A

A

Project Report

At

On

A STUDY ON WORKING CAPITAL MANAGEMENT OF BANK.

IN

BHUBANESWAR.(From 21/02/2011 - 10/05/2011)

Submitted by:-

BAILOCHAN SAHU

Roll No - 520951171Registration No 520951171

GYANABHARATI 2ND FLOOR

NILIMA COMPLEX DELTA SQUARE

BARAMUNDA BHUBANESWAR

A

PROJECT REPORT ON

WORKING CAPITAL MANAGEMENT OF BANK

Submitted in partial fulfillment of the requirement

For the award of the Degree

Of Master of Business Administration

By

BAILOCHAN SAHU

Reg no: 520951171TO

SIKKIM MANIPAL UNIVERSITY OF

HEALTH MEDICAL AND TECHNOLOGICAL SCIENCES COMPANY CERTIFICATE

It is to certify that BAILOCHAN SAHU a final year student of Sikkim Manipal University has completed the project work entitled. A PROJECT REPORT ON WORKING CAPITAL MANAGEMENT OF BANK. For the award of the partial fulfillment for the degree of Masters in Business Application of Sikkim Manipal University of health Medical and technological sciences.

During his working period of project he found to be hardworking and sincere.

I wish her a better Future in the field of Management.

Examiners CertificateThe project report of BAILOCHAN SAHU Entitled

A PROJECT REPORT ON WORKING CAPITAL MANAGEMENT OF BANK CHANNEL OF ICICI BANK.

Is approved and is acceptable in quality and form.

CERTIFICATE

This is to certify that the report entitled A PROJECT REPORT ON WORKING CAPITAL MANAGEMENT OF BANK CHANNEL OF ICICI BANK IN BHUBANESWAR Submitted in partial fulfillment of the requirements for the degree of Master of Business Administration (MBA) of Sikkim Manipal University of health Medical and Technological sciences. MR BAILOCHAN SAHU has worked under my supervision and guidance and that no part of this report has been submitted for the award of any other degree, diploma, fellowship or other similar titles or prizes and then may has not been published in any journal or magazine.

CertifiedMr.Rajesh Dash.Branch Head-Finance. ICICI BANK

CERTIFICATE

This is to certify that the report entitled A PROJECT REPORT ON WORKING CAPITAL MANAGEMENT OF ICICI BANK Submitted in partial fulfilment of the requirements for the degree of Master of Business Administration (MBA) of Sikkim Manipal University of Health Medical and Technological Sciences. MR Bidyadhar das has worked under my supervision and guidance and that no part of this report has been submitted for the award of any other degree, diploma, fellowship or other similar titles or prizes and then may has not been published in any journal or magazine.

Certified

ACKNOWLEDGEMENTIt is my proud privilege to express my deep sense of gratitude to my Respected Project-Head Mr. Saurav Kumar Dalabehera Faculty in Department of Management, Gyanabharati, and Bhubaneshwar. For his wise concern, co-operation, inspiration, valuable and scholarly guidance and consistent encouragement to undertake this project work.

I am thankful to my loving friends for their help, encouragement, co-operation and kind assistance to prepare this Project Report.

Finally my deep sense of gratitude to my loving parents.

DECLARATION

I BAILOCHAN SAHU do here by declare that the project report entitled A PROJECT REPORT ON WORKING CAPITAL MANAGEMENT OF BANK . Submitted by me for the partial fulfillment of my MBA course to Sikkim Manipal University, India is of my own efforts and has not been submitted for the award of any other degree, diploma, fellowship, or any other similar title or prizes.Acknowledgement

At this stage I must thank God, the Professor of Majesty and Splendor, the Omnipresent and the ever merciful. Whose invisible guidance helped me in each and every moment of my life.

I would also like to thank my parent for allowing me to do whatever I liked, my elder brothers who helped me in facing each and every problem of my life and without their support I would not be able to reach at this stage.

In presenting this report I express my heartfelt thanks to Mr. Prayag samal (Bank Manager of ICICI Bank), Mr.Ritesh Raj Singh (Cashier Manager of ICICI Bank) ,My warmest thank to Mr. Samuel Pradhan (Sn. Mgr Cashier of ICICI Bank),Mr Amit Daruka (Branch Manager of ICICI Bank). who were always with me with there valuable suggestion.I am grateful to Mr. Sourav Kumar Dalbehera my internal guide who was always for me and without his guidance the project could not have been completed.

My sincere gratitude to Center head Mr. Surendra kumar sahoo and faculties whose constant help immense me to be in track throughout my project. Last but not the least I would like to thank all friends and the entire person who helped me directly or indirectly in making this report successful.

Bailochan sahuTable of content

Chapter No.Name of ChapterPage NO.

1. INTRODUCTION

BANK OVERVIEW

01-05

2. OBJECTIVE OF THE STUDY

06-07

3. METHODOLOGY

Research design.

Data source & Methodology.

Tools Used.

Scope of the Study.

Significance of the study08-12

4. Limitations of the Study

Limitation of knowledge regarding the banking Operations. Limitation to gather all the relevant information.

13

5. Presentation and Analysis of data. Risks in banking business.

Type of risk

Decision making

Credit appraisal

Credit appraisal procedures in ICICI BANK

Methods of assessment of working capital

Assessment of term loan

Credit risk assessment

Financial Ratio analysis What a credit analyst needs to ensure14

15-17

18-20

21

22-28

29-31

32-35

36-44

45-53

54-63

64-65

6. Summary and Conclusion

66-67

7.Appendix68

INTRODUCTION

Its working capital financing consists mainly of cash credit facilities and bill discounting. Under the cash credit facility, a line of credit is provided up to a pre-established amount based on the borrower's projected level of inventories, receivables and cash deficits. Up to this pre-established amount, disbursements are made based on the actual level of inventories and receivables. The facility is generally given for a period of up to 12 months, with a review after that period. Its cash credit facility is generally fully secured with full recourse to the borrower. In most cases, ICICI Bank has a first charge on the borrower's current assets, which normally are inventory and receivables. Bill discounting involves the financing of short-term trade receivables through negotiable instruments. These negotiable instruments can then be discounted with other banks if required, providing us with liquidity. ICICI Bank provides letter of credit facilities to its customers both for meeting their working capital needs as well as for capital equipment purchases. Lines of credit for letters of credit are approved as part of a working capital loan package provided to a borrower. These facilities, like cash credit facilities, are generally given for a period up to 12 months, with review after that period. ICICI Bank provides guarantees, which can be drawn down any number of times up to the committed amount of the facility. ICICI Bank issue guarantees on behalf of its borrowers in favor of corporations and Government authorities. Guarantees are generally issued for the purpose of bid bonds, guaranteeing the performance of its borrowers under a contract as security for advance payments made to its borrowers by project authorities and for deferral of and exemption from the payment of import duties granted to its borrowers by the Government against fulfillment of certain export obligations by its borrowers. The term of these guarantees is generally up to 36 months though in specific cases, the term could be higher. In addition, as a

Working capital is the life blood and controlling nerve center of a business.

Working capital is vital to a business. The organizations have to make available of funds to pay their day to day bills, wages and so on. The working capital is made up of the Current assets net of the current liabilities. It is very important to a company to manage its working capital carefully. This is particularly true where there is a substantial time lag between making the product and receiving the money for it. In this situation the company has paid out all the costs associated with making the product (labour, raw materials and so on) but not yet got any money for it. They must therefore ensure they have enough Cash to do this. The way working capital moves around the business is modeled by the working capital cycle. This shows the cash coming into the business, what happens to it while the business has it and then where it goes.Between each stage of this working capital cycle there is a time lag. For some businesses this will be very long where it takes them a long time to make and sell the product. They will need a substantial amount of working capital to survive. Others though may receive their cash very quickly after paying out for raw materials etc. Perhaps even before theyve paid their bills- they will need less working capital.

For all businesses though they need to plan how much cash they are going to have. The best way of doing this is a CASH FLOW FORECAST.

Working capital is a life blood and controlling nerve center of a business Various aspects of working capital determines the health and growth of an Organization.

Working Capital refers to Current assets mines current liabilities. Working capital measures how much in liquid assets a company has available to build its business. The number can be positive or negative, depending on how much debt the company is carrying. In general, companies that have a lot of working capital will be more successful since they can expend and improve their operations. Companies with negative working capital may lack the funds necessary for growth. The above information about working capital influence me for making a project on working capital Management of the ICICI BANK.

Economy needs capital to move on. Without sufficient capital, the infrastructural, industrial, and agriculture activities cannot be undertaken. These are essential for economic growth of the economy on which GDP, and thereby the per capita income of the people depends.

Only when the savings of the people are mobilized and channelized, they can be used systematically for economic activity. Here comes the role of banks and FI who are involved in mobilizing the savings of the public and lending it for various economic activities.

Financial Sector, especially, banking, is however, passing through a process of radical change. De regulation in the financial sector has widened the opportunities and threats for the entities financed by the banks. This calls for new models of assessment of risks to which such entities are freshly exposed. The deregulation has also resulted in introduction of a string of new products by the banks. Many new products have also created multiple sources for banks to generate higher profits, than the traditional financial intermediation, but they have also opened up new areas of risk. BANK OVERVIEW

. ICICI Bank. ICICI Limited began diversifying its operations from project-based lending to corporate financing at the time of appraisal. In addition, as a part of its housing finance initiative, ICICI Limited set up ICICI Home Finance Company in 1999 as a wholly-owned subsidiary for provision of housing loans. During implementation, based on opportunities in the

market, ICICI Limited merged with ICICI Bank and refocused its operations on retail and commercial banking. The size of ICICI Banks housing finance portfolio as of 31 March 2008 was Rs585 billion, of which loans to the relatively lower income group (loans of less than Rs0.5 million) constituted 16%. The size of ICICI Home Finance Companys housing portfolio was Rs67 billion as of 31 March 2008. ICICI Home Finance Company has recently started focusing

on large ticket (non-priority sector) loans and home equity loans. To un-bundle these risks, a step towards upgrading their risk assessment and risk management has been undertaken by some banks. An important focus of these efforts has been the development of new methodologies, and the introduction of more rigorous practices, to measure and manage risk. The rapid growth and increasing complexity of financial market activity, together with increasing competition, have been important catalysts to these developments. However, this step has highlighted the challenges associated with quantifying and ascertaining risk, given the scarcity of historical loan performance data.

OBJECTIVE OF THE STUDY:-

To assertion management of working capital and to calculate various ratio relating to working capital.

To suggest the steps to be taken to increase the efficiency in management of working capital.

To study the liquidity position of he organization by taking analyzing important components of working capital.

To study the general working of the company with relation to the decision regarding managing working capital.

To get exposure with practical field study with actual figures.

To understand the various problems faced by the company and the industry as a whole in proper implementation of Working capital Management. The necessary precautions if possible to be undertaken to prevent and control them.

To study the past performance of the working capital management in the company, its future prospects and achievable position in near future considering changing position of industries.

The main objective of this study i.e. to ascertain the risk while investing in a particular borrower and accounting beforehand for and any unprecedented change displayed by him over the time period is accomplished by the following steps:

Starting with brief overview of various risks in banking, and later emphasizing on the credit risk management and the issues involved there in.

A broad overview of the credit appraisal process of the banks and the risk analysis done by them.

A broad overview of the project finance process of the banks for financing projects like infrastructure projects.

Using the credit risk rating framework to determine risk adjusted pricing for exposuresMETHODOLOGY

Research design.

The design chosen for this study is descriptive research design. The rationale behind using the descriptive research design is that the study was carried on working capital management for which the source is annual reports, and cost reports etc. the financial analysis is done keeping special emphasis on balance sheet profit and loss statement, cost report and ratio analysis.Data Source and Methodology

The present study is based upon primary and secondary data. The sources of primary data are the official records and discussion with the officers in the finance dept. of the organization. The secondary sources of the data include various publications of the organization and annual reports and audited financial statements. The data, which are presented in this report, have been taken from secondary sources.

For analyzing the performance of working capital management, simple mathematical tools like Percentages, Averages, and Ratios have been used in this project work. To know the financial performances of this division, calculation of Operation Cycle, Earning before Interest & Taxes have been calculated.The study was undertaken as a part of MBA curriculum during March- April in the form of summer training.

The work was carried out in the office of ICICI BANK . Both primary and secondary data were acquired for the smooth and successful completion of the study. The primary report and interview and secondary data are collected from the Balance sheet of the project and annual reports etc. Tool used

Ratio analysis, current ratio, liquid ratio, inventory ratio, ratio of inventory to working capital and graphs has been used as devices for analyzing the performance of working capital management ICICI BANK..Scope of the study

The study of the working capital helps someone to know about the position of the current assets and current liability of an organization. This gives a clear picture that how the firm is maintaining its day-to-day requirements by using the funds available .the working capital requirements of the business are maintained according to that.

Excess working capital more than its requirement is idle to the business point of view. When the working capital is not sufficient that is also not good for the business because it shows the weakness of liquidity. Above that if working capital is not sufficient then it is difficult to maintain its day-to-day activities.

This project on Credit Appraisal involves a plethora of issues and aspects. To undertake this project in its entirety involves more time, expertise, and in-depth knowledge of banking functions. Thus, with limited knowledge, sincere efforts have been made to evaluate the key elements.

The study is restricted to appreciate the system of Credit Appraisal the banks undertake, how the risk biased pricing is done and what all precautions does the bank take before favorably considering any loan proposalICICI Bank also offer cash management services (such as collection, payment and remittance services), escrow, trust and retention account facilities, online payment facilities, custodial services and tax collection services on behalf of the overnment of India and the governments of Indian states. Under cash management services, ICICI Bank offer its corporate clients custom- made collection, payment and remittance services allowing them to reduce the time period between collections and remittances, thereby streamlining their cash flows. Its cash management products include physical cheque-based clearing in locations where settlement systems are not uniform, electronic clearing services, central pooling of country-wide collections, dividend and interest remittance services and Internet-based payment products. ICICI Bank also act as bankers to corporates for their dividend pay out to their shareholders, as also for interest pay out to the companys investors and depositors which results in interest-free float balances for us. ICICI Bank also offers custodial services to clients. At year-end fiscal 2007, total assets held in custody on behalf of its clients (mainly foreign institutional investors, offshore funds, overseas corporate bodies and depositary banks for GDR investors) were Rs. 910.49 billion. As a registered depositary participant of National Securities Depository Limited and Central Depository Services (India) Limited, the two securities depositaries operating in India, ICICI Bank also provide electronic depositary facilities to investors. Further, ICICI Bank generates fee income from its syndication and securitization activities.

Significance of the Study

While Financial Institutions have faced difficulties over the years for a multitude of reasons, the major cause continues to be directly related to the credit standards for borrowers or a lack of attention to changes in economic or other circumstances that can lead to deterioration in the credit standing of a banks borrowers. Non-recovery of the dues form the borrower not only affects profitability, but also necessitates maintaining of more owned funds by way of capital and reserves and provisions to act as a cushion for the loan losses. In consequence, disturbing the credit cycle and giving birth to other banking problems.

Avoidance of these loan losses, rather reducing them to acceptable limits, is one of the pre-occupations of managements of banks. Losses are inevitable, as the risk is inherent in Credit, but banks should strive to see that what originates these problems loan accounts and take steps to mitigate that in future. Picking up this theme, this study charts the mechanism adopted by the banks in rating the credit risks, in fixing the amount of credit to be extended during a financial year, the industries to focus on, the geographical spread, the type of proposals to be financed, the disbursal mechanism, and the collateral value, the method of pricing, the repayment schedule, the monitoring and review process.

The significance of the studying these considerations gets reflected in knowing that, lending is not just a matter of making the loan and waiting for payment .Loans are to be properly rated, priced, monitored, and reviewed so as to effectively measure the credit risk along the risk continuum, and foreseeing before hand of any undesirable prospect of the borrowers business. Current accounts, which are non-interest bearing demand deposits. In addition to deposits from Indian residents, ICICI Bank accept time and savings deposits from non-resident Indians, foreign nationals of Indian origin and foreign nationals rking in India. These deposits are accepted on a repatriable and a non-repatriable basis and are maintained in rupees and select foreign currencies.

Following a strategy focused on customer profiles and product segmentation,ICICI Bank offer differentiated liability products to various categories of customers depending on their age group, such as Young Star Accounts for children below the age of 18 years, Student Banking Services for students, Salary Accounts for alaried employees and Senior Citizens Account for individuals above the age of 60 years. During fiscal 2007, ICICI Bank launched special term deposit products for urations of 390, 590 and 890 days. ICICI Bank have also segmented various categories of customers to offer targeted products, like Private Banking for high net worth individuals, Defence Banking Services for defence personnel, Special Savings Accounts for trusts and Roaming Current Account for businessmen.

Limitations of the Study Limitation of knowledge regarding the banking Operations: As this was first time I was exposed to the practical banking process scenario, it was nor possible to know all the issues involved in the credit risk management of the bank.

ICICI Bank take deposits from its corporate clients with terms ranging from 15 days (seven days in respect of deposits over Rs. 1.5 million) to 10 years but predominantly from 15 days to one year. RBI regulates the term of deposits in India, but not the interest rates, with some minor exceptions. Banks are not permitted to pay interest for periods less than seven days. Also, pursuant to the current regulations, ICICI Bank are permitted to vary the interest rates on its corporate deposits based upon the size range of the deposit so long as the rates offered are the same for every customer of a deposit of a certain size range on a given day. Its deposit products for corporations include:

Limitation to gather all the relevant information: As a trainee, it was not possible to access all the important documents and circulars of the bank as some of them as confidential and not supposed to be disclosed to the outsiders. As a result, some of the bank specific information could not be collected.

ICICI Bank offer retail liability products in the form of a variety of unsecured redeemable bonds. RBI has prescribed limits for issuance of bonds by banks. During the financial year ended March 31, 2007, ICICI Bank did not issue any bonds to retail investors. While ICICI Bank expects that deposits will continue to be its primary source of funding, ICICI Bank may conduct bond issues in the future.

Presentation and Analysis of data1. Risks in banking business.

2. Type of risk

3. Decision making

4. Credit appraisal

5. Credit appraisal procedures in ICICI BANK

6. Methods of assessment of working capital

7. Assessment of term loan

8. Credit risk assessment

9. Ratio analysis

10. What a credit analyst needs to ensure

Risk in Banking Business

Through its distribution network, ICICI Bank offer government of India savings bonds, insurance policies from ICICI Prudential Life Insurance Company and ICICI Lombard General Insurance Company and distribute public offerings of equity shares by Indian companies. ICICI Bank also offers a variety of mutual fund products from ICICI Prudential Asset Management Company and other select mutual funds. ICICI Bank also levies services charges on deposit accounts. ICICI Bank offer fee-based products and services including foreign exchange products, documentary credits and guarantees to small and medium enterprises. As a depositary participant of the National Securities Depository Limited and Central Depository Services (India) Limited, ICICI Bank offer depositary share accounts to settle securities transactions in a dematerialized mode. Further, ICICI Bank are one of the banks designated by RBI for issuing approvals to non- resident Indians and overseas corporate bodies to trade in shares and convertible debentures on the Indian stock exchanges.

ICICI Bank provide a range of commercial banking products and services to Indias leading corporations and growth-oriented middle market companies, including loan products, fee and commission-based products and services, deposits and foreign exchange and derivatives products. ICICI Bank serves its corporate clients through two corporate relationship groups, the Global Clients Group and the Major Clients Group. The Global Investment Banking Group and the Global Project Finance Group focus on origination and execution of investment banking and project finance mandates. The Transaction Banking Group focuses on transaction banking and product development and sales. The Global Markets Group provides foreign exchange and other treasury products to corporate as well as small enterprise clients

Risk is inherent and absolutely unavoidable in banking. It is a variable which can be calibrated, measured and compared. The degree of risk attached to an event is generally linked to the likelihood of the occurrence of that event. The higher the probability of the actual outcome being different from the expected outcome, the higher is the risk attached to that event. Hence, risk is generally measured using the concept of standard deviation.

It is the potential loss that an asset or a portfolio is likely to suffer due to a variety of reasons .Since risk is accepted in business as a trade off between reward and threat, it does not mean that taking risk brings loss only; it brings forth benefits as well. In other words, it is necessary to accept risks, if the desire is to reap the anticipated benefits.

Risk, in its pragmatic definition, therefore, includes both threats that can materialize and opportunities that can be exploited. Stressing the downturn effect of taking risks, there can be serious implications on banks when the various explored /unexplored are not prudently managed.The market where investment funds like bonds, equities and mortgages are traded is known as the capital market. The primal role of the capital market is to channelize investments from investors who have surplus funds to the ones who are running a deficit. The capital market offers both long term and overnight funds. The financial instruments that have short or medium term maturity periods are dealt in the money market whereas the financial instruments that have long maturity periods are dealt in the capital market. The different types of financial instruments that are traded in the capital markets are equity instruments, credit market instruments, insurance instruments, foreign exchange instruments, hybrid instruments and derivative instruments.

In studying the capital market theory we deal with issues like the role of the capital markets, the major capital markets in the US, the initial public offerings and the role of the venture capital in capital markets, financial innovation and markets in derivative instruments, the role of securities and the exchange commission, the role of the federal reserve system, role of the US Treasury and the regulatory requirements on the capital market. The market where investment funds like bonds, equities and mortgages are traded is known as the capital market. The financial instruments that have short or medium term maturity periods are dealt in the money market whereas the financial instruments that have long maturity periods are dealt in the capital market. The main function of the capital market is to channelize investments from the investors who have surplus funds to the investors who have deficit funds. The different types of financial instruments that are traded in the capital markets are equity instruments, credit market instruments, insurance instruments, foreign exchange instruments, hybrid instruments and derivative instruments. The money market instruments that are traded in the capital market are Treasury Bills, federal agency securities, federal funds, negotiable certificates of deposits

The issues that have been mentioned above to explain the capital market theory may be discussed under the following heads:

Type of Risks A bank faces a number of risks in the course of its regular operations. Some of the important risks faced by bank are as under:

Credit Risks

Interest-rate Risks

Operational Risks

Liquidity Risks

Market Risks

Insurance Risks

Business Risks

Strategy Risks

Reputation/Brand Risks

Credit Risks: Whenever a bank acquires a loan asset, it assumes the risk that the borrower may default that is, not repay the principal and/or interest on time. Different types of assets in the bank exhibit different probabilities of default. Loans typically exhibit the greatest Credit risk. Banks investment securities generally exhibit less Credit risk because the borrowers are predominantly central, state, and local government units where the default percentage is Zero. To assess the borrowers creditworthiness, banks perform a credit analysis on each loan request to assess the borrowers capacity to repay.

Interest-rate Risks: It is ascertained, basically, by comparing the sensitivity of interest income to changes in assets yields with the sensitivity of Interest expense to changes in a Interest costs of liabilities. In any integrated (Globalize) economy, wild fluctuations in financial parameters are bound to have far-reaching consequences for the bottom line of the banks and other Financial Institutions. For instance, a change in the Interest rate can suddenly make borrowed money very inexpensive or very costly. A variety of tools are now available to help manage the risks of such events occurring. Some important products include futures, forwards, options, and swaps. Mind-boggling advances in information technology, the spread of personal computers and their networking have considerably facilitated this task. But the organizations should clearly understand the mechanism and their implications of these products, failing which they might end up exposing themselves to greater risk.

Liquidity Risks: Market liquidity risk is defined as the in ability of the bank to conclude a large transaction in a particular instrument at any thing near the current market price. Funding Liquidity risk is defined as the inability of the bank to obtain the funds to meet cash flow obligations. Thus, Liquidity risk is generally discussed in terms of assets, demonstrating the bankers ability to convert the asset into cash with minimal loss form price depreciation .banks continuously compare the probable cash inflows with the future demands needs, so as to meet the payment obligations and future expansion needs.

Operational Risks: Operational Risk is the risk of unexpected losses arising from deficiencies in a banks management information, support and control systems and procedures. These deficiencies could lead towards offering inappropriate financial products or incorrect advice to customers causing legal exposure or loss of goodwill, or a systems failure could leave a bank or dealer without the effective ability to trade or to assess its current portfolio. To take case of this risk, most banks have identified system vendors for a proper workflow and process automation, which will help the banks in reducing and detecting errors. But the success in controlling this risk through system vendors is to be seen over a period.

Market Risks: Market Risk is defined as the risk of a potential loss in fair values arising form adverse changes in market rates and prices.

Insurance Risks: The risk that the product pricing and reserves did not appropriately cover claims.

Business Risks: The risk that the businesses were not able to cover their ongoing expense with ongoing income following a severe crisis(excluding items already captured by other risk categories)

Strategy Risks: The risk that business activities were not responsive to changes in industry trends.

Reputation/Brand risks: The risk that the banks market or service image might decline. Apart form the above mentioned risk, there are various types of risks like exchange risk, country risk, off balance sheet risk etc. which add more intricacies to the major head of default risk.

Nevertheless, the management of lending, the core businesses of most banks, is mostly about granting of credit and managing the credit risk. Credit risks management ought, therefore to be a core competency of the Financial Institution.

Decision Making

A decision on providing credit to an entrepreneur may be arrived at in a subjective or objective manner. A subjective analysis is often impressionistic in character

An objective analysis instills a certain degree of certainty and refinement. A credit functionary in a bank has always been undertaking risk analysis in course of taking a lending decision, but the present day emphasis on credit risk management is all about objective of a given scenario, quantifying the risk and taking appropriate precautions.

Credit Appraisal

Low efficiency and high default rates are the major risks in lending. After a loan has been disbursed, financing institutions rely on a punctual and complete repayment of the amount granted. Thus, it is of utmost importance to carefully, assess the acceptability of the promoter(s) and viability of the planned project at its pre-investment stage (i.e before sanction of the loan)

Objectives of Credit Appraisal

To ensure healthy, productive and strong loan portfolio of the bank. Towards this:

Avoid over-financing or under-financing

Minimize interest risk and liquidity risk

Maintain a balance between liquidity and profitability.

Determine the required terms & conditions while lending.

Elements of Credit Appraisal

Risk is inherent in all credit appraisals. Analysis is to be done to assess whether it is a fair banking risk or not. In fact, the ultimate aim of all appraisals is to assess whether the loan proposal is fair banking risk or not. Sometimes, a proposal may be considered a fair banking risk only with certain stipulations or pre-conditions.

The Appraisal by a credit analyst usually, involves the Five Ps model. The first P is with regard to the acceptability of the person or the prospective borrower. This involves ascertaining whether his integrity and capacity are as per banks norms.

If the first P i.e. the person is found acceptable then only the appraiser should go on to the next step i.e. he should checkout on the technical feasibility and commercial viability of the project. This is second P discussed in detail

If the project is also found acceptable per say, then the appraiser can go on to the third P i.e. Payment (re-payment), to determine the liquidity and interest risk involved in the lending

If all the above Ps are found acceptable, the appraiser still needs to check out on the Protection offered i.e. the security aspect of lending. This is the fourth P .In other words, the appraiser examines whether the prospective borrower is offering adequate collateral security. Collateral security is the additional security offered to the banker. The assets purchased out of the bank finance constitute the primary security. Anything additional offered as a security is known as collateral security. This is examined for the reason that the assumptions made while checking out the first 3 P may not hold true in the changing scenario. Or the assessment on the first 3 P may turn to be incorrect, despite due to diligence.

In short as much as a banker basically, deals with funds borrowed from the public, he is a Trustee of the public economy. He needs something to fall back upon if things do not turnout as expected.

It is quite possible that a banker may decide not to finance even if all the four Ps discussed above are acceptable in the case of a particular proposal. This could be because of the fifth P i.e. the perspective. In other words, a proposal has to fit into the perspective i.e. the lending has to be in tune with the priorities and policies of the Government, the RBI (which controls the functioning of the banks) and the bank concerned. For instance the financing liquor related activities may be low priority or prohibition may be in force. Some activity, even if viable, may not be in the national interest. Of course, the perspective, or priorities, and policies, keep changing form time to time and the perspective at what material time is what matters.

The Five P Forces model of Credit Appraisal is as follows:

The different Ps dealt with in more detail here under:

Person:

Person

Integrity Capacity

Managerial Financial

Experience Expertise.

Integrity is the most important of all the factors in assessing the credit worthiness of the customer. Integrity refers to moral uprightness, honesty and soundness of the person.

Capacity has two parameters-managerial and financial. Financial capacity or the financial soundness of the person is the ability of the person to undertake a venture of the size proposed, i.e. the ability to bring in the capital towards his margin (i.e the contribution to the ventures). In fact, in the case of a new venture it should also cover the ability to absorb possible initial losses.

Under managerial capacity the experience an expertise of the person are assessed. Expertise is the qualification a person has in activity concerned. While expertise can also be hired, the promoter must have the basic business acumen.

Project

Project

Technical feasibility Economic ViabilityUnder Technical feasibility details pertaining to location lay-out equipment and various production factors are studied in detail to determine the possibility of realizing the proposed production schedules.

Economic Viability broadly refers to the possibility of carrying out the venture profitably. Cost of the project, assessment of the production factors, past tends, future projects ion of sale and profitability based on past trends or industry averages and the emerging demands & supply position (gap), break even analysis & Sensitivity analysis and debt service charge ratio (DSCR) statement etc helps us in assessing the techno economic viability of the project per se, which is an important component in the decision-making process. Payment (Re Payment)

There are 2 different aspects to be taken care of with regard to the payment. They are:

Time (Liquidity Risks)

Rate of interest (Interest-rate Risks)

Usually the credit risk rating (CRA), discussed in details in a subsequent chapter, goes up if the credit is for a short term. This is because it does not block the liquidity of the bank and there is less chance of interest rate risk or any other type of risk materializing. This is mainly reflected in the facility wise risk rating of the banks. The risk rating will improve or deteriorate depending upon the tenor of the facility. This is so because the banks cannot have a reliable future forecast for say more than 3yeras.

The normal maximum tenor for term loans is 8years in SBI as well as in some other banks. The banks may, however, grant loans for longer durations in some special cases like agriculture (plantations) housing finance or educational loans.

Protection

Protection

Primary Security Collateral Security

Collateral Security is the additional security obtained by banks form the borrowers as a cushion to fall back upon, in case of need i.e. in case the assumption goes wrong. Especially, when the primary security is insufficient to cover the entire loan with interest

The significance of collateral security is that it makes a good loan better but it cannot make a bad loan good. In other word a proposal has to be first viable by itself, without which a banker would never consider funding, even if 100% collateral security cover is available.

Perspectives/Policies

Even if all the above 4 parameters are satisfactory, a loan can not be sanctioned unless the following considerations are also taken care of:

It should not be against the law of the land.

It should not be against national interest

Compliance of environmental regulations

RBI Guidelines

Banks own loan policies

The banks loan policy may prescribe exposure restrictions like industry/sector exposure limits and the country exposure limit. These are monitored by the risk management Department (RMD) of the bank concerned on an on-going basis.

Besides, some activities may be considered as low priority by a particular bank at a particular point of time. For instance Commercial complex was considered low priority by ICICI BANK about a decade back, but not so any longer. Even personal loans (consumption Loans) which are a rage these days were not encouraged about a decade back.

A proposal thus has to satisfy all the above parameters to become eligible for bank finance.

Credit Appraisal Procedure in ICICI BANK

While sometimes the representatives of a company approach the bank to avail the required credit, at other times, the relationship managers of the bank who call on the potential customers and bring the loan proposals to the books of the bank. .In either cases the Credit Appraisal/sanction process broadly as follows:

1) The bank requests the company to provide certain information and data required to appraise the credit proposal. These are:

Annual report (Balance Sheet) of past three years.

CMA (Credit Monitoring Arrangement) data i.e. financials relating to two immediately preceding years and the projections for the future (current year and the next for looking working capital and up to the last year of repayment in the case of the term loan).

Business forecast (including financial projections as indicated above) with assumptions made

Management details

Other details relevant to the specific proposal on hand.

2) The team of the credit processing cell (CPC) of the bank carries out a pre sanction inspection of the site of the venture (existing or proposed)

3) The team holds discussions with the promoters/management team to crystallize the requirements of the company and facilitates /pricing to be sanctioned to meet such requirements. They also seek clarifications regarding the observation made by them while going through the proposal or during the pre sanction visit.

4) The relationship managers of the bank are, of course, also involved in the interactions with the company.

5) On obtaining of all data/information, the CPC team members carry out the appraisal with the help of a prescribed format of the bank, which naturally covers the Five Ps of appraisal indicated earlier

6) The Appraisal /proposal, in the prescribed format, is put up into the appropriate authority for sanction .on receipt of sanction the same is conveyed to the application company.

7) Flow chart. Flow Chart

No

Yes No

Yes

Methods of Assessment of Working Capital

1) Operating Cycle Method:

For units enjoying Working Capital Limits up to Rs2lacs.

2) Simple or Traditional Method:

For Working Capital limits greater than Rs2lacs & less than Rs25lacs

3) Turnover Method (Nayak Committee Method):

Up to Rs5 Crores for small scale industries (SSI) units. Now similar assessment for commercial units also

4) Projected Balance sheet (PBS) Method:

For non-SSI units: Rs25lacs & above

For SSI units: Rs5crs and above

5) Cash Budgeted Method:

For seasonal industries, concentration units, ad-hoc limits, sick units under rehabilitation, establishment of letters of credit.

6) Maximum Permissible bank finance (MPBF) Method: For non-banking financial companies (NBFC)

Various Methods of Assessing Working Capital

1) Operating Cycle Method: Operating cycle of a manufacturing unit is the process of converting cash into raw materials, goods in process and finished goods, and arranging for sale of the finished goods so that the cash is eventually realized. Operating cycle is the sum of the following components of time:

Time taken to acquire raw materials and average period for which they are in store.

Conversion process time.

Average Period for which finished goods are in store, and

Average collection period of the receivables

The quantum of working capital required by the unit from a bank deposit depends on the time taken to complete an operating cycle. Working capital required is equal to operating expenses divided by the number of operating cycles in a year. Under this method, the working capital required is a function of Operating expenses and length of operating cycle.

2) Simple or Traditional Method: Under this method, the average level of different current assets (raw materials, Stock-in process, finished goods, and receivables) required for completing one production cycle is reckoned as the total working capital required. The total working capital net of credit available in respect of raw materials supply is reckoned as the Working capital Gap(WCG). After stipulating a margin(borrowers own contribution) of 20-25% of the WCG, the balance is made available as bank finance(working capital limit)

3) Turnover Method: (Nayak Committee recommendations on credit to SSI sector)

The working capital assistance to all SSI units must be computed on the basis of a minimum 20% of the projected annual turnover (PAT). For new/existing units enjoying/ requiring aggregate fund-based working capital limits up to Rs5 Crores. The total working capital requirement, working capital loan and (borrowers) margin must be 25%, 20%, and 5% respectively of the PAT. The above norm is also used for commercial(C&I) and Small business finance (SBF) segment for appraising limits up to Rs25lacs. The projected annual turnover means gross sales inclusive of excise duty.

Projected Balance sheet (PBS) Method:

As the name suggests, the assessment is based on the analysis of the borrowers projected balance sheet, funds flow and critical parameters like profitability, liquidity, gearing etc. The quantification will be carried out in a flexible manner with proper examination of all relevant parameters and acceptability in each case. Unlike in the MPBF method which is done with projected balance sheet, the minimum margin stipulation is not insisted upon. The Working Capital finance assessed under this method is therefore known as Assessed bank Finance (ABF) instead of MPBF. MPBF method is now being used for financing only the NBFCs.

Cash Budgeted Method: Cash Budget is a projected cash flow statement showing the forecast of the cash receipts, cash disbursements and net cash balance over a period of time. No credit or transfer transactions are reported in cash budget. Cash Budget is a prepared, at short intervals, in advance to ensure efficient management of cash as cash is an idle asset.

The Cash Budget Method is in use for assessing working capital finance for seasonal industries (Sugar, tea etc) for construction activities and also for sanction of Ad-hoc working capital limits, i.e. temporarily additional limits during the run of a year Bankers also obtain Cash Budget while issuing usance Letter of Credit and in case of sick units under rehabilitation. The basic information required for preparing cash budget is:

Production & Sales Budget

Terms of Sale- Cash Sales and credit sales with their respective shares (%)

Period of credit allowed on sales and period of actual realization of sundry debtors (receivables)

Details of other definite receipts, if any

Period of credit available for purchases

Terms of payment for other expenses/payables

Opening cash balance

Opening cash credit balance

Assessment of Term loan

The following parameters are examined for appraisal/ assessment of term loan.

Purpose of the term loan:

Details about the purpose of the term loan. Whether it is for purchase of land, building or machinery or any other reason? Cost of Project:

It gives the components of cost included in the project viz,

Plant

Land &Building

Machinery

Generator set

Other equipment

Preliminary & Pre operative Expenses

Provision for contingencies

Working capital margin

Means of Finance:

It gives the detailed idea about different means of financing i.e.

Internal accruals

Unsecured loans

Term Loan required from bank

Project Implementation Schedule:

Project implementation schedule gives the idea about the expected schedule of

completion of the project up to commencement of commercial production.(in

case of new unit)

Production factors- Land, building, raw materials, labor power, water etc

Marketing Strategies

Commercial viability including Debt service coverage ratio(DSCR)

Break even analysis (refer to the decision making tools for the detailed description)

Sensitivity Analysis (refer to the decision making tools for the detailed description)

Security margin (refer to the decision making tools for the detailed description)Automobile finance generally involves the provision of retail consumer credit for an average maturity of three to five years to acquire specified new and used automobiles. Automobile loans are secured by a charge on the purchased automobile. ICICI Bank has a strong external distribution network and a strong in-house team to manage the distribution network which has been instrumental in achieving this leadership position. ICICI Bank also has strong relationships with automobile manufacturers and is a preferred financier with several automobile manufacturers in India. ICICI Bank also provides two wheeler loans. Personal loans are unsecured loans provided to customers who use these funds for various purposes such as higher education, medical expenses, social events and holidays. Recently ICICI Bank has experienced rapid growth in its portfolio of personal loans. Its portfolio of personal loans includes micro-banking loans, which are relatively small value loans to lower income customers in urban areas.

ICICI Bank has a credit card base of over 7.5 million cards. As the Indian economy develops, ICICI Bank expect that the retail market will seek short-term credit for personal uses, and its offering of credit cards will facilitate further extension of its retail credit business. ICICI Bank also earns fee incomes from card transactions as the issuing bank and as the acquiring bank where the transaction occurs on a point of sale terminal installed by us.

Project Financing:

A funding structure that relies on future cash flows form a specific development as the primary source of repayment with that development assets, rights and interests legally held as collateral security It already has similar tie ups with ICICI Bank,Punjab National Bank, IDBI, Oriental Bank of Commerce, Bank of Rajasthan and Karur Vysya Bank Union Bank of India, with its network, ethos and customer-centric approach plan, is attempting to address the fast-growing phenomenon of internet trading and seamlessly cater to the convenience and value-seeking, cash-rich and time-poor new-age consumers.

The integrated portal ICICI Bank paisabuilder.in will allow customers of the bank to seamlessly execute their transactions as per their needs and demands.

Any customer of Union Bank of India at any of its CBS branches can use this online trading platform from any place having an internet connection. When the customer indicates an intention to purchase any security, his account is earmarked with the amount. The amount is debited from his account only when the transaction is put through and his demat account is credited in due course.

Similarly when he desires to sell securities, lien is marked on the securities. When the transaction is concluded his demat account is debited and his account is credited in due course

This new alliance is in line with ICICI Capitals strategy of increasing its reach and penetration across the country.

This also facilitates the creation of new business opportunities and seamless customer centricity by leveraging the core competencies of both the organizations. Both organizations will work closely and leverage each others strengths to eventually ensure customer delight

Commenting on the tie up with ICICI Bank , Union Bank of India, said, This tie up takes Union Bank one step closer towards its vision of becoming a one stop shop for financial services offering technology based products for its customers

An advanced online trading portal, ICICI BANK paisa builder in is built with a core objective to provide easy and informed investing experience to investors.

This association will provide customers of the bank with a world class online investing platform with the backing of two very reputed and established financial institutions of the country.

This strong alliance will help us to expand our services to the consumers on a larger platform; ICICI Bank paisa builder in is targeted mainly at the retail investors.

The site will enable the investors to make an informed decision by minimizing risk involved in equity investment support the investor throughout the entire investment process including faster trade executions

ICICI Bank paisa builder in is a portal designed to empower the common investor with the information and analytical tools needed to take charge of their investing needs.

The portal enables online investing in Equities, Mutual Funds and IPOs.

ICICI Bank paisa builder in helps investors make the right investment decisions by providing them with pertinent news, information and analysis along with company specific fundamental analysis. Facilities of investing online in Equity (NSE & BSE), Mutual Funds (including SIP facility) and IPOs, portfolio tracker, choice of equity trading platforms and custom stock screener are some of the other unique features, apart from the comprehensive information and analytical tools that are showcased on ICICI Bank paisa builder in

The portal has been designed keeping a retail investor in mind for easier comprehension and very easy navigation within the site

ICICI Bank is a leading provider of financial services and is a 100% subsidiary of ICICI Bank. with the objective of catering to specific financial requirements of financial institutions, banks, mutual funds and corporate houses.

ICICI Bank is seeking to extend its reach to the growing small enterprises sector through segmented offerings. ICICI Bank provides supply chain financing, including financing of selected customers of its corporate clients. ICICI Bank also provide financing on a cluster-based approach that is financing of small enterprises that have a homogeneous profile such as apparel manufacturers, auto ancillaries, pharmaceuticals and gems & jewellery. ICICI Bank has launched smart business loans to meet the working capital needs of small businesses. ICICI Bank also provides short term loans to small businesses for a period of up to 36 months. The funding under this facility is unsecured and the loan amount varies from more than Rs. 0.2 million to Rs. 2.5 million per customer. ICICI Capital provides a complete range of financial products and services that includes Stock Broking for Institutional and Retail clients, DepositoryTypes of Project financing-

Project finance with recourse ---to sponsors

Non recourse ------------- recourse only to project cash flows and project assets

Limited cash flows----------- recourse to sponsors under certain defined circumstances

Types of Projects:

BOT: Build operate- Transfer: Private sector finances, constructs and operates the facility and transfers to govt. after the expiration of the contract period.

BOOT: Build own--operate- Transfer: Private sector finances, constructs, owns

and operates the facility and transfers the ownership upon expiration of the

contract period.

BOO: Build ownoperate: Private sector finances, constructs and operates the facility

Major Risks involved:

Technology risk

Promoter /management risk

Construction

Raw material/input supply risk

Marketing /off-take

Operation

Political

Legal

Environment

Force majeure risk

Interest rate risk

Inflation

Mechanism for control of cash

TRA mechanism

Lockbox Arrangement

Build up of various reserves such as maintenance reserves

Debt service reserve

CMA Data

As indicated earlier the bank calls for certain information and data for processing a loan request. The data referred to earlier is primarily what is known as CMA data. This is so known as it was developed by the RBI under its Credit monitoring Arrangement. The CMA data consists of the following:

Operating Statement (Profit & Loss)

Analysis of assets and Liabilities

Fund flow statement

Comparative Statement of current assets & current Liabilities

The data relating to the last two years and the next year is incorporated in the statement.

The Steps involved in the preparation of CMA:

Preparation of operating statement form the profit & Loss a/c and balance sheet of the firm for the past two years, the estimates for the current year and the projections for the next year.

Analysis of balance sheet i.e. re-arranging the balance sheet items (assets and liabilities) under the respective heads to enable analysis as per banks norms

Generation of fund flow Statement to analyze the movement of funds between 2 balance sheet items

Preparation of the comparative statement of current assets and current liabilities to delineate the trend which is necessary for projections

Current year estimates and future years projections are made based on the trends of net sale figure and the profitability ratios

The CMA helps in quantifying and analyzing the financial risk of the company.

Credit Risk Assessment (CRA)

Risk

No

Yes

Borrowers accounts are rated through the Credit Risk Assessment (CRA) process. The Credit Risk Assessment (CRA) system is an essential ingredient of the credit appraisal exercise.

CRA takes into account the various types of risks associated with borrower unit/ loan proposal .The CRA rating is a one point risk indictor of an individual credit exposure and is used to identify, measure and monitor the credit risks of individual proposals. At the corporate level, CRA is used to track the quality of Banks credit portfolio.

The CRA exercise quantifies the various types of risks involved in a loan proposal and assigns a Credit Risk rating CRA is rating. This rating is done with two major objectives in view

The project formulation process appears to have been deficient in some respects. For instance, the success of NHBs CFI refinance scheme1 3 (launched in January 1999) was limited by capacity constraints among CFIs and NGOs, and the high intermediation cost of HFI lending through these institutions. These issues were subsequently highlighted in the HF I PCR.1 4 The processing mission failed to address these issues in the project design; doing so might have

resulted in more rapid implementation and better achievement of outcomes of components involving CFIs and NGOs. Furthermore, the appraisal mission carried out a financial review of the Borrowers, but did not address the fact that the refinance operations of NHB lacked a system to track detailed end-borrower data (including income levels). This emerged as a major implementation bottleneck. In addition, an appropriate definition of what constitutes a LIH should have been determined at appraisal, and the income threshold adjusted appropriately for inflation

It is necessary to appraise and rate the credit exposure to determine whether it meets the risk criteria (i.e. the minimum risk rating, less than which the bank will not consider the request for sanctioning a loan.)

The second objective is to ensure a fair relationship b/w the risk and reward; that is to price the loan in accordance with the risk rating (CRA rating) that it receives.

The CRA Process:

The broad categories of Credit related risks that are assessed under the CRA process are:

Financial Risks

Industry risks

Management risks

These are individually measured, through a set of processes, to arrive at an integrated value of credit risk.

1. Financial Risks: An assessment of financial risks is done through an appraisal of the financial strengths of the company based on its performance and financial indicators relating to liquidity, profitability, gearing (borrowings to own funds) and turn-over ratios.

Positive and negative signals that emanate from or perceived form the movement of the indicators over the past/years future projections and from inter-firm comparison are also factored into such analysis.

The following financial ratios, derived from the balance sheet, are generally applied in the case of working capital advances:

Current ratio: As indicator of liquidity

Solvency ratio: Structural Strength

Interest coverage: capability of servicing interest

Profitability: Scope for profit generation form the business.

Return on capital employed (ROCE): efficiency in the use of capital

Inventory& receivables/sales (days): efficiency in the turnover of inventory and in collection of bills.

For long term loans the above ratios, with the following additions are used:

Project/Debt Equity: To assess risk in term exposures.

Average Gross debt service Coverage ratio (DSCR)

These two ratios reflect the companys repayment capability .Each ratio is given in a weight as per the banks norms and aggregated.

An analysis of one year financial may not be very reliable, the financials of the past 3-4 years are also studied to know the trends in the financials strengths of the company and used for vetting those projected.

2. Industry Risks: The basic strengths of the company get imparted by it market environment and the type of industry it is involved in:

The latter involves in factors like:

Competition & market demand fluctuations

Industry cyclicality

Government policy and regulations impacting that industry

Technology levels

Inputs profile, their availability and price

Products: User characteristics, alternatives/ substitutes

Each parameter is rated on a certain scale with designated weights and is reduced to mathematical score

3. Management Risks: The borrowers efficiency and the manner in which it management its functions are managed.

Parameters used to assess management risks include integrity, expertise, track record, and competence and capital market perceptions. Assessment of industry and management risks is to some extent, subjective as they cant be fully based on numeric. The proximity to company and initiative skills is important in such assignments.

Over-All Rating: The overall credit risk rating is a total of the above three major risk aggregates

Credit Risk and Pricing: One of the key parameters to pricing is the perception of the credit risk by lending banks. Banks link their rate of interest to the credit rate score, with the borrower with the highest score being levied the lowest rate and vice versa. The principle is Higher the risk, higher the price. Low Credit Risk Assessment (CRA) score indicates high risks.Salient Points of Credit Risk Assessment (CRA) System Credit Risk Assessment (CRA) is done for Small Scale Industries/AGL advantages with-fund based limits of Rs 25 lakhs and above and for all C& I advances

The Overall score for risk rating is to be rated on a 8-point scale

The ratings are ICICI/ICICI L1 (lowest risk) through ICICI 8/ICICI L8 (highest risk)

ICICI 4/ICICI L4 would be minimum rating required for financing, which is also referred to as the hurdle rate for new connections as well as enhancements in case of existing accounts

In case of take over of advances from other banks/financial institutions, the rating should fall under ICICI 3/ICICI L3.

A firm with risk rating below ICICI 5/ICICI L5 is not financed generally.

There is a minimum cut-off score under each of the parameters for the company to qualify for lending

Rating Agencies in India

In India, We have the following rated agencies:

CRISIL

ICRA

CARE

FITCH Earning Ltd.

All these agencies undertake to appraise the credit quality of various debt instruments like debentures, fixed deposits, and Commercial papers (CP). They do not rate the company but only a debt instrument issued by a company to raise money. The companys track record in meeting its commitment and its liability to service debts promptly both towards interests and repayment of principal is rated by these agencies.

The main objective of such exercise is to provide a guide to potential investors on the risk potential in a given debt instrument. The rating agencies examine all aspects of a company that have a bearing on its credit worthiness. The rating process of these agencies is explained in the appendix-II in details. Broadly, three major factors are scrutinized in depth. They are:

Business Parameters like industry profile, operating efficiency and market position of a company

Financial Position covering adequacy of cash flows, accounting quality and profitability

Managerial competence, reflected by corporate governance, board members, track record, philosophies, strategies

To improve the mortgage registration system, NHB and ICICI Bank formed a working group and submitted a draft report to the Government in 2006. The recommendations of the draft report included that (i) states reduce the stamp duty for equitable mortgages, (ii) the Government consider making registration of equitable mortgages compulsory, (iii) registration charges be reduced to facilitate and encourage registration; and (iv) state governments notify additional areas where equitable mortgage may be used. The project completion review mission

could not obtain information on the status of implementation of the draft report, however. With respect to Indias MBS market, it may be noted that after the pilot securitization by NHB, there have been several issuances by market participants. However, the MBS market has had limited success and the number of issues has decreased in recent years, due in part to legal and regulatory hurdles and a lack of long-term investors. In addition, MBS issues in India do not typically meet the true sale criteria under the Basle II norms.2 5 A study is being undertaken as

part of ADB TA (footnote 6) to NHB and HDFC that will include ecommendations for policy and regulatory development and establishment of an agency to enable issuance of true sale residential MBSs.

The rating by these agencies may also be factored into in the decision making of the lending bank but their ratings are no substitute for Credit Risk Assessment (CRA) rating of the bank.

Financial Ratio Analysis

1. Profitability Ratios:

a.) Return on Capital Employed = Profit before Depreciation, Interest & taxes(PBDITA)(ROCE) Net Assets

Return on Capital Employed (ROCE) is used as a measure of the returns that a company is realizing from its capital employed. The ratio can also be seen as representing the efficiency with which capital is being utilized to generate revenue. It is commonly used as a measure for comparing the performance between businesses and for assessing whether a business generates enough returns to pay for its cost of capital.

ROCE compares earnings with capital invested in the company. It is similar to Return on Assets, but takes into account sources of financing. In the denominator we have net assets or capital employed instead of total assets (which is the case of Return on Assets). In the numerator we have Pre-tax operating profit or EBDIT.

b.) Interest Coverage Ratio = Profit before Interest & Taxes (PBITA) Interest Expenses

Also known as the Times interest earned ratio, it indicates a firms long-term debt paying ability from the income statement view and tells us how many times the firm can cover or meet the interest payments associated with debt. High times interest earned ratio indicates the greater ability to pay.

A high and stable interest coverage ratio indicates the good performance of the company and indicates the company is able to refinance the principal when it comes due. In effect, the funds will probably never be required to pay off the principal if the company has a good record of covering the interest expense. A company with high interest coverage ratio can finance high amount of debt at a low rate of interest from the market.

2. Liquidity Ratios:

a) Current Ratio = Current Assets Current Liabilities

It measures the excess value of current assets over Current Liabilities. Higher current ratio indicates that higher the amount of current assets in relation to current liabilities and greater assurance to meet the current liabilities. For creditors the excess of current assets over current liabilities provide a buffer against losses that may be incurred in disposition or liquidation of the current assets other than cash.

So we can say that current ratio measures the merging of safety for the creditors. It measures the level of safety against uncertainty. The current ratio is considered to be more indicative of the short-term debt-paying ability than the working capital. Current ratio also depends on the operating cycle of the company. The longer the operating cycle, the higher the current ratio and vice versa.

b) Quick Ratio = Current Assets Inventory Current Liabilities

This ratio is considered to be more reliable indicator of a companys ability to meet its short-term financial obligations. This ratio deducts inventory from the assets before computing the ratio. The reasons for removing the inventory are that inventory may be slow-moving or possibly obsolete, and parts of the inventory that may have been pledged to specify creditors can sometimes be difficult to liquidate. Potential creditors like to use this ratio because it reveals a companys ability to pay-off under the worst possible conditions.

3. Solvency Ratios

a.) Debt Ratio = Total Outstanding Liabilities Tangible Net-Worth

It indicates the firms long-term debt paying ability and indicates the percentage of assets financed from debt fund. Debt Ratio is used to measure long term solvency of the company. Generally the creditors are the users of the ratio as it helps to determine how well they are protected in case of solvency. Creditors prefer low debt ratios because lower the ratio, the greater the cushion against creditors losses in the event of liquidation. If the debt ratio is higher it means creditors are not well protected and company may find difficulties in issue of additional debt.

b.) Debt/ Equity Ratio = Total Debt Total Equity

This ratio helps determine how well creditors are protected in case of solvency. Normally, the debt component includes all the liabilities including current. And the equity component consists of net-worth and preference capital. It includes only the preference shares not redeemable in one year. From the perspective of long-term debt-paying ability, the lower this ratio is, the better the companys debt position.

4. Debt-Service Coverage Ratios (for Long-term Loans)

a.) Net Debt-Service Coverage Ratio = PAT + Depreciation + Non-cash Expenditure Annual Term Loan Repayment Obligation

b.) Gross Debt-Service Coverage Ratio = PAT + Depreciation + Non-cash Expenditure+ Interest on Term Loan

Annual Term Loan Repayment Obligation + Interest on Term Loan

Debt-Service Coverage Ratio is mostly used by term-lending financial institutions to measure the interest payment ability of the firm.

Break-Even Analysis

Break-even analysis is a technique widely used by production management and management accountants. It is based on categorizing production costs between those which are "variable" (costs that change when the production output changes) and those that are "fixed" (costs not directly related to the volume of production).

The break even point for a product is the point where total revenue received equals total costs associated with the sale of the product (TR=TC). A break even point is typically calculated in order for businesses to determine if it would be profitable to sell a proposed product, as opposed to attempting to modify an existing product instead so it can be made lucrative. Break-Even Analysis can also be used to analyze the potential profitability of an expenditure in a sales-based business.

The Break-Even Chart

In its simplest form, the break-even chart is a graphical representation of costs at various levels of activity shown on the same chart as the variation of income (or sales, revenue) with the same variation in activity. The point at which neither profit nor loss is made is known as the "break-even point" and is represented on the chart below by the intersection of the two lines:

In the diagram above, the line OA represents the variation of income at varying levels of production activity ("output"). OB represents the total fixed costs in the business. As output increases, variable costs are incurred, meaning that total costs (fixed + variable) also increase. At low levels of output, Costs are greater than Income. At the point of intersection, P, costs are exactly equal to income, and hence neither profit nor loss is made.

Sensitivity Analysis:

Sensitivity analysis is the study of how the variation in the output of a model (numerical or otherwise) can be apportioned, qualitatively or quantitatively, to different sources of variation

Overview

A mathematical model is defined by a series of equations, input factors, parameters, and variables aimed to characterize the process being investigated. Input is subject to many sources of uncertainty including errors of measurement, absence of information and poor or partial understanding of the driving forces and mechanisms. This uncertainty imposes a limit on our confidence in the response or output of the model. Further, models may have to cope with the natural intrinsic variability of the system, such as the occurrence of stochastic events.

Good modeling practice requires that the modeler provides an evaluation of the confidence in the model, possibly assessing the uncertainties associated with the modeling process and with the outcome of the model itself. Uncertainty and Sensitivity Analysis offer valid tools for characterizing the uncertainty associated with a model.

Methodology

There are several possible procedures to perform uncertainty (UA) and sensitivity analysis (SA). The most common sensitivity analysis is sampling-based. A sampling-based sensitivity is one in which the model is executed repeatedly for combinations of values sampled from the distribution (assumed known) of the input factors. Other methods are based on the decomposition of the variance of the model output and are model independent.

In general, UA and SA are performed jointly by executing the model repeatedly for combination of factor values sampled with some probability distribution. The following steps can be listed:

Specify the target function and select the input of interest

Assign a distribution function to the selected factors

Generate a matrix of inputs with that distribution(s) through an appropriate design

Evaluate the model and compute the distribution of the target function

Select a method for assessing the influence or relative importance of each input factor on the target function.

Business Context

In a decision problem, the analyst may want to identify cost drivers as well as other quantities for which we need to acquire better knowledge in order to make an informed decision. On the other hand, some quantities have no influence on the predictions, so that we can save resources at no loss in accuracy by relaxing some of the conditions.

Sensitivity analysis can help in a variety of other circumstances which can be handled by the settings illustrated below:

To identify critical assumptions or compare alternative model structures

Guide future data collections

Detect important criteria

Optimize the tolerance of manufactured parts in terms of the uncertainty in the parameters

Optimize resources allocation

Model simplification or model lumping, etc.

Activity-Wise Cash-Flow Statements

Components of a Cash Flow

1) Cash flow from operating activities: It is the cash generated from the operations of a company, generally defined as revenues less all operating expenses, but calculated through a series of adjustments to net income. The OCF can be found on the statement of cash flows. It is also known as "cash flow provided by operations" and calculated as :

OCF= EBIT + Depreciation -Taxes

Operating cashflowis the cash that a company generates through running its business. It's arguably a better measure of a business's profits than earnings because a company can show positive net earnings (on the income statement) and still not be able to pay its debts. It can also be used as a check on the quality of a company's earnings. If a firm reports record earnings but negative cash, it may be using aggressive accounting techniques

2) Cash flow from financing activities: A category in the cash flow statement that accounts for external activities such as issuing cash dividends, adding or changing loans, or issuing and selling more stock. The formula for cash flow from financing activities is as follows:FCF = Cash Received from Issuing Stock or Debt - Cash Paid as Dividends and for Re-

Acquisition of Debt/Stock

This section of the statement of cash flows measures the flow of cash between a firm and its owners and creditors. Negative numbers can mean the company is servicing debt, but it can also mean the company is making dividend payments and stock repurchases, which investors might be glad to see

3) Cash flow from investing activities: An item on the cash flow statementthat reports the aggregate change in a company's cash position resulting from any gains (or losses) from investments in the financial markets and operating subsidiaries, and changes resulting fromamounts spent on investments in capital assets such as plant and equipment. When analyzing a company's cash flow statement, it is important to consider each of the various sectionswhich contribute to the overall change in cash position.In many cases, a firm may have negative overall cash flow for a given quarter, butif the companycan generate positive cash flow fromits business operations, the negative overall cash flow may be a result ofheavy investment expenditures, whichis not necessarily a bad thingWhat a Credit Analyst needs to ensure?

The following are the salient points that a credit analyst needs to ensure:

Depreciation

Sales

Interest Cost of Borrowing

Previous Years Expenses

Investments & advances in associates/Subsidiaries

Fixed assets

Frequency of change in accounting policies

Balance sheet manipulations

Off- Balance sheet items

Check Points that the banks need to be Careful of

All the information provided by the prospective customers may not be true. So, the addresses and other details furnished by the applicant needs to be verified.

The applicant may deposit false document of land and other properties in order to avail the credit facilities. There have been instances of the same property being mortgaged to more than one bank/Financial Institutions.

The position of any evasion of tax payment or other statutory dues (liabilities towards the government) by the applicant, as these will have priority over bank dues.

The stock which may be offered as security, may be moved out of the position may not be updated, which may effect the interest of the bank.

The Letter of credit (LC) may be drawn in favor of non-existing equity.

The company may obtain payment of bills directly through another bank.

Summary and Conclusion 1. Conclusion of the study

Conclusion

Credit risk is primarily financial risk in banking systems and exists in virtually all industries/ income-producing activities. How a bank selects and manages its credit risk is critical to its performance over time; indeed capital depletion through loan losses has been the proximate cause of most institutional failures. Identifying and rating credit risk is the essential first step in managing its effectively.

Examiners should ideally rate credit risk based more on borrowers expected performance, i.e. likelihood that the borrowers will be able to service its obligations in accordance with term. Payment performance is a future event; so examiners credit analysis should focus primarily on borrowers ability to meet its future debt service obligation.

Generally, a borrowers expected performance is based on borrowers financial strength as reflected by its historical & projected balance-sheet and Profit-loss statements, i.e. its performance and its future prospects in light of condition that may occur during the term of the loan. By doing so, the examiners shouldnt focus on Yes/No approval decisions but on the borrower rating and transaction risk characteristics that determines a loan value. The question dealt should be Whether this risk should be taken, if yes, how much risk at what price; rather than Is this good or bad loan

Now to ascertain the risk of investing in a particular borrower and pricing it appropriately it is not so easy but at the same time, it is of critical importance because low quality borrowers are more likely to default, their demand for credit is less sensitive to interest rates than high quality borrowers. Thus, borrowers willing to accept a high interest rate will tend to be of lower quality than average. Larger and more profitable firms are able to borrow on better terms on all the three dimensions of price, collateral and contractual maturity.

The banks have to strike the right balance between reward and risks. This can happen if the risk management systems are in place and are working effectively enough. Each bank may however, have its own risk appetite, irrespective of effectiveness of its risk management systems. Some banks may not maximize the returns as they allow lot of business to go past them because of their low risk appetite while other may not maximize because of too high a risk appetite.

Again, the credit risk rating/Credit Risk management systems should be constantly revised to factor in ever changing environmental threats and opportunities.

Appendix page No.

I. Appendix 169-72II. Appendix 2 73-78III. Appendix 379-83

IV. Appendix 4 84-100

V. Referrence

101

APPENDIX-I

What is Individual Credit Rating (ICR)?

Individual Credit Rating (ICR) is an objective assessment of the risk attached to a financial transaction with respect to an individual at a given point of time, based on the quantification of parameters influencing credit risk. There is need for credit ratings of individuals who not only borrow form banks, but also form various other creditors. Individual Credit Rating (ICR) is necessary in countries like the US and the UK. No loan is sanctioned to an individual without a certification form the rating agency.

Utility of Individual Credit Rating (ICR) The concept of Individual Credit Rating (ICR) is useful for personal transactions like credit card membership, leasing and hire purchases, housing finance, trade advances, consumer durables financing and personal bank loans.

The agencies which extend credit to individuals are banks, finance companies that have expertise in credit assessment. Hence, the rating by an agency may not be of great values unless it is found that it is more cost-effective. If the rating agency has large databases so as to provide instant service, then the service may become attractive to the lender.

ONICRAs Model

Onida Individual Credit Rating Agency (ONICRA), a subsidiary of Onida Finance was launched by Onida to give ratings to the individuals.

ONICRAs methodology is somewhat different. To begin with, an individual cannot approach ONICRA directly. It is the finance firm that will insist on its customer obtaining an individual credit rating to reduce its risk exposure. Thus, ONICRA sign tie-ups with several finance firms. Service charge will depend upon on the nature of assignment. Rating for the purpose of a credit card will be charged on a case-to-case basis, depending upon the nature of work involved. After obtaining and cross checking the information and documentary evidence furnished, the rating process begins. The information is fed into an automated credit rating model and the rating gener