap of 10%, at present it has gone up to 49% with some restrictions. The new policy shook the Banking sector in India completely. Bankers, till this time, were used to the 4-6-4 method (Borrow at 4%; Lend at 6%; Go home at 4) of functioning. The new wave ushered in a modern outlook and tech-savvy methods of working for traditional banks. All this led to the retail boom in India. People not just demanded more from their banks but also received more. Current scenarioCurrently (2013), overall, banking in India is considered as fairly mature in terms of supply, product range and reach-even though reach in rural India still remains a challenge for the private sector and foreign banks. Even in terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets-as compared to other banks in comparable economies in its region. The Reserve Bank of India is an autonomous body, with minimal pressure from the government. The stated policy of the Bank on the Indian Rupee is to manage volatility-without any stated exchange rate-and this has mostly been true.With the growth in the Indian economy expected to be strong for quite some time-especially in its services sector, the demand for banking services-especially retail banking, mortgages and investment services are expected to be strong. M&As, takeovers, asset sales and much more action (as it is unravelling in China) will happen on this front in India.

Procedure for providing Bank Credit Banks offers different types of credit facilities to the eligible borrowers. For this, there are several procedures, controls and guidelines laid out. Credit Analysis, Sanctions & Approvals, Monitoring and Asset Recovery Management comprise the entire gamut of activities in the lending process of a bank which are clearly shown as below:

Credit Analysis

Sanctions & Approvals

Monitoring & Asset Recovery Management

From the above chart we can see that Credit Analysis is the core and the basic function of a bank before providing loan to any person/company, etc. It is the most important aspect of the lending procedure and therefore it is discussed in detail as below.

Recent policy developments regarding Bank Credit Bank lending was done for a long time by assessing the working capital needs based on the concept of MPBF (maximum permissible bank finance). This practice has been withdrawn with the effect from April 15th 1997 in the sense that the date, banks have been left free to choose their own method (from the method such as turnover, cash budget, present MPBF, or any other theory) of assessing working Capital requirement of the borrowers. The cash credit system has been the bane, yet it has exhibited a remarkable strength of survival all these years. In spite of many efforts which were direct in nature, only a slow progress has been made to reduce its importance and increase bill financing. Therefore a concrete and direct policy step was taken on April 21, 1995 which made it mandatory for banks, consortia, syndicates to restrict cash credit components to the prescribed limit, the balance being given in the form of a short term loan, which would be a demand loan for a maximum period of one year, or in case of seasonal industries, for six months. The interest rates on the cash credit and loan components are to be fixed in accordance with the prime lending rates fixed by the banks. This loan system was first made applicable to the borrowers with an MPBF of Rs 20 crore and above; and in their case, the ratio of cash credit (loan) to MPBF was progressively reduced(increased) from 75 (25) per cent in April 1995 , to 60 (40) percent in September 1995, 40 (60) per cent in April 1996 , and 20 (80) percent in April 1997. With the withdrawal of instructions about the MPBF in April 1997 , the prescribed cash credit and loan components came to be related to the working capital limit arrived in banks as per the method of their choice. With effect from September 3, 1997, the RBI has permitted banks to raise their existing exposure limit to a business group from 50% to 60%; the additional 10% limit being exclusively meant for investment in infrastructure projects. The term lending by banks also has subject to the limits fixed by RBI. In 1993, this limit was raised from Rs 10 crore to Rs 50 crore in case of a loan for a single project by a single bank, and from Rs 150 crore to Rs 200 crore for a single project by all the banks. The latter limit was subsequently raised to Rs 500 crore in the case of general projects and Rs 1000 crore for power projects. From September3, 1997 these caps on term lending by banks were removed subject to their compliance with the prudential exposure norms.

The banks can invest in and underwrite shares and debentures of corporate bodies. At present, they can invest five percent of their incremental deposits in equities of companies including other banks. Their investment in shares/ Bonds of DFHI, Securities trading Corporation of India (STCI), all Indian financial institutions and bonds (debentures) and preference shares of the companies are excluded from this ceiling of five per cent with affect from April 1997 . From the same date banks could extend loans within this ceiling to the corporate against shares held by them. They could also offer overdraft facilities to stock brokers registered with help of SEBI against shares and debentures held by them for nine months without change of ownership. Changing phase of bank creditA study group headed by Shri Prakash Tandon, the then Chairman of Punjab National Bank, was constituted by the RBI in July 1974 with eminent personalities drawn from leading banks, financial institutions and a wide cross-section of the industry with a view to study the entire gamut of Bank's finance for working capital and suggest ways for optimum utilization of Bank credit. This was the first elaborate attempt by the central bank to organize the Bank credit. Most banks in India even today continue to look at the needs of the corporate in the light of methodology recommended by the Group. The report of this group is widely known as Tandon Committee report. The weaknesses in the Cash Credit system have persisted with the non-implementation of one of the crucial recommendations of the Committee. In the background of credit expansion seen in 1977-79 and its ill effects on the economy, RBI appointed a working group to study and suggesti) Modifications in the Cash Credit system to make it amenable to better management of funds by the Bankers and ii) Alternate type of credit facilities to ensure better credit discipline and co relation between credit and production. The Group was headed by Sh. K.B. Chore of RBI and was named Chore Committee.

Another group headed by Sh. P.R. Nayak (Nayak Committee) was entrusted the job of looking into the difficulties faced by Small Scale Industries due to the sophisticated nature of Tandon & Chore Committee recommendations. His report is applicable to units with credit requirements of less than Rs.50 lacs. The recommendations made by Tandon Committee and reinforced by Chore Committee were implemented in all Banks and Bank Credit became much more organized. However, the recommendations were perceived as too strict by the industry and there has been a continuous clamor from the Industry for movement from mandatory control to a voluntary market related restraint. With recent liberalization of economy and reforms in the financial sector, RBI has given the freedom to the Banks to work out their own norms for inventory and the earlier norms are now to be taken as guidelines and not a mandate. In fact, beginning with the slack season credit policy of 1997-98, RBI has also given full freedom to all the Banks to devise their own method of assessing the short term credit requirements of their clients and grant lines of credit accordingly. Most banks, however, continue to be guided by the principles enunciated in Tandon Committee report. Trends of Bank Credit in India The face of Indian banking has changed radically in the last decade. A perusal of the Basic Statistical Returns submitted by banks to the Reserve Bank of India shows that between 1996 and 2005, personal loans have been the fastest growing asset, increasing from 9.3 per cent of the total bank credit in 1996 to 22.2 per cent in 2005. Of course, this is partly due to the huge rise in housing loans, which rose from 2.8 per cent of the bank credit to 11 per cent over the period, but other personal loans comprising loans against fixed deposits, gold loans and unsecured personal loans also rose from 6.1 per cent to 10.7 per cent. Other categories whose share increased were loans to professionals and loans to finance companies. In contrast, there has been a sharp decline in the share of lendings to industry. Credit to small scale industries fell from 10.1 per cent of the total in 1996 to 4.1 per cent in 2005. Reasons for declining trend of bank credit A major share of the economic growth has been led by the expansion of the service sector Capital intensity and investment intensity required for growth in the current economic context may not be as high as it used to be in the past.

In manufacturing sector more efficient utilization of existing capacities contributed to the sectoral growth rather rather than any large addition of fresh capacities. The consequential increase in the demand for credit was also subdued. Greater and cheaper avenues for credit resulted in a bigger share of disintermediation being resorted to by large borrowers.

The other trend has been the substantial drop in the share of rural credit, while the share of metropolitan centres has increased. While bankers say that up gradation of rural centres into semi-urban could be one reason (the share of semi-urban centres has gone up), it is also true that the reforms have been urban-centric and have tended to benefit the metros more. The number of rural bank offices fell from 32,981 in March 1996 to 31,967 by March 2005. The states have been the main beneficiaries of bank credit are the northern region as it has increased its share from 18.7 per cent of the total credit in 1996 to 22.2 per cent in 2005. As it was seen that Delhis share went up from 9.5 per cent to 12.1 per cent over the period. This is not due to food credit, the account of which is maintained in Delhi. Clearly, the national capital has gained a lot from liberalisation. Trends for the year 2008-09 The aggregate deposits of scheduled commercial banks have expanded during 2008-09 at a somewhat slower rate (19.8%) than in 2007-08 (22.4%). Within aggregate deposits demand deposits have shown an absolute fall (-Rs 4,179 crore) in contrast to the sizeable increase (Rs 94,579 crore or by 22%) in 2007-08,. On the other hand, time deposits have shown an accelerated increase of 22.6% (or Rs 647,806 crore) as against 21.8% (Rs 512,844 crore) in the previous year. In the investment portfolio of banks, the expansion during 2008- 09 at Rs 194,031crore has been much lower than the expansion of Rs 340,250 crore as increase in net bank credit to government under monetary data for the same period. This has happened because the latter has a sizeable amount of RBI credit to government following the increased open market operations. Finally, there has occurred considerable slowdown in bank credit expansion. Because of relatively higher procurement of foodgrains, food credit has expanded by Rs 1,812 crore during 2008-09 as against an absolute fall of Rs 2,121 crore in 2007-08. Nonfood credit growth at Rs 406,287 (17.5%) has been slower than in the previous year at Rs 432,846 (23.0%).

About Vijaya Bank Vijaya Bank is a medium sized nationalized Bank with presence across India. Vijaya Bank was established by Shri. Attavara Balakrishna Shetty at Bunts Hostel in Mangalore on October 23, 1931.The objective was to promote banking habits, thrift and entrepreneurship among the farming community of Dakshina Kannada district in Karnataka State. The bank became a scheduled bank in 1958. Vijaya Bank steadily grew into a large All India bank, with nine smaller banks merging with it during 1963-68. The bank was nationalized on April 15, 1980. Currently, Vijaya Bank employs 12,500 people. The Bank has recently recruited young workforce to cope up with the changing banking scenario & to compete with the growing private sector & foreign banks functioning in the country. The bank has built a network of 1360 branches, 864 centers, 48 Extension Counters and 866 ATMs as on 31.03.2013, that span all 28 states and 4 union territories in the country. All branches are functioning on the CBS (Centralized Banking Solution) platform, covering 100% of the Bank's business. The Bank has chosen Finacle from Infosys as its Centralized Banking Solution (CBS). In line with prevailing trends, the bank has been focusing on technological upgrades to operations. It now offers services such as credit cards, merchant banking, hire purchase and leasing, and electronic remittance services. Vijaya Bank is one among the few banks in the country to take up principal membership of VISA International and MasterCard International Credit Analysis means an investigation/assessment done by the financial institutions before providing any loans & advances/project finance. It checks the commercial, financial & technical viability of the project proposed its funding pattern & further checks the primary & collateral security cover available for recovery of such funds. MSME Micro, Small and medium-sized enterprises (MSMEs) are the backbone of all economies and are a key source of economic growth, dynamism and flexibility in advanced industrialized countries, as well as in emerging and developing economies. MSMEs constitute the dominant form of business organization, accounting for over 95% and up to 99% of enterprises depending on the country. They are responsible for between 60-70% net

job creations in Developing countries. Small businesses are particularly important for bringing innovative products or techniques to the market. Credit facility is necessary to help them set up and expand their operations, develop new products, and invest in new staff or production facilities. Many small businesses start out as an idea from one or two people, who invest their own money and probably turn to family and friends for financial help in return for a share in the business. But if they are successful, there comes a time for all developing MSMEs when they need new investment to expand or innovate further. That is where they often run into problems, because they find it much harder than larger businesses to obtain financing from banks, capital markets or other suppliers of credit. In India, the enterprises have been classified broadly into two categories: (i) Manufacturing; and (ii) Those engaged in providing/rendering of services. Both categories of enterprises have been further classified into micro, small and medium enterprises based on their investment in plant and machinery (for manufacturing enterprises) or on equipment (in case of enterprises providing or rendering services). The present ceiling on investment to be classified as micro, small or medium enterprises is as under: Classification Micro Small Medium Investment Ceiling Manufacturing Enterprise Up to `25 lakh Above `25 lakh and up to `5 crore Above `5 crore up to `10 crore

Service Enterprise Up to `10 lakh Above `10 lakh up to `2 crore Above `2 crore up to `5 crore

Brief overview of Credit: Credit is the provision of resources (such as granting a loan) by one party to another party where that second party does not reimburse the first party immediately, thereby generating a debt, and instead arranges either to repay or return those resources (or material(s) of equal value) at a later date. The first party is called a creditor, also known as a lender, while the second party is called a debtor, also known as a borrower. A credit is a legal contract where one party receives resource or wealth from another party and promises to repay him on a future date along with interest. In simple terms, a credit is an agreement of postponed payments of goods bought or loan. With the issuance of a credit, a debt is formed.

Credit Analysis/Appraisal is a process to ascertain the risks associated with the extension of the credit facility. It is generally carried by the financial institutions which are involved in providing financial funding to its customers. Credit risk is a risk related to non-repayment of the credit obtained by the customer of a bank. Thus it is necessary to appraise the credibility of the customer in order to mitigate the credit risk. Proper evaluation of the customer is performed which measures the financial condition and the ability of the customer to repay back the loan in future. Generally the credit facilities are extended against the security know as collateral. But even though the loans are backed by the collateral, banks are normally interested in the actual loan amount to be repaid along with the interest. Thus, the customer's cash flows are ascertained to ensure the timely payment of principal and the interest. However the 3 C of credit are crucial & relevant to all borrowers/ lending which must be kept in mind at all times. Character Capacity Collateral

If any one of these are missing in the equation then the lending officer must question the viability of credit. There is no guarantee to ensure a loan does not run into problems; however if proper credit evaluation techniques and monitoring are implemented then naturally the loan loss probability / problems will be minimized, which should be the objective of every lending officer. Brief overview of loans Credit can be of two types fund base & non-fund base: FUND based includes: Working Capital Term Loan

NON-FUND based includes: Letter of Credit Bank Guarantee

This Internship projects deals with the FUND based loans provided by Vijaya Bank and how the credit analysis process was done for evaluating the customer. FUND BASED:WORKING CAPITAL:The objective of running any industry is earning profits. An industry will require funds to acquire Fixed assets like land, building, plant, machinery, equipment, vehicles, tools etc., & also to run the business i.e. its day to day operations. Funds required for day to-day working will be to finance production & sales. For production, funds are needed for purchase of raw materials/ stores/ fuel, for employment of labour, for power charges etc., for storing finishing goods till they are sold out & for financing the sales by way of sundry debtors/ receivables. Capital or funds required for an industry can therefore be bifurcated as fixed capital & working capital. Working capital in this context is the excess of current assets over current liabilities. The excess of current assets over current liabilities is treated as net working capital or liquid surplus & represents that portion of the working capital which has been provided from the long term source. Working capital is defined as the funds required to carry the required levels of current assets to enable the unit to carry on its operations at the expected levels uninterruptedly. Working capital requirement of a company can be estimated by understanding the operating cycle of the company. Operating cycle/Working Capital Cycle is the average period of time required for a business to make an initial outlay of cash to produce goods, sell the goods, and receive cash from customers in exchange for the goods. Any business activity is characterized by a cycle of operations consisting of purchase of raw materials for cash, converting these into finished goods & realizing cash by sale of these finished goods. The time that lapses between cash

outlay & cash realization by sale of finished goods & realization of sundry debtors is known as the length of the operating cycle. That is, the operating cycle consists of: Time taken to acquire raw materials & average period for which they are in store. Conversion process time Average period for which finished goods are in store & Average collection period of receivables (Sundry Debtors)

Operating cycle is also called the cash-to-cash cycle & indicates how cash is converted into raw material, stocks in process, finished goods, bills (receivables) & finally back to cash. Working capital is the total cash that is circulating in this cycle. Therefore, working capital can be turned over or redeployed after completing the cycle. TERM LOAN 1. A term loan is granted for a fixed term of not less than 3 years intended normally for financing fixed assets acquired with a repayment schedule normally not exceeding 8 years. 2. A term loan is a loan granted for the purpose of capital assets, such as purchase of land, construction of, buildings, purchase of machinery, modernization, renovation or rationalization of plant, & repayable from out of the future earning of the enterprise, in installments, as per a prearranged schedule. From the above definition, the following differences between a term loan & the working capital credit afforded by the Bank are apparent: The purpose of the term loan is for acquisition of capital assets. The term loan is an advance not repayable on demand but only in installments ranging over a period of years. The repayment of term loan is not out of sale proceeds of the goods & commodities per se, whether given as security or not. The repayment should come out of the future cash accruals from the activity of the unit. The security is not the readily saleable goods & commodities but the fixed assets of the units.

3. It may thus be observed that the scope & operation of the term loans are entirely different from those of the conventional working capital advances. The Banks commitment is for a long period & the risk involved is greater. An element of risk is inherent in any type of loan because of the uncertainty of the repayment. Longer the duration of the credit, greater is the attendant uncertainty of repayment & consequently the risk involved also becomes greater. 4. However, it may be observed that term loans are not so lacking in liquidity as they appear to be. These loans are subject to a definite repayment programme unlike short term loans for working capital (especially the cash credits) which are being renewed year after year. Term loans would be repaid in a regular way from the anticipated income of the industry/ trade. 5. These distinctive characteristics of term loans distinguish them from the short term credit granted by the banks & it becomes necessary therefore, to adopt a different approach in examining the applications of borrowers for such credit & for appraising such proposals. 6. The repayment of a term loan depends on the future income of the borrowing unit. Hence, the primary task of the bank before granting term loans is to assure itself that the anticipated income from the unit would provide the necessary amount for the repayment of the loan. This will involve a detailed scrutiny of the scheme, its financial aspects, economic aspects, technical aspects, a projection of future trends of outputs & sales & estimates of cost, returns, flow of funds & profits. 7. Appraisal of Term Loans Appraisal of term loan for, say, an industrial unit is a process comprising several steps. There are four broad aspects of appraisal, namely Technical Feasibility - To determine the suitability of the technology selected & the adequacy of the technical investigation & design;

Economic Feasibility - To ascertain the extent of profitability of the project & its sufficiency in relation to the repayment obligations pertaining to term assistance;

Financial Feasibility - To determine the accuracy of cost estimates, suitability of the envisaged pattern of financing & general soundness of the capital structure; &

Managerial Competency To ascertain that competent men are behind the project to ensure its successful implementation & efficient management after commencement of commercial production.

7.1 Technical Feasibility The examination of this item consists of an assessment of the various requirement of the actual production process. It is in short a study of the availability, costs, quality & accessibility of all the goods & services needed. a) The location of the project is highly relevant to its technical feasibility & hence special attention will have to be paid to this feature. Projects whose technical requirements could have been taken care of in one location sometimes fail because they are established in another place where conditions are less favorable. One project was located near a river to facilitate easy transportation by barge but lower water level in certain seasons made essential transportation almost impossible. Too many projects have become uneconomical because sufficient care has not been taken in the location of the project, e.g. a woolen scouring & spinning mill needed large quantities of good water but was located in a place which lacked ordinary supply of water & the limited water supply available also required efficient softening treatment. The accessibility to the various resources has meaning only with reference to location. Inadequate transport facilities or lack of sufficient power or water for instance, can adversely affect an otherwise sound industrial project. b) Size of the plant One of the most important considerations affecting the feasibility of a new industrial enterprise is the right size of the plant. The size of the plant will be such that it will give an economic product which will be competitive when compared to the alternative product available in the market. A

smaller plant than the optimum size may result in increased production costs & may not be able to sell its products at competitive prices. c) Type of technology An important feature of the feasibility relates to the type of technology to be adopted for a project. A new technology will have to be fully examined & tired before it is adopted. It is equally important to avoid adopting equipment or processes which are absolute or likely to become outdated soon. The principle underlying the technological selection is that a developing country cannot afford to be the first to adopt the new nor yet the last to cast the old aside. d) Labour The labour requirements of a project, need to be assessed with special care. Though labour in terms of unemployed persons is abundant in the country, there is shortage of trained personnel. The quality of labour required & the training facilities made available to the unit will have to be taken into account e) Technical Report A technical report using the Banks Consultancy Cell, external consultants, etc., should be obtained with specific comments on the feasibility of scheme, its profitability, whether machinery proposed to be acquired by the unit under the scheme will be sufficient for all stages of production, the extent of competition prevailing, marketability of the products etc., wherever necessary. 7.2 Economic Feasibility An economic feasibility appraisal has reference to the earning capacity of the project. Since earnings depend on the volume of sales, it is necessary to determine how much output or the additional production from an established unit the market is likely to absorb at given prices. a) A thorough market analysis is one of the most essential parts of project investigation. This involves getting answers to three questions. a) How big is the market? b) How much it is likely to grow? c) How much of it can the project capture? The first step in this direction is to consider the current situation, taking account of the total output of the product concerned & the existing demand for it with a view to establishing whether there is unsatisfied demand for the product. Care should be taken to see that there is no idle capacity in the existing industries. ii) Future possible future changes in the volume & patterns of supply & demand will have to be estimated in order to assess the long term prospects of the industry. Forecasting of demand is a complicated matter but one of the vital importance. It is complicated because a

variety of factors affect the demand for product e.g. technological advances could bring substitutes into market while changes in tastes & consumer preference might cause sizable shifts in demand. iii) Intermediate product The demand for Intermediate product will depend upon the demand & supply of the ultimate product (e.g. jute bags, paper for printing, parts for machines, tyres for automobiles). The market analysis in this case should cover the market for the ultimate product. 7.3 Financial Feasibility The basis data required for the financial feasibility appraisal can be broadly grouped under the following heads i) ii) iii) Cost of the project including working capital Cost of production & estimates of profitability Cash flow estimates & sources of finance.

The cash flow estimates will help to decide the disbursal of the term loan. The estimate of profitability & the breakeven point will enable the banker to draw up the repayment programme, start-up time etc. The profitability estimates will also give the estimate of the Debt Service Coverage which is the most important single factor in all the term credit analysis. A study of the projected balance sheet of the concern is essential as it is necessary for the appraisal of a term loan to ensure that the implementation of the proposed scheme. Break-even point: In a manufacturing unit, if at a particular level of production, the total manufacturing cost equals the sales revenue, this point of no profit/ no loss is known as the break-even point. Break-even point is expressed as a percentage of full capacity. A good project will have reasonably low break-even point which not be encountered in the projections of future profitability of the unit. Debt/ Service Coverage: The debt service coverage ratio serves as a guide to determining the period of repayment of a loan. This is calculated by dividing cash accruals in a year by amount of annual obligations

towards term debt. The cash accruals for this purpose should comprise net profit after taxes with interest, depreciation provision & other non cash expenses added back to it. Debt Service Coverage Ratio = Cash accruals Maturing annual obligations

This ratio is valuable, in that it serves as a measure of the repayment capacity of the project/ unit & is, therefore, appropriately included in the cash flow statements. The ratio may vary from industry to industry but one has to view it with circumspection when it is lower than the benchmark of 1.75. The repayment programme should be so stipulated that the ratio is comfortable. 7.4 Managerial Competence In a dynamic environment, the capacity of an enterprise to forge ahead of its competitors depends to a large extent, on the relative strength of its management. Hence, an appraisal of management is the touchstone of term credit analysis. If there is a change in the administration & managerial set up, the success of the project may be put to test. The integrity & credit worthiness of the personnel in charge of the management of the industry as well as their experience in management of industrial concerns should be examined. In high cost schemes, an idea of the units key personnel may also be necessary. CREDIT ANALYSIS PROCESS Receipt of application from applicant | Receipt of documents (Balance sheet, KYC papers, Different govt. registration no., MOA, AOA, and Properties documents) | Pre-sanction visit by bank officers | Check for RBI defaulters list, willful defaulters list, CIBIL data, ECGC caution list, etc. | Title clearance reports of the properties to be obtained from empanelled advocates

| Valuation reports of the properties to be obtained from empanelled valuer/engineers | Preparation of financial data | Proposal preparation | Assessment of proposal | Sanction/approval of proposal by appropriate sanctioning authority | Documentations, agreements, mortgages | Disbursement of loan | Post sanction activities such as receiving stock statements, review of accounts, renew of accounts, etc (on regular basis)

Building up of a proposal An analysis of a proposal begins with the gathering of adequate background knowledge about borrowers character and credit worthiness. In the concept of analysis, much reliance is placed on the credentials of the borrower. Therefore, there is a necessity for evaluation of the borrower in regard to his standing in the business, means and respectability. The result of the elaborate scrutiny concerning all these aspects is required to be put into a precise credit report which helps in taking decision on a credit proposal. Each individual case has to be examined in the light of its own circumstances and judgment exercised on issues enumerated above and a final decision has to be arrived at on the basis of scrutiny of all the issues. Information regarding character, honesty, and financial position has to be discreetly gathered from following sources:

a. The borrower: the bank should develop as much credit information as possible during the initial interview with the borrower/partners of firm/ directors of company/ proposed guarantor /co-obligator and principal officials of firms/company, nature of its business, past and expected profitability, the degree of competition that the firm/company faces and whether or not it has had or anticipated any difficulty etc.Information regarding its principal officers should be collected during such interview. b. Borrowers financial statements: for lending decisions, financial information is a significant part of the total information system. It is derived basically from borrowers: Trading and profit and loss statement Balance sheet Cash and fund flow statements

c. Banks own records: If he is an existing borrower, banks own records are a rich source of additional information. Operations in the borrowers account and other dealings at the bank level in regard to collections, discounting/retirement of bills etc. often useful clues to borrowers operating and financial transactions. A review of the previous years operations in the account and assessments of borrowers financial statements relating to that period will provide a rich source of information about the borrower. d. Opinions: Bank should compile opinions on their borrowers. They should contain full and reliable records of the character, estimated means and business activities of all firms and individuals who are under any form of liability to the bank, whether as direct borrowers or as co-obligators. Full particulars of parties immovable properties where they are situated, whether they are free from encumbrance and in the case of land, acreage should be recorded together with fair estimates of their value. As far as possible written statements of their properties should be taken in evaluating properties owned by parties jointly with others and as a rule such properties should be disregarded in arriving at the net means. e. From other banks: in respect of fresh proposals, enquiries with local banks should be made before entertaining the proposal to avoid multiple financing without our full knowledge. In case of new customer having dealings with other banks, confidential opinion of his banker has to be obtained.

f. Income tax assessment order- Income tax assessment orders agricultural income tax assessment orders give an insight into the borrowers account and the extent to which it is profitable. Comments thereon by the income tax office shall indicate the shortcomings (lacunae) in the business. In the case of estate owners agricultural tax assessment orders to be obtained to arrive at parties credit worthiness. g. Sales tax assessment orders: Sales tax assessment orders will reveal the turnover in business and when read with trading/ manufacturing and profit & loss account, it may be possible to have a fair assessment of tendencies in trade i.e., whether over-trading or carefully trading within recourses at command or trading entirely on the borrowed funds.

h. Wealth tax assessment orders: wealth tax assessment order will indicate the net worth of individuals and reveals the liquid source available to bring the required margin money for the venture. i. Market sources: Constant touch with the market will help to have first hand information about the gains or losses in particular business borrowers. j. Property statements: The property statement of borrower will give an idea of his worth, liabilities and his income from real estates (immovable properties). k. Municipal property registers: reference to municipal property registers will give an idea of building owned within the municipality, Rental Values and house tax payable. It may be noted that the said registers are open for reference to all persons. l. Other external sources: other external sources, if any, like stock exchange directory, business periodicals/magazines/journals etc. transactions of the

A proposal document will have the following details 1. MSME Background Name of the Borrower Date of Establishment Line of Activity

Name of the Proprietor/Director/Partner Share Holding Pattern Existing Credit Facilities with the bank Compliance to Sanction norms Major Inspection/Audit Results Key financial indicators Capacity Details Sales Sectorial Exposure

2. Terms of Proposal Primary Securities Collateral Securities Security Coverage Purpose of Credit Concessions

3. Additional Information Associate Concerns Account Review Credit Assessment Bank Guarantee Limit

4. Project Profile Project Outlay Promoter Capability Technical Viability

Economic Viability Financial Viability Project Implementation Schedule SCOT Analysis Risk Rating and Pricing Recommendations

Methodolgy Projected Balance Sheet/Turnover Method

Projected Turnover Method for SSI Units up to WC limits of 5.00 crore / Others up to 2.00 Crores: Sl Year1 Year2 Year3 Year4 No Particulars/ year (Audited) (Provis) (Estim.) (Proj.) . 1 Actual / Estimated Sales 0.00 0.00 0.00 0.00 2 Accepted Sales for Credit Assessment 0.00 0.00 0.00 0.00 25% of accepted level of Sales reckoned for 3 0.00 0.00 0.00 0.00 Working Capital requirement 4 Less: 5% of (3) as Promoters Contribution 0.00 0.00 0.00 0.00 5 Actual Net working Capital 0.00 0.00 0.00 0.00 6 Highest of (4) and (5) 0.00 0.00 0.00 0.00 7 Eligible Bank Finance (3-6) 0.00 0.00 0.00 0.00

Projected Balance Sheet Method for SSI Units for WC limits of more than 5.00 crore Others more than 2.00 Crores: Sl No. 1 2 3 4 5 6 7 8 9 10 Particulars/ Year Total Current Assets (TCA) Other Current Liabilities (OCL - Excluding Short Term Bank Borrowings) Working Capital Gap (WCG) (1-2) Net Working Capital (NWC) Eligible Bank Finance (EBF) (3-4) % of NWC to TCA % of OCL to TCA % of EBF to TCA Credit Limit sought Credit Limit proposed
Year1 (Audited) Year2 (Provis) Year3 (Estim.)

Year4 (Proj.)

0.00 0.00 0.00 0.00 0.00 0% 0% 0% 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0% 0% 0% 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0% 0% 0% 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0% 0% 0% 0.00 0.00

Profitability Analysis and Computation of DSCR

Profitability Analysis and Computation of DSCR Particulars/ Years Profit After Tax Depreciation Term Loan interest Inflow- A Repayment towards Term Loan Proposed loan Term Loan Principle Repayment Interest on TL Total Out flow-B DSCR (A/B) Average DSCR Minimum DSCR 31.03.1 1 (Audite d) 0.00 0.00 0.00 0.00 31.03.1 2 (Audite d) 0.00 0.00 0.00 0.00 M/s. ABC 31.03.1 3 (Provis ) 0.00 0.00 0.00 0.00 31.03.1 4 (Estim. ) 0.00 0.00 0.00 0.00 31.03.1 5 (Proj.) 0.00 0.00 0.00 0.00 31.03.1 6 (Proj.) 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 #DIV/0! 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

Interest Coverage Ratio

31.03.11 (Audited) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 31.03.12 (Audited) 0.00 0.00 0.00 0.00 0.00 31.03.13 (Provis) 0.00 0.00 0.00 0.00 0.00 31.03.1 4 (Estim.) 0.00 0.00 0.00 0.00 0.00 31.03.15 (Proj.) 0.00 0.00 0.00 0.00 0.00

Interest Coverage Ratio Profit Before Tax Term Loan Interest Inflow - A Interest on Term Loan - B ICR (A/B) Avg ICR Minimum ICR

Sensitivity Analysis
Sensitivity AnalysisScenario I 5% decrease in sales Net sales Decrease in sales by 5% Difference in Revenue Normal inflow Adjusted inflow Total outflow DSCR Average DSCR Minimum DSCR 31.03.11 (Audited) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 31.03.12 (Audited) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 31.03.13 (Provis) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 31.03.1 4 (Estim.) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 31.03.15 (Proj.) 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Sensitivity AnalysisScenario II 5% increase in RM cost Net sales Raw Material Cost RM increased by 5% Difference in cost Normal Inflow Adjusted inflow Total outflow DSCR Average DSCR Minimum DSCR

31.03.11 (Audited) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

31.03.12 (Audited) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

31.03.13 (Provis) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

31.03.1 4 (Estim.) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

31.03.15 (Proj.) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Scenario III- Simultaneous occurance of both Difference in revenue in 5% decrease in sales Difference in cost Scenario II Total difference Normal Inflow Adjusted inflow Total outflow DSCR Average DSCR Minimum DSCR

31.03.11 (Audited) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

31.03.12 (Audited) 0.00 0.00 0.00 0.00 0.00 0.00 0.00

31.03.1 3 (Provis) 0.00 0.00 0.00 0.00 0.00 0.00 0.00

31.03.14 (Estim.) 0.00 0.00 0.00 0.00 0.00 0.00 0.00

31.03.15 (Proj.) 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Risk Rating A projected Balance Sheet is received from the borrower for next 6 to 8 years. All the key financial ratios are calculated for the projected balance sheet. Key financial ratio also referred as Risk Rating Parameters includes Current ratio (Ideally 1.25: 1), Debt-Equity Ratio (Total Outstanding Liability/Tangible Net worth Ideally 3:1), Net Working Capital, DebtService Coverage Ratio(DSCR), Current Asset Turnover ratio, Fixed asset turnover ratio, Liquidity ratio, Net sales and profit, operating profit margin, PBDIT, Return on capital employed, Security Coverage Ratio, Interest Coverage ratio. Eligible bank credit is calculated using Projected Turnover method. These risk rating parameters are fed as input for a CRISIL Rating Module. Along with the above mentioned parameters, information regarding Industry and business risk, Regulatory aspects & Government policy, Industry Trend, Infra Facilities, Demand &

Supply, Input Availability, Financial Risk, Management Risk, Management competency and industry exposure, Market reputation, A/C connection, Promoters net worth are fed as input in terms of Score out of 10(1 being the worst and 10 being the best). With this information CRISIL rating module comes up with a single rating value for the Proposal. The output varies from VB3 to VB10. VB3 Investment Grade High Safety VB4 Investment Grade Adequate Safety VB5/VB6 Investment Grade Moderate Safety VB7 Investment Grade Minimum Safety VB8 Sub Investment Grade Inadequate Safety VB9 Sub Investment Grade High Risk VB10 Default Based on the output score, the VB rating are being determined and the lending decisions depends on this rating score. Vijaya Bank provides loan only for the customers having rating on or below VB7. By this way bank ensures only prominent customers are being entertained for loans. CONCLUSION Credit analysis is a process of analyzing the credit worthiness of loan applicants. The fund of depositors i.e. general public are mobilized by means of such advances / investments. Thus it is extremely important for lender bank to assess the risk associated with credit, thereby ensure the security for fund deposited by depositors. Credit analysis procedure of Vijaya Bank is as follows: In case of MSME lending bank strictly follow its circular and fulfils all requirement of necessary documents required for different types of loan so that bank do not suffer any types of loss.

Bank is very much particular about CIBIL report of borrowers in case of each type of lending.

Bank lending process in case of MSME loan is very much fast after compiling with all the criteria of bank.

In case of project financing bank follow lengthy norms to check the feasibility of the project such as: Firstly personal appraisal of promoter is done by the bank to ensure that promoters are experienced in the line of business and capable to implement and run the project efficiently. Secondly detail study about the technical aspect is done to find the technical soundness of project such as proper scrutiny of financial report is done, valuation of property by government approved valuer is done and view regarding each and every area of project is done under technical analysis. A detail study relating financial viability of project is done by detail study of cash flow, fund flow statements and by calculating import ratio which is very much necessary for project appraisal such as DSCR, DER etc. the main purpose of financial appraisal is insure that project will ensure sufficient surplus to repay the installment and interest. Risk analysis is done by bank to determine the risk associated with the project. This is mainly done by sensitivity analysis and by Vijaya bank credit rating or scoring. With sensitive analysis feasibility of project is determined under worsened condition. Credit rating or VB scoring is done of various parameters such as personal, management, financial etc , thereby determine credit worthiness of customer. It is on basis of credit risk level, a collateral security to be given by borrower is determined.

This shows that Vijaya Bank has sound credit appraisal system.