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Loan Management System 1. Introduction Credit management must mandate a consistent lending process and related internal controls. Policies should provide for the following elements of a properly functioning loan approval process: loans decisions are made and approved by appropriate staff, with the appropriate authorization and ability; lenders should be delegated formal lending limits in accordance with their lender credentials/experience; loans follow a pre-established loan processing flow, which sets out the proper movement of loan applications within the credit union; loan information and credit analysis are properly documented on standardized forms; loan applications are analyzed against established credit criteria; loan funds are disbursed through proper channels, with proper safeguards against theft or fraud; Generally, loan renewals are subject to the same criteria and credit evaluation process as when first approved.
Loan Approvals: The loan approval process comprises of processing and evaluating loan applications, documenting loan decisions and distributing loan funds. It is important that management establish a loan approval process which includes controls over lending authority and ability. A properly functioning loan approval process requires the following: loans follow a pre-established loan processing flow, which sets out the proper movement of loan applications within the credit union; borrower information and credit analysis are properly documented against established credit criteria; loans decisions are made and approved by appropriate staff, with the appropriate authorization and ability; Loan funds are disbursed, after applicable security is in place, through proper channels, with proper safeguards against theft or fraud.
Loan Processing Flow Every credit union should establish a standardized loan processing flow, and document this process in operational procedures. The following are the general steps in the loan process:
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The loan process begins with a lender establishing credit for a member in accordance with board policy. A security custodian would then and file the security. A disbursements officer should advance the funds and the ing staff should record the transaction. Two signatures should appear on the journal voucher sent to the disbursements clerk who advances funds to the member. The originating loan officer and either the general manager, or his designate (e.g. assistant manager) should authorize the journal voucher, after examining the ing file. Advances should be totalled on a daily basis by ing. The sum of the advances should be compared by senior management to the value of promissory notes or other evidence of indebtedness. Any discrepancies should be followed up immediately. Before a loan file is stored, it is recommended that it be reviewed against an accompanying loan checklist by senior management and initialled as evidence of such review. Finally, senior management and the credit committee, should receive detailed loan disbursements summaries on a monthly basis (where it exists).
Credit Appraisal: Credit 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 the principal and the interest.
2. Approach for the safety of loans: Two approach 1. Pre-Sanction Appraisal 2. Post-Sanction Appraisal Pre-Sanction Appraisal:
To determine the bank-ability of each loan proposal
Concerned with measurement of risk(iness) of a loan proposal
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When a credit proposal is presented to a branch by a prospective borrower for sanction by an appropriate authority, the appropriate authority may either sanction or reject the proposal. The decision to sanction or reject the proposal has to be based on a careful analysis of various facts Data presented by the borrower concerning him and the proposal. Such an objective and in-depth study of the information and data should convince the sanctioning authority that the money lent to the borrower for the desired purpose will be safe and it will be repaid with interest over the desired period ,if the assumptions and and conditions on which it is sanctioned, are fulfilled. Such an in-depth study is called the pre-sanction credit appraisal. It provides the sanctioning authority with the reasons and justifications for either sanctioning or rejecting a credit proposal. It, thus, helps in the decision making process of the sanctioning authority. The entire gamut of credit appraisal can be segregated into 7 sections is under: a. Borrower Appraisal. b. Technical Appraisal. c. Management Appraisal. d. Financial Appraisal. e. Economic Appraisal. f. Market Appraisal.
BORROWER APPRAISAL / KNOW YOUR CUSTOMER (KYC) NORMS: The borrower is appraised on the following parameters also known as the 3 ‘C’sof the borrower i.e. character, capacity and capital. Character: Character is the greatest and the most important asset, which any individual can have. Even if a borrower has the capacity and capital to repay a loan, it is the character of the borrower which indicates his intention to repay. If the character or integrity of a borrower is known to be questionable, every banker would avoid him even if backed by sufficient collaterals. Capacity: It deals with the ability of the borrower to manage an enterprise or venture successfully with the resources available to him. His educational, technical and professional qualifications, his antecedents, present activity, experience in the line of business, experiences of the family, special skill or knowledge possessed by him, his past record etc. would give a hindsight into his capacity to manage the show successfully and repay the loan. Capital: It is his ability to meet the loss, if any, sustained in the business or venture from his own LOAN MANAGEMENT SYSTEM
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investment or capital without shifting it to his creditor or banker. Unless a borrower has some Stake in the business, he may not take much interest in its success.
Key Elements of the KYC Policy: a) Customer Acceptance Policy b) Customer Identification Procedures c) Monitoring of Transactions and d) Risk Management
TECHNICAL APPRAISAL: The technical appraisal of a credit proposal involves a detailed study of the following aspects: (1) Availability of basic infrastructure. (2) Licensing/registration requirements. (3) Selection of technology. (4) Availability of suitable technical process, raw material skilled labor etc.
MANAGEMENT APPRAISAL: In case of projects, units or enterprises run by individuals as sole proprietors or partnership firms, it is usually one or two persons who manage the entire project, unit or the enterprise whether it be of manufacturing or trading. However, in case of corporate borrowers and also in case of large borrowal s, it is usually a set of professionals who manage the entity each specialized in a specific area of management i.e. production, finance, marketing, personnel etc. Unless there is a complete integration of all these functions within an organization, it cannot function effectively.
FINANCIAL APPRAISAL: The term financial appraisal refers to the study of the following aspects of the project/unit: Determination of the cost of the project. Assessment of the source of funds/means of financing the project. Profitability estimates. LOAN MANAGEMENT SYSTEM
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Break even analysis. Cash flow projections. Projected balance-sheet.
ECONOMIC APPRAISAL: The performance of a project is influenced by a variety of other economic, social and cultural factors. Even if a project is technically feasible and financially viable, it may not satisfy the economic needs viz. employment potential, development of industrially backward areas, environmental pollution etc. Further as capital is a scarce resource, it is necessary that it must be allocated in such a way that it yields best possible return to the society in general and the investor in particular. As such a detailed appraisal of the project in of the return it generates to the investor and the lending institutions is necessary before a decision is taken to commit resources. One of the most important methods of appraising this is the computation of the Internal Rate of Return of the project.
Internal Rate of Return (IRR): IRR is defined as the discount rate at which the present values of all investments made in a project are equal to the present value of all future returns from the project over the assumed life period of the project. Thus (IRR) is an indicator of the earning capacity of the project. A higher IRR indicates a better prospect for the unit. The investment is treated as cash out flow and the return on the same is treated as cash inflow. The discounted values of the cash inflows and cash outflows shall be zero at a particular rate of discount. The task is to work out this rate which is called the Internal Rate of Return. Normally IRR is compared with the cost of capital and if IRR exceeds the cost of capital, the project is termed viable. IRR is worked out on a trial and error basis and interpolated to obtain the required rate.
Sensitivity Analysis: The normal financial appraisal of a project is based on certain assumed values for certain critical variables/parameters viz. sales realization, unit value of product sold, cost of raw material, capacity utilization etc. However, any variation in the assumed values of these parameters may result in a more favorable or unfavorable IRR. The process of computing the IRR and the repaying capacity of the borrower for different values of each of these parameters is called the sensitivity analysis.
MARKET APPRAISAL: While appraising a proposal it is not only necessary to find out whether it is technically feasible and financially viable, but also important to ascertain the marketability of the product LOAN MANAGEMENT SYSTEM
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manufactured/sold. If goods produced cannot be sold there would be no point in producing them. Hence the marketability or sale ability of goods is of great importance. Existence of a market for the product provides the rationale for its production. If the product sought to be manufactured is the only one of its kind for which there are no substitutes, the marketing of the same may not be a problem excepting when it can be freely imported and that too at a lesser cost. However, if there are many competitors, the entrepreneur may find the going tough. However a combination of the factors like man behind the show, the quality of the product and the strategy for its sale will result in its successful marketing.
3. Loan Documentation Proper assessment of credit risk, loan monitoring and delinquency control begin with well documented member files. Maintaining orderly and adequately documented loan files is an important element of credit risk management. Proper documentation provides the following major benefits: It constitutes evidence of the and conditions of a member's indebtedness. It creates valid security which can be realized if it is in compliance with legal requirements. It provides an audit trail of the loan decision (e.g. that the loan was authorized in accordance with policy and good lending judgment). It allows easy and efficient follow up of problem situations (e.g. skip tracing) or routine member inquiries. It establishes a member's credit history for future lending decisions.
Ideally, it is recommended that security documentation be maintained physically separated from the loan application and credit investigation information. Alternatively, credit and security files should be stored together in a fire-proof environment. Negotiable security should be subject to the dual control of a security custodian and a designated senior management person. All files should be purged on a regular and periodic basis by the appropriate lending officer to ensure their continuing validity. The recommended contents of both the credit and security files for various loan categories. For commercial borrowers, current documentation will include additional data which s credit transactions; It is recommended that in each credit file, a loan checklist be included, summarizing the various steps that have been taken to properly establish a new loan. This loan checklist should be completed by the lending officer responsible for the loan or by a designated credit committee member, where applicable. It should be reviewed and initialled by the loans supervisor/manager LOAN MANAGEMENT SYSTEM
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to ensure the credit and security files are in order before these files are stored.
RECOMMENDED FILE DOCUMENTATION Credit File
Security File
For Personal Credit: ·
Loan checklist
·
Approved loan application
· Chattel mortgage documents
·
Credit investigation
·
·
Credit analysis
· Payroll applicable)
· Life and disability insurance application or waiver · Copy of bill of sale for chattel purchased ·
Member correspondence
·
Record of telephone conversations
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or
other
security
Promissory note deduction
authorization
(if
· Insurance endorsement (if applicable) · PPSA search ·
PPSA registration
07
For Mortgages:
· Mortgage document
·
Loan checklist
·
Approved loan application
· Lawyer's letter of final report and opinion with ing documentation
·
Credit investigation
·
·
Credit analysis
. Independent legal advice certificate (if applicable)
·
Member correspondence
·
CMHC application (if applicable)
·
Record of telephone conversations
For Commercial Credit:·
Pledge of fire insurance
· CMHC approval (if applicable) · Qualified appraisal report · Commitment letter/mortgage loan offer ·
Instructions to lawyer
·
Certificate of title insurance
·
Loan checklist
Loan agreement commitment letter
·
Approved commercial loan application
·
·
Borrower's financial statements
· General security agreement and/or other security documents
· ing financial sum-maries (e.g. budgets and/or aged listings of receivables, payables, inventory and fixed assets)
and/or
loan
Promissory note
·
PPSA search
·
PPSA registration Assignment of fire/life insurance
·
Credit investigation
·
·
Credit analysis
·
Member correspondence
· Independent legal advice certificate (if applicable)
·
Record of telephone conversations
·
Any applicable guarantees
·
Lawyer's opinion letter
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4. Post Sanction appraisal: To ensure proper documentation, follow-up and supervision.
Documentation: Post sanction is the process of appraising the credit worthiness of a loan applicant. Factors like age, income, number of dependents, nature of employment, continuity of employment, repayment capacity, previous loans, credit cards, etc. are taken into while appraising the credit worthiness of a person. Every bank or lending institution has its own of officials for this purpose. 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. 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. Credit allows you to buy goods or commodities now, and pay for them later. We use credit to buy things with an agreement to repay the loans over a period of time. The most common way to avail credit is by the use of credit cards. Other credit plans include personal loans, home loans, vehicle loans, student loans, small business loans, trade. LOAN MANAGEMENT SYSTEM
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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 , a credit is an agreement of postponed payments of goods bought or loan. With the issuance of a credit, a debt is formed.
5. 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
FUND BASED:-
WORKING CAPITAL:1. GENERAL The objective of running any industry is earning profits. An industry will require funds to acquire “Fixed assets” like land, building, plant, machinery, equipment’s, vehicles, tools etc., & also to run the business i.e. its day- to -day operations. LOAN MANAGEMENT SYSTEM
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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 labor, 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.
2. Definition 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. Thus Working Capital required is dependent on
(a) The volume of activity (viz. level of operations i.e. Production & sales)
(b) The activity carried on viz. mfg process, product, production programme, the materials & marketing mix.
3. OPERATING CYCLE METHOD
a) Any manufacturing activity is characterized by a cycle of operations consisting of purchase of purchase of raw materials for cash, converting these into finished goods & realizing cash by sale of these finished goods.
b) Diagrammatically, the OPERATING CYCLE is represented as under
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Raw Materials
Stock in Process
Cash
Finished Goods
Bills
c) Thetime 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.
d) That is, the operating cycle consists of:
Time taken to acquire raw materials & average period for which they are in store.
Conversion process time LOAN MANAGEMENT SYSTEM
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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. LOAN MANAGEMENT SYSTEM
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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 Bank’s 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
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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.
NON-FUND BASED:LETTER OF CREDIT
Introduction The expectation of the seller of any goods or services is that he should get the payment immediately on delivery of the same. This may not materialize if the seller & the buyer are at different places (either within the same country or in different countries). The seller desires to have an assurance for payment by the purchaser. At the same time the purchaser desires that the amount should be paid only when the goods are actually received. Here arises the need of Letter of Credit (LCs). The objective of LC is to provide a means of payment to the seller & the delivery of goods & services to the buyer at the same time.
Definition A Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at the request & on the instructions of the customer (the applicant) or on its own behalf,
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i.
is to make a payment to or to the order of a third party (the beneficiary), or is to accept & pay bills of exchange (drafts drawn by the beneficiary); or
ii.
authorizes another bank to effect such payment, or to accept & pay such bills of exchanges (drafts); or
iii.
authorizes another bank to negotiate against stipulated document(s), provided that the & conditions of the credit are complied with.
Basic Principle: The basic principle behind an LC is to facilitate orderly movement of trade; it is therefore necessary that the evidence of movement of goods is present. Hence documentary LCs is those which contains documents of title to goods as part of the LC documents. Clean bills which do not have document of title to goods are not normally established by banks. Bankers and all concerned deal only in documents & not in goods. If documents are in order issuing bank will pay irrespective of whether the goods are of expected quality or not. Banks are also not responsible for the genuineness of the documents & quantity/quality of goods. If importer is your borrower, the bank has to advice him to convert all his requirements in the form of documents to ensure quantity & quality of goods.
Parties to the LC 1)
Applicant – The buyer who applies for opening LC
2)
Beneficiary – The seller who supplies goods
3)
Issuing Bank – The Bank which opens the LC
4)
Advising Bank – The Bank which advises the LC after confirming authenticity
5)
Negotiating Bank – The Bank which negotiates the documents
6)
Confirming Bank – The Bank which adds its confirmation to the LC
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7)
Reimbursing Bank – The Bank which reimburses the LC amount to negotiating bank
8)
Second beneficiary – The additional beneficiary in case of transferable LCs
Confirming bank may not be there in a transaction unless the beneficiary demand confirmation by his own bankers & such a request is made part of LC . A bank will confirm an LC for his beneficiary if opening bank requests this as part of LC . Reimbursing bank is used in an LC transaction by an opening bank when the bank does not have a direct correspondent/branch through whom the negotiating bank can be reimbursed. Here, the opening bank will direct the reimbursing bank to reimburse the negotiating bank with the payment made to the beneficiary. In the case of transferable LC, the LC may be transferred to the second beneficiary & if provided in the LC it can be transferred even more than once.
6. Security for lending: •
Section 5 of B. R. Act defines secured and unsecured loans Secured – Loans and advances made on security of assets the market value of which is not at any time less than the amount of the loan or advances Unsecured – Means a loans or advance not so secured
•
Security taken as an insurance against unwarranted situations
Two types: Primary and Collateral Primary Security – Generally from a viable and professionally managed enterprise
Personal
Created by a duly executed promissory note, acceptance or endorsement of bill of exchange etc.
Gives bank the right of action to proceed against the borrower personally in the event of default
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•
Impersonal •
Created by way of a charge (pledge, hypothecation, mortgage, assignment etc.Collateral Security – Meaning running parallel or together
•
Taken as additional and separate security
•
Could be secured / unsecured guarantees, pledge of shares and other securities, deposits of title deeds etc.
•
Used to reinforce the primary security (for e.g. plantation advances are not considered fully secured until crop is harvested)
7. Credit Risk RBI defines credit risk as: “The possibility of losses associated with diminution in the credit quality of borrowers or counterparties. In a bank’s portfolio, losses stem from outright default due to inability or unwillingness of a customer or counterparty to meet commitments in relation to lending, trading, settlement and other financial transactions. Alternatively, losses result from reduction in portfolio value arising from actual or perceived deterioration in credit quality.” Credit risk is defined, “as the potential that a borrower or counter-party will fail to meet its obligations in accordance with agreed ”
It is the probability of loss from a credit transaction
According to Reserve Bank of India, the following are the forms of credit risk:
Non-repayment of the principal of the loan and/or the interest on it
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Contingent liabilities like letters of credit/guarantees issued by the bank on behalf of the client and upon crystallization amount not deposited by the customer
In the case of treasury operations, default by the counter-parties in meeting the obligations
In the case of securities trading, settlement not taking place when it is due
In the case of cross-border obligations, any default arising from the flow of foreign exchange and/or due to restrictions imposed on remittances out of the country
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8. NPA WHAT IS MEANT BY NPA (NON PERFORMING ASSETS)
Security interest can be initiated only if the securedasset is classified as Nonperforming asset.Non-performing asset means an asset or of borrower, which has beenclassified by bank or financial institution as sub –standard, doubtful or loss asset, inaccordance with the direction or guidelines relating to assets classification issued byRBI.
Definitions: An asset, including a leased asset, becomes non-performing when it ceases togenerate income for the bank. A ‘non-performing asset’ (NPA) was defined as a credit facility in respect ofwhich the interest and/ or instalment of principal has remained ‘past due’ for a specifiedperiod of time. With a view to moving towards international best practices and to ensure greatertransparency, it has been decided to adopt the ‘90 days’ overdue’ norm for identificationof NPAs, from the year ending March 31, 2004. Accordingly, with effect from March 31,2004, a non-performing asset (NPA) shall be a loan or an advance where; Interest and/ or instalment of principal remain overdue for a period ofmore than 90 days in respect of a term loan The remains ‘out of order’ for a period of more than 90 days, inrespect of an Overdraft/Cash Credit (OD/CC), The bill remains overdue for a period of more than 90 days in the case ofbills purchased and discounted, Interest and/or instalment of principal remains overdue for two harvestseasons but for a period not exceeding two half years in the case of anadvance granted for agricultural purposes, and Any amount to be received remains overdue for a period of more than 90days in respect of other s.
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As a facilitating measure for smooth transition to 90 days norm, banks have beenadvised to move over to charging of interest at monthly rests, by April 1, 2002. However,the date of classification of an advance as NPA should not be changed on ofcharging of interest at monthly rests. Banks should, therefore, continue to classify an as NPA only if the interest charged during any quarter is not serviced fully within180 days from the end of the quarter with effect from April 1, 2002 and 90 days from theend of the quarter with effect from March 31, 2004.
Out of order An should be treated as out of order if the outstanding balance remainscontinuously in excess of sanctioned limit /drawing power. in case where the outstandingbalance in the principal operating is less than the sanctioned amount /drawingpower, but there are no credits continuously for six months as on the date of balancesheet or credit are not enough to cover the interest debited during the same period ,these should be treated as ‘out of order’.
Overdue Any amount due to the bank under any credit facility is ‘overdue’ if it is not paidon due date fixed by the bank.
9. Asset Classification Categories of NPAs Standard Assets: Standard assets are the ones in which the bank is receiving interest as well as theprincipal amount of the loan regularly from the customer. Here it is also very importantthat in this case the arrears of interest and the principal amount of loan does not exceed 90days at the end of financial year. If asset fails to be in category of standard asset that isamount due more than 90 days then it is NPA and NPAs are further need to classify in subcategories.
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Banks are required to classify non-performing assets further into thefollowing three categories based on the period for which the asset has remained nonperformingand the realisability of the dues:
( 1 ) Sub-standard Assets:-With effect from 31 March 2005, a sub standard asset would be one, which hasremained NPA for a period less than or equal to 12 month. The following features areexhibited by sub standard assets: the current net worth of the borrowers / guarantor or thecurrent market value of the security charged is not enough to ensure recovery of the duesto the banks in full; and the asset has well-defined credit weaknesses that jeopardize theliquidation of the debt and are characterised by the distinct possibility that the banks willsustain some loss, if deficiencies are not corrected.
( 2 ) Doubtful Assets:-A loan classified as doubtful has all the weaknesses inherent in assets that wereclassified as sub-standard, with the added characteristic that the weaknesses makecollection or liquidation in full, – on the basis of currently known facts, conditions andvalues – highly questionable and improbableWith effect from March 31, 2005, an asset would be classified as doubtful if it remainedin the sub-standard category for 12 months.
( 3 ) Loss Assets:-A loss asset is one which considered uncollectible and of such little value that itscontinuance as a bankable asset is not warranted- although there may be some salvage orrecovery value. Also, these assets would have been identified as ‘loss assets’ by the bankor internal or external auditors or the RBI inspection but the amount would not have beenwrittenoff wholly.
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10.FACTORS FOR RISE IN NPA’s The banking sector has been facing the serious problems of the rising NPAs. Butthe problem of NPAs is more in public sector banks when compared to private sectorbanks and foreign banks. The NPAs in PSB are growing due to external as well as internalfactors.
EXTERNAL FACTORS Ineffective recovery tribunal
The Govt. has set of numbers of recovery tribunals, which works forrecovery of loans and advances.
Due to their negligence and ineffectiveness intheir work the bank suffers the consequence of non-recover, their by reducing theirprofitability and liquidity.
Wilful Defaults
There are borrowers who are able to payback loans but are intentionallywithdrawing it.
These groups of people should be identified and proper measuresshould be taken in order to get back the money extended to them as advances andloans.
Natural calamities
This is the measure factor, which is creating alarming rise in NPAs of thePSBs.
Every now and then India is hit by major natural calamities thus making theborrowers unable to pay back there loans.
Thus the bank has to make large amountof provisions in order to compensate those loans, hence end up the fiscal with areduced profit.
Mainly ours framers depends on rain fall for cropping.
Due toirregularities of rain fall the framers are not to achieve the production level thusthey are not repaying the loans.
Industrial sickness
Improper project handling , ineffective management , lack of adequateresources , lack of advance technology , day to day changing govt. Policies givebirth to industrial sickness.
Hence the banks that finance those industriesultimately end up with a low recovery of their loans reducing their profit andliquidity.
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Lack of demand
Entrepreneurs in India could not foresee their product demand and startsproduction which ultimately piles up their product thus making them unable to payback the money they borrow to operate these activities.
The banks recover theamount by selling of their assets, which covers a minimum label. Thus the banksrecord the nonrecovered part as NPAs and has to make provision for it.
Change on Govt. policies
With every new govt. banking sector gets new policies for its operation.
Thus it has to cope with the changing principles and policies for the regulation ofthe rising of NPAs.
INTERNAL FACTORS
Defective Lending process There are three cardinal principles of bank lending that have been followed by thecommercial banks since long. i. Principles of safety ii. Principle of liquidity iii. Principles of profitability
i. Principles of safety The repayment of loan depends upon the borrowers: a. Capacity to pay b. Willingness to pay . Inappropriate technology
Due to inappropriate technology and management information system, marketdriven decisions on real time basis cannot be taken.
Proper MIS and financialing system is not implemented in the banks, which leads to poor creditcollection, thus NPA.
All the branches of the bank should be computerised.
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Improper SWOT analysis
The improper strength, weakness, opportunity and threat analysis is another reasonfor rise in NPAs.
While providing unsecured advances the banks depend more onthe honesty, integrity, and financial soundness and credit worthiness of theborrower.
. Poor credit appraisal system
Poor credit appraisal is another factor for the rise in NPAs.
Due to poor creditappraisal the bank gives advances to those who are not able to repay it back. Theyshould use good credit appraisal to decrease the NPAs.
Managerial deficiencies
The banker should always select the borrower very carefully and should taketangible assets as security to safe guard its interests.
When accepting securitiesbanks should consider the
Marketability
Acceptability
Safety
Transferability.
NPA MANAGEMENT – PREVENTIVE MEASURES Formation of the Credit Information Bureau (India) Limited (CIBIL) Release of Wilful Defaulter’s List. RBI also releases a list of borrowers withaggregate outstanding of Rs.1 crore and above against whom banks have filedsuits for recovery of their funds Reporting of Frauds to RBI Risk assessment and Risk management
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RBI has advised banks to examine all cases of wilful default of Rs.1 crore andabove and file suits in such cases. Board of Directors are required to review NPAs of Rs.1 crore and above with special reference to fixing of staffability.
Prudential norms for banks for the purchase/ sale transactions (A) Asset classification norms
The non-performing financial asset purchased, may be classified as 'standard'in the books of the purchasing bank for a period of 90 days from the date ofpurchase.
Thereafter, the asset classification status of the financial asset purchased,shall be determined by the record of recovery in the books of the purchasing bankwith reference to cash flows estimated while purchasing the asset which should bein compliance with requirements.
The asset classification status of an existing exposure (other than purchasedfinancial asset) to the same obligor in the books of the purchasing bank willcontinue to be governed by the record of recovery of that exposure and hence maybe different.
Where the purchase/sale does not satisfy any of the prudential requirementsprescribed in these guidelines the asset classification status of the financial asset inthe books of the purchasing bank at the time of purchase shall be the same as inthe books of the selling bank.
Thereafter, the asset classification status willcontinue to be determined with reference to the date of NPA in the selling bank.Any restructure/reschedule/rephrase of the repayment schedule or theestimated cash flow of the non-performing financial asset by the purchasing bankshall render the as a non-performing asset.
(B) Provisioning norms Books of selling bank i. When a bank sells its non-performing financial assets to other banks, the same will be removed from its books on transfer. ii. If the sale is at a price below the net book value (NBV) (i.e., book value less provisions held), the shortfall should be debited to the profit and loss of LOAN MANAGEMENT SYSTEM
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that year. iii. If the sale is for a value higher than the NBV, the excess provision shall not be reversed but will be utilised to meet the shortfall/ loss on of sale of other non performing financial assets. Books of purchasing bank The asset shall attract provisioning requirement appropriate to its assetclassification status in the books of the purchasing bank. (C) ing of recoveries Any recovery in respect of a non-performing asset purchased from otherbanks should first be adjusted against its acquisition cost. Recoveries in excess ofthe acquisition cost can be recognised as profit. (D) Capital Adequacy For the purpose of capital adequacy, banks should assign 100% riskweights to the nonperforming financial assets purchased from other banks. In casethe non-performing asset purchased is an investment, then it would attract capitalcharge for market risks also. For NBFCs the relevant instructions on capitaladequacy would be applicable. (E) Exposure Norms The purchasing bank will reckon exposure on the obligor of the specificfinancial asset. Hence these banks should ensure compliance with the prudentialcredit exposure ceilings (both single and group) after reckoning the exposures tothe obligors arising on of the purchase. For NBFCs the relevantinstructions on exposure norms would be applicable.
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REFERENCES
www.sbi.com
en.wikipedia.org/wiki/Credit_management
www.rbi.org.in › Notifications
www.cab.org.in/Lists/.../26/NPA%20MANAGEMENT
en.wikipedia.org/wiki/Non-performing_asset
Principles and Practices of Banking - Macmillan
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Loan Approvals: The loan approval process comprises of processing and evaluating loan applications, documenting loan decisions and distributing loan funds. It is important that management establish a loan approval process which includes controls over lending authority and ability. A properly functioning loan approval process requires the following: loans follow a pre-established loan processing flow, which sets out the proper movement of loan applications within the credit union; borrower information and credit analysis are properly documented against established credit criteria; loans decisions are made and approved by appropriate staff, with the appropriate authorization and ability; Loan funds are disbursed, after applicable security is in place, through proper channels, with proper safeguards against theft or fraud.
Loan Processing Flow Every credit union should establish a standardized loan processing flow, and document this process in operational procedures. The following are the general steps in the loan process:
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The loan process begins with a lender establishing credit for a member in accordance with board policy. A security custodian would then and file the security. A disbursements officer should advance the funds and the ing staff should record the transaction. Two signatures should appear on the journal voucher sent to the disbursements clerk who advances funds to the member. The originating loan officer and either the general manager, or his designate (e.g. assistant manager) should authorize the journal voucher, after examining the ing file. Advances should be totalled on a daily basis by ing. The sum of the advances should be compared by senior management to the value of promissory notes or other evidence of indebtedness. Any discrepancies should be followed up immediately. Before a loan file is stored, it is recommended that it be reviewed against an accompanying loan checklist by senior management and initialled as evidence of such review. Finally, senior management and the credit committee, should receive detailed loan disbursements summaries on a monthly basis (where it exists).
Credit Appraisal: Credit 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 the principal and the interest.
2. Approach for the safety of loans: Two approach 1. Pre-Sanction Appraisal 2. Post-Sanction Appraisal Pre-Sanction Appraisal:
To determine the bank-ability of each loan proposal
Concerned with measurement of risk(iness) of a loan proposal
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When a credit proposal is presented to a branch by a prospective borrower for sanction by an appropriate authority, the appropriate authority may either sanction or reject the proposal. The decision to sanction or reject the proposal has to be based on a careful analysis of various facts Data presented by the borrower concerning him and the proposal. Such an objective and in-depth study of the information and data should convince the sanctioning authority that the money lent to the borrower for the desired purpose will be safe and it will be repaid with interest over the desired period ,if the assumptions and and conditions on which it is sanctioned, are fulfilled. Such an in-depth study is called the pre-sanction credit appraisal. It provides the sanctioning authority with the reasons and justifications for either sanctioning or rejecting a credit proposal. It, thus, helps in the decision making process of the sanctioning authority. The entire gamut of credit appraisal can be segregated into 7 sections is under: a. Borrower Appraisal. b. Technical Appraisal. c. Management Appraisal. d. Financial Appraisal. e. Economic Appraisal. f. Market Appraisal.
BORROWER APPRAISAL / KNOW YOUR CUSTOMER (KYC) NORMS: The borrower is appraised on the following parameters also known as the 3 ‘C’sof the borrower i.e. character, capacity and capital. Character: Character is the greatest and the most important asset, which any individual can have. Even if a borrower has the capacity and capital to repay a loan, it is the character of the borrower which indicates his intention to repay. If the character or integrity of a borrower is known to be questionable, every banker would avoid him even if backed by sufficient collaterals. Capacity: It deals with the ability of the borrower to manage an enterprise or venture successfully with the resources available to him. His educational, technical and professional qualifications, his antecedents, present activity, experience in the line of business, experiences of the family, special skill or knowledge possessed by him, his past record etc. would give a hindsight into his capacity to manage the show successfully and repay the loan. Capital: It is his ability to meet the loss, if any, sustained in the business or venture from his own LOAN MANAGEMENT SYSTEM
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investment or capital without shifting it to his creditor or banker. Unless a borrower has some Stake in the business, he may not take much interest in its success.
Key Elements of the KYC Policy: a) Customer Acceptance Policy b) Customer Identification Procedures c) Monitoring of Transactions and d) Risk Management
TECHNICAL APPRAISAL: The technical appraisal of a credit proposal involves a detailed study of the following aspects: (1) Availability of basic infrastructure. (2) Licensing/registration requirements. (3) Selection of technology. (4) Availability of suitable technical process, raw material skilled labor etc.
MANAGEMENT APPRAISAL: In case of projects, units or enterprises run by individuals as sole proprietors or partnership firms, it is usually one or two persons who manage the entire project, unit or the enterprise whether it be of manufacturing or trading. However, in case of corporate borrowers and also in case of large borrowal s, it is usually a set of professionals who manage the entity each specialized in a specific area of management i.e. production, finance, marketing, personnel etc. Unless there is a complete integration of all these functions within an organization, it cannot function effectively.
FINANCIAL APPRAISAL: The term financial appraisal refers to the study of the following aspects of the project/unit: Determination of the cost of the project. Assessment of the source of funds/means of financing the project. Profitability estimates. LOAN MANAGEMENT SYSTEM
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Break even analysis. Cash flow projections. Projected balance-sheet.
ECONOMIC APPRAISAL: The performance of a project is influenced by a variety of other economic, social and cultural factors. Even if a project is technically feasible and financially viable, it may not satisfy the economic needs viz. employment potential, development of industrially backward areas, environmental pollution etc. Further as capital is a scarce resource, it is necessary that it must be allocated in such a way that it yields best possible return to the society in general and the investor in particular. As such a detailed appraisal of the project in of the return it generates to the investor and the lending institutions is necessary before a decision is taken to commit resources. One of the most important methods of appraising this is the computation of the Internal Rate of Return of the project.
Internal Rate of Return (IRR): IRR is defined as the discount rate at which the present values of all investments made in a project are equal to the present value of all future returns from the project over the assumed life period of the project. Thus (IRR) is an indicator of the earning capacity of the project. A higher IRR indicates a better prospect for the unit. The investment is treated as cash out flow and the return on the same is treated as cash inflow. The discounted values of the cash inflows and cash outflows shall be zero at a particular rate of discount. The task is to work out this rate which is called the Internal Rate of Return. Normally IRR is compared with the cost of capital and if IRR exceeds the cost of capital, the project is termed viable. IRR is worked out on a trial and error basis and interpolated to obtain the required rate.
Sensitivity Analysis: The normal financial appraisal of a project is based on certain assumed values for certain critical variables/parameters viz. sales realization, unit value of product sold, cost of raw material, capacity utilization etc. However, any variation in the assumed values of these parameters may result in a more favorable or unfavorable IRR. The process of computing the IRR and the repaying capacity of the borrower for different values of each of these parameters is called the sensitivity analysis.
MARKET APPRAISAL: While appraising a proposal it is not only necessary to find out whether it is technically feasible and financially viable, but also important to ascertain the marketability of the product LOAN MANAGEMENT SYSTEM
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manufactured/sold. If goods produced cannot be sold there would be no point in producing them. Hence the marketability or sale ability of goods is of great importance. Existence of a market for the product provides the rationale for its production. If the product sought to be manufactured is the only one of its kind for which there are no substitutes, the marketing of the same may not be a problem excepting when it can be freely imported and that too at a lesser cost. However, if there are many competitors, the entrepreneur may find the going tough. However a combination of the factors like man behind the show, the quality of the product and the strategy for its sale will result in its successful marketing.
3. Loan Documentation Proper assessment of credit risk, loan monitoring and delinquency control begin with well documented member files. Maintaining orderly and adequately documented loan files is an important element of credit risk management. Proper documentation provides the following major benefits: It constitutes evidence of the and conditions of a member's indebtedness. It creates valid security which can be realized if it is in compliance with legal requirements. It provides an audit trail of the loan decision (e.g. that the loan was authorized in accordance with policy and good lending judgment). It allows easy and efficient follow up of problem situations (e.g. skip tracing) or routine member inquiries. It establishes a member's credit history for future lending decisions.
Ideally, it is recommended that security documentation be maintained physically separated from the loan application and credit investigation information. Alternatively, credit and security files should be stored together in a fire-proof environment. Negotiable security should be subject to the dual control of a security custodian and a designated senior management person. All files should be purged on a regular and periodic basis by the appropriate lending officer to ensure their continuing validity. The recommended contents of both the credit and security files for various loan categories. For commercial borrowers, current documentation will include additional data which s credit transactions; It is recommended that in each credit file, a loan checklist be included, summarizing the various steps that have been taken to properly establish a new loan. This loan checklist should be completed by the lending officer responsible for the loan or by a designated credit committee member, where applicable. It should be reviewed and initialled by the loans supervisor/manager LOAN MANAGEMENT SYSTEM
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to ensure the credit and security files are in order before these files are stored.
RECOMMENDED FILE DOCUMENTATION Credit File
Security File
For Personal Credit: ·
Loan checklist
·
Approved loan application
· Chattel mortgage documents
·
Credit investigation
·
·
Credit analysis
· Payroll applicable)
· Life and disability insurance application or waiver · Copy of bill of sale for chattel purchased ·
Member correspondence
·
Record of telephone conversations
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or
other
security
Promissory note deduction
authorization
(if
· Insurance endorsement (if applicable) · PPSA search ·
PPSA registration
07
For Mortgages:
· Mortgage document
·
Loan checklist
·
Approved loan application
· Lawyer's letter of final report and opinion with ing documentation
·
Credit investigation
·
·
Credit analysis
. Independent legal advice certificate (if applicable)
·
Member correspondence
·
CMHC application (if applicable)
·
Record of telephone conversations
For Commercial Credit:·
Pledge of fire insurance
· CMHC approval (if applicable) · Qualified appraisal report · Commitment letter/mortgage loan offer ·
Instructions to lawyer
·
Certificate of title insurance
·
Loan checklist
Loan agreement commitment letter
·
Approved commercial loan application
·
·
Borrower's financial statements
· General security agreement and/or other security documents
· ing financial sum-maries (e.g. budgets and/or aged listings of receivables, payables, inventory and fixed assets)
and/or
loan
Promissory note
·
PPSA search
·
PPSA registration Assignment of fire/life insurance
·
Credit investigation
·
·
Credit analysis
·
Member correspondence
· Independent legal advice certificate (if applicable)
·
Record of telephone conversations
·
Any applicable guarantees
·
Lawyer's opinion letter
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4. Post Sanction appraisal: To ensure proper documentation, follow-up and supervision.
Documentation: Post sanction is the process of appraising the credit worthiness of a loan applicant. Factors like age, income, number of dependents, nature of employment, continuity of employment, repayment capacity, previous loans, credit cards, etc. are taken into while appraising the credit worthiness of a person. Every bank or lending institution has its own of officials for this purpose. 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. 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. Credit allows you to buy goods or commodities now, and pay for them later. We use credit to buy things with an agreement to repay the loans over a period of time. The most common way to avail credit is by the use of credit cards. Other credit plans include personal loans, home loans, vehicle loans, student loans, small business loans, trade. LOAN MANAGEMENT SYSTEM
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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 , a credit is an agreement of postponed payments of goods bought or loan. With the issuance of a credit, a debt is formed.
5. 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
FUND BASED:-
WORKING CAPITAL:1. GENERAL The objective of running any industry is earning profits. An industry will require funds to acquire “Fixed assets” like land, building, plant, machinery, equipment’s, vehicles, tools etc., & also to run the business i.e. its day- to -day operations. LOAN MANAGEMENT SYSTEM
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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 labor, 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.
2. Definition 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. Thus Working Capital required is dependent on
(a) The volume of activity (viz. level of operations i.e. Production & sales)
(b) The activity carried on viz. mfg process, product, production programme, the materials & marketing mix.
3. OPERATING CYCLE METHOD
a) Any manufacturing activity is characterized by a cycle of operations consisting of purchase of purchase of raw materials for cash, converting these into finished goods & realizing cash by sale of these finished goods.
b) Diagrammatically, the OPERATING CYCLE is represented as under
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Raw Materials
Stock in Process
Cash
Finished Goods
Bills
c) Thetime 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.
d) That is, the operating cycle consists of:
Time taken to acquire raw materials & average period for which they are in store.
Conversion process time LOAN MANAGEMENT SYSTEM
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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. LOAN MANAGEMENT SYSTEM
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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 Bank’s 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
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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.
NON-FUND BASED:LETTER OF CREDIT
Introduction The expectation of the seller of any goods or services is that he should get the payment immediately on delivery of the same. This may not materialize if the seller & the buyer are at different places (either within the same country or in different countries). The seller desires to have an assurance for payment by the purchaser. At the same time the purchaser desires that the amount should be paid only when the goods are actually received. Here arises the need of Letter of Credit (LCs). The objective of LC is to provide a means of payment to the seller & the delivery of goods & services to the buyer at the same time.
Definition A Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at the request & on the instructions of the customer (the applicant) or on its own behalf,
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i.
is to make a payment to or to the order of a third party (the beneficiary), or is to accept & pay bills of exchange (drafts drawn by the beneficiary); or
ii.
authorizes another bank to effect such payment, or to accept & pay such bills of exchanges (drafts); or
iii.
authorizes another bank to negotiate against stipulated document(s), provided that the & conditions of the credit are complied with.
Basic Principle: The basic principle behind an LC is to facilitate orderly movement of trade; it is therefore necessary that the evidence of movement of goods is present. Hence documentary LCs is those which contains documents of title to goods as part of the LC documents. Clean bills which do not have document of title to goods are not normally established by banks. Bankers and all concerned deal only in documents & not in goods. If documents are in order issuing bank will pay irrespective of whether the goods are of expected quality or not. Banks are also not responsible for the genuineness of the documents & quantity/quality of goods. If importer is your borrower, the bank has to advice him to convert all his requirements in the form of documents to ensure quantity & quality of goods.
Parties to the LC 1)
Applicant – The buyer who applies for opening LC
2)
Beneficiary – The seller who supplies goods
3)
Issuing Bank – The Bank which opens the LC
4)
Advising Bank – The Bank which advises the LC after confirming authenticity
5)
Negotiating Bank – The Bank which negotiates the documents
6)
Confirming Bank – The Bank which adds its confirmation to the LC
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7)
Reimbursing Bank – The Bank which reimburses the LC amount to negotiating bank
8)
Second beneficiary – The additional beneficiary in case of transferable LCs
Confirming bank may not be there in a transaction unless the beneficiary demand confirmation by his own bankers & such a request is made part of LC . A bank will confirm an LC for his beneficiary if opening bank requests this as part of LC . Reimbursing bank is used in an LC transaction by an opening bank when the bank does not have a direct correspondent/branch through whom the negotiating bank can be reimbursed. Here, the opening bank will direct the reimbursing bank to reimburse the negotiating bank with the payment made to the beneficiary. In the case of transferable LC, the LC may be transferred to the second beneficiary & if provided in the LC it can be transferred even more than once.
6. Security for lending: •
Section 5 of B. R. Act defines secured and unsecured loans Secured – Loans and advances made on security of assets the market value of which is not at any time less than the amount of the loan or advances Unsecured – Means a loans or advance not so secured
•
Security taken as an insurance against unwarranted situations
Two types: Primary and Collateral Primary Security – Generally from a viable and professionally managed enterprise
Personal
Created by a duly executed promissory note, acceptance or endorsement of bill of exchange etc.
Gives bank the right of action to proceed against the borrower personally in the event of default
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•
Impersonal •
Created by way of a charge (pledge, hypothecation, mortgage, assignment etc.Collateral Security – Meaning running parallel or together
•
Taken as additional and separate security
•
Could be secured / unsecured guarantees, pledge of shares and other securities, deposits of title deeds etc.
•
Used to reinforce the primary security (for e.g. plantation advances are not considered fully secured until crop is harvested)
7. Credit Risk RBI defines credit risk as: “The possibility of losses associated with diminution in the credit quality of borrowers or counterparties. In a bank’s portfolio, losses stem from outright default due to inability or unwillingness of a customer or counterparty to meet commitments in relation to lending, trading, settlement and other financial transactions. Alternatively, losses result from reduction in portfolio value arising from actual or perceived deterioration in credit quality.” Credit risk is defined, “as the potential that a borrower or counter-party will fail to meet its obligations in accordance with agreed ”
It is the probability of loss from a credit transaction
According to Reserve Bank of India, the following are the forms of credit risk:
Non-repayment of the principal of the loan and/or the interest on it
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Contingent liabilities like letters of credit/guarantees issued by the bank on behalf of the client and upon crystallization amount not deposited by the customer
In the case of treasury operations, default by the counter-parties in meeting the obligations
In the case of securities trading, settlement not taking place when it is due
In the case of cross-border obligations, any default arising from the flow of foreign exchange and/or due to restrictions imposed on remittances out of the country
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8. NPA WHAT IS MEANT BY NPA (NON PERFORMING ASSETS)
Security interest can be initiated only if the securedasset is classified as Nonperforming asset.Non-performing asset means an asset or of borrower, which has beenclassified by bank or financial institution as sub –standard, doubtful or loss asset, inaccordance with the direction or guidelines relating to assets classification issued byRBI.
Definitions: An asset, including a leased asset, becomes non-performing when it ceases togenerate income for the bank. A ‘non-performing asset’ (NPA) was defined as a credit facility in respect ofwhich the interest and/ or instalment of principal has remained ‘past due’ for a specifiedperiod of time. With a view to moving towards international best practices and to ensure greatertransparency, it has been decided to adopt the ‘90 days’ overdue’ norm for identificationof NPAs, from the year ending March 31, 2004. Accordingly, with effect from March 31,2004, a non-performing asset (NPA) shall be a loan or an advance where; Interest and/ or instalment of principal remain overdue for a period ofmore than 90 days in respect of a term loan The remains ‘out of order’ for a period of more than 90 days, inrespect of an Overdraft/Cash Credit (OD/CC), The bill remains overdue for a period of more than 90 days in the case ofbills purchased and discounted, Interest and/or instalment of principal remains overdue for two harvestseasons but for a period not exceeding two half years in the case of anadvance granted for agricultural purposes, and Any amount to be received remains overdue for a period of more than 90days in respect of other s.
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As a facilitating measure for smooth transition to 90 days norm, banks have beenadvised to move over to charging of interest at monthly rests, by April 1, 2002. However,the date of classification of an advance as NPA should not be changed on ofcharging of interest at monthly rests. Banks should, therefore, continue to classify an as NPA only if the interest charged during any quarter is not serviced fully within180 days from the end of the quarter with effect from April 1, 2002 and 90 days from theend of the quarter with effect from March 31, 2004.
Out of order An should be treated as out of order if the outstanding balance remainscontinuously in excess of sanctioned limit /drawing power. in case where the outstandingbalance in the principal operating is less than the sanctioned amount /drawingpower, but there are no credits continuously for six months as on the date of balancesheet or credit are not enough to cover the interest debited during the same period ,these should be treated as ‘out of order’.
Overdue Any amount due to the bank under any credit facility is ‘overdue’ if it is not paidon due date fixed by the bank.
9. Asset Classification Categories of NPAs Standard Assets: Standard assets are the ones in which the bank is receiving interest as well as theprincipal amount of the loan regularly from the customer. Here it is also very importantthat in this case the arrears of interest and the principal amount of loan does not exceed 90days at the end of financial year. If asset fails to be in category of standard asset that isamount due more than 90 days then it is NPA and NPAs are further need to classify in subcategories.
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Banks are required to classify non-performing assets further into thefollowing three categories based on the period for which the asset has remained nonperformingand the realisability of the dues:
( 1 ) Sub-standard Assets:-With effect from 31 March 2005, a sub standard asset would be one, which hasremained NPA for a period less than or equal to 12 month. The following features areexhibited by sub standard assets: the current net worth of the borrowers / guarantor or thecurrent market value of the security charged is not enough to ensure recovery of the duesto the banks in full; and the asset has well-defined credit weaknesses that jeopardize theliquidation of the debt and are characterised by the distinct possibility that the banks willsustain some loss, if deficiencies are not corrected.
( 2 ) Doubtful Assets:-A loan classified as doubtful has all the weaknesses inherent in assets that wereclassified as sub-standard, with the added characteristic that the weaknesses makecollection or liquidation in full, – on the basis of currently known facts, conditions andvalues – highly questionable and improbableWith effect from March 31, 2005, an asset would be classified as doubtful if it remainedin the sub-standard category for 12 months.
( 3 ) Loss Assets:-A loss asset is one which considered uncollectible and of such little value that itscontinuance as a bankable asset is not warranted- although there may be some salvage orrecovery value. Also, these assets would have been identified as ‘loss assets’ by the bankor internal or external auditors or the RBI inspection but the amount would not have beenwrittenoff wholly.
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10.FACTORS FOR RISE IN NPA’s The banking sector has been facing the serious problems of the rising NPAs. Butthe problem of NPAs is more in public sector banks when compared to private sectorbanks and foreign banks. The NPAs in PSB are growing due to external as well as internalfactors.
EXTERNAL FACTORS Ineffective recovery tribunal
The Govt. has set of numbers of recovery tribunals, which works forrecovery of loans and advances.
Due to their negligence and ineffectiveness intheir work the bank suffers the consequence of non-recover, their by reducing theirprofitability and liquidity.
Wilful Defaults
There are borrowers who are able to payback loans but are intentionallywithdrawing it.
These groups of people should be identified and proper measuresshould be taken in order to get back the money extended to them as advances andloans.
Natural calamities
This is the measure factor, which is creating alarming rise in NPAs of thePSBs.
Every now and then India is hit by major natural calamities thus making theborrowers unable to pay back there loans.
Thus the bank has to make large amountof provisions in order to compensate those loans, hence end up the fiscal with areduced profit.
Mainly ours framers depends on rain fall for cropping.
Due toirregularities of rain fall the framers are not to achieve the production level thusthey are not repaying the loans.
Industrial sickness
Improper project handling , ineffective management , lack of adequateresources , lack of advance technology , day to day changing govt. Policies givebirth to industrial sickness.
Hence the banks that finance those industriesultimately end up with a low recovery of their loans reducing their profit andliquidity.
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Lack of demand
Entrepreneurs in India could not foresee their product demand and startsproduction which ultimately piles up their product thus making them unable to payback the money they borrow to operate these activities.
The banks recover theamount by selling of their assets, which covers a minimum label. Thus the banksrecord the nonrecovered part as NPAs and has to make provision for it.
Change on Govt. policies
With every new govt. banking sector gets new policies for its operation.
Thus it has to cope with the changing principles and policies for the regulation ofthe rising of NPAs.
INTERNAL FACTORS
Defective Lending process There are three cardinal principles of bank lending that have been followed by thecommercial banks since long. i. Principles of safety ii. Principle of liquidity iii. Principles of profitability
i. Principles of safety The repayment of loan depends upon the borrowers: a. Capacity to pay b. Willingness to pay . Inappropriate technology
Due to inappropriate technology and management information system, marketdriven decisions on real time basis cannot be taken.
Proper MIS and financialing system is not implemented in the banks, which leads to poor creditcollection, thus NPA.
All the branches of the bank should be computerised.
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Improper SWOT analysis
The improper strength, weakness, opportunity and threat analysis is another reasonfor rise in NPAs.
While providing unsecured advances the banks depend more onthe honesty, integrity, and financial soundness and credit worthiness of theborrower.
. Poor credit appraisal system
Poor credit appraisal is another factor for the rise in NPAs.
Due to poor creditappraisal the bank gives advances to those who are not able to repay it back. Theyshould use good credit appraisal to decrease the NPAs.
Managerial deficiencies
The banker should always select the borrower very carefully and should taketangible assets as security to safe guard its interests.
When accepting securitiesbanks should consider the
Marketability
Acceptability
Safety
Transferability.
NPA MANAGEMENT – PREVENTIVE MEASURES Formation of the Credit Information Bureau (India) Limited (CIBIL) Release of Wilful Defaulter’s List. RBI also releases a list of borrowers withaggregate outstanding of Rs.1 crore and above against whom banks have filedsuits for recovery of their funds Reporting of Frauds to RBI Risk assessment and Risk management
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RBI has advised banks to examine all cases of wilful default of Rs.1 crore andabove and file suits in such cases. Board of Directors are required to review NPAs of Rs.1 crore and above with special reference to fixing of staffability.
Prudential norms for banks for the purchase/ sale transactions (A) Asset classification norms
The non-performing financial asset purchased, may be classified as 'standard'in the books of the purchasing bank for a period of 90 days from the date ofpurchase.
Thereafter, the asset classification status of the financial asset purchased,shall be determined by the record of recovery in the books of the purchasing bankwith reference to cash flows estimated while purchasing the asset which should bein compliance with requirements.
The asset classification status of an existing exposure (other than purchasedfinancial asset) to the same obligor in the books of the purchasing bank willcontinue to be governed by the record of recovery of that exposure and hence maybe different.
Where the purchase/sale does not satisfy any of the prudential requirementsprescribed in these guidelines the asset classification status of the financial asset inthe books of the purchasing bank at the time of purchase shall be the same as inthe books of the selling bank.
Thereafter, the asset classification status willcontinue to be determined with reference to the date of NPA in the selling bank.Any restructure/reschedule/rephrase of the repayment schedule or theestimated cash flow of the non-performing financial asset by the purchasing bankshall render the as a non-performing asset.
(B) Provisioning norms Books of selling bank i. When a bank sells its non-performing financial assets to other banks, the same will be removed from its books on transfer. ii. If the sale is at a price below the net book value (NBV) (i.e., book value less provisions held), the shortfall should be debited to the profit and loss of LOAN MANAGEMENT SYSTEM
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that year. iii. If the sale is for a value higher than the NBV, the excess provision shall not be reversed but will be utilised to meet the shortfall/ loss on of sale of other non performing financial assets. Books of purchasing bank The asset shall attract provisioning requirement appropriate to its assetclassification status in the books of the purchasing bank. (C) ing of recoveries Any recovery in respect of a non-performing asset purchased from otherbanks should first be adjusted against its acquisition cost. Recoveries in excess ofthe acquisition cost can be recognised as profit. (D) Capital Adequacy For the purpose of capital adequacy, banks should assign 100% riskweights to the nonperforming financial assets purchased from other banks. In casethe non-performing asset purchased is an investment, then it would attract capitalcharge for market risks also. For NBFCs the relevant instructions on capitaladequacy would be applicable. (E) Exposure Norms The purchasing bank will reckon exposure on the obligor of the specificfinancial asset. Hence these banks should ensure compliance with the prudentialcredit exposure ceilings (both single and group) after reckoning the exposures tothe obligors arising on of the purchase. For NBFCs the relevantinstructions on exposure norms would be applicable.
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REFERENCES
www.sbi.com
en.wikipedia.org/wiki/Credit_management
www.rbi.org.in › Notifications
www.cab.org.in/Lists/.../26/NPA%20MANAGEMENT
en.wikipedia.org/wiki/Non-performing_asset
Principles and Practices of Banking - Macmillan
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