Extending Credit to Businesses

and Individuals
(Managing Credit Risk)
 Loans Management
• The Loan Policy: Retail vs Corporate vs SME
• The Loan Process- Credit Appraisal
• Corporate and Retail
• Pricing of Loan
• Accounting of Loan
• Modelling Credit Risk (Estimating the Default Risk
Premium); market based and accounting based models
• Post Sanction Monitoring
• Hedging Credit Risk
• Non Performing Assets
• Corporate Distress
• Structured Financing
 Lending
• Lending: heart of the industry, loans are the
dominant assets, generate the largest share of
operating income, and represent the bank’s greatest
risk exposure.
• Loan officers are the most visible employees and a
bank’s loan policy has a dramatic impact on the
business community
• Lending is all about managing Risk (High return –
high risk)
• Risk of lending is managed, never eliminated
 The role of asymmetric information in
lending
• Asymmetric information: Inequality of information between the
lender and borrower. Given imperfect information is available to
lenders, the average interest rate can be too high for borrowers
with low-risk investment projects, and vice versa
• Adverse selection means that high-risk borrowers are willing to
pay the average rate of interest, which is less than what they
would have to pay if their true condition is known to bank and
low-risk borrowers are not willing to pay it. Thus, banks tend to
attract borrowers with higher than average riskiness, who don’t
have access to capital and money markets. It happens before
loans are made.
• Moral hazard occurs after a loan is made. The borrower has an
incentive to engage in higher risk activities (to earn higher
returns) at the expense of the bank.
 Trends
• Lending has become much more competitive
– Large corporations have other sources of funding
• Amount of Stressed loans on Banks has increased
alarmingly
• Evaluation of credit quality still very important for
small &medium-sized firms
• Loan growth and quality directly impacts the Capital
Requirement
• Is amount of consumer credit too large?
• Non-performing loans as a risk measure
• Need for better capturing Credit Risk in BASEL III
 Kind of loans
• Size & type of borrower:
– Retail
– Corporate
– SME
• RBI Classification:
– Priority
– Non Priority
• Secured/ Unsecured
• Food / Non-food
 Priority Sector Lending

BANK ADVANCES

NON-PRIORITY
PRIORITY SECTOR
SECTOR

AGRI SSI OTHER PRIORITY

Retail trade, SRTO
Direct Agri
Housing Loans
Indirect Agri
Educational Loan

Lending to SHG, MFI’s, etc

7
 PSL Targets as % of ANBC*
Domestic Foreign Banks
Banks
Total target 40% 32%
Agricultural Advances (Atleast 18% NIL
13.5% should be direct agri)
Educational Loan Upto Rs 10 lakh for India & upto Rs
20 lakh for overseas
Small Enterprises 10%
Export credit 12%
Housing Rs 20 lakh
Advances to weaker section 10%
DRI (Differential rate of int.) 1%

*Adjusted Net Bank Credit

 Issues in PSL
• What if the target is not achieved?
– Parking funds with NABARD/SIDBI
– New catch!
• Implications for defaulting Banks
• Are the targets practical?
• How to meet PSL target?
– Portfolio buyouts
– Innovative interpretations of RBI guidelines –e.g.
processing...
• Once sanctioned…. always a priority because it
never gets repaid..
Non achievement of PSL target
 Amount of shortfall to be invested in NABARD/SIDBI bonds
at very low rates. The rate of return on such bonds is as
follows –

Shortfall % Rate of return

Less than 2 % Bank Rate
Between 2 % & 5% Bank Rate – 1%
Between 5% & 9% Bank Rate – 2%
Above 9 % Bank Rate – 3%

 Current Bank rate is 6%

10
 The Credit Process
• Loan Policy
– Formalizes lending guidelines that employees follow
to conduct bank business
• Credit Philosophy
– Management’s philosophy that determines how much
risk the bank will take and in what form
• Credit Culture
– The fundamental principles that drive lending activity
and how management analyzes risk
 The Credit Process
• Credit Culture
– The fundamental principles that drive lending
activity and how management analyzes risk
• Values Driven
– Focus is on credit quality
• Current-Profit Driven
– Focus is on short-term earnings
• Market-Share Driven
– Focus is on having the highest market share
 The Credit Process
Business Development and Credit
Analysis
 Market research
 Advertising, public relations
 Officer call programs
 Obtain formal loan request
 Obtain financial statements,
borrowing resolution, credit
reports
 Financial statement and cash
flow analysis
 Evaluate collateral
 Line officer makes
recommendation on
accepting/rejecting loan
Credit Execution and
Administration
 Loan committee reviews
proposal/recommendation
 Accept/reject decision made, terms
negotiated
 Loan agreement prepared with
collateral documentation
 Borrower signs agreement, turns
over collateral, receives loan
proceeds
 Perfect security interest
 File materials in credit file
 Process loan payments, obtain
periodic financial statements, call
on borrower
Credit Review
 Review loan documentation
 Monitor compliance with loan
agreement:
Positive and negative loan
covenants
Delinquencies in loan
payments
Discuss nature of delinquency or
other problems with borrower
 Institute corrective action:
Modify credit terms
Obtain additional capital,
collateral, guarantees
Call loan
 What is loan policy?
• Document detailing
– Whom to lend
– How much to lend
– For what purpose
– Security
– Return
• Corporate: Policy is broad based; flexible, mostly industry
specific
• Retail: Narrow, focused, product specific, somewhat rigid
and detailed
 Loan Policy depends on:
• Risk appetite of the bank
• Objective of the bank
– It needn't always be making profits e.g. achieving
Priority Sector Targets, achieving portfolio
diversification, achieving market share
• The Loan policy is prepared after thorough
research into the industry practices (borrower,
competition); risk return trade off
 Why loan policy is critical?

• Acts as a major guidance

• Balancing divergent views is a tough task!

– Credit – should address all risk
– Operations – Convenient to book, monitor, track
– Collections – Should filter risky customers
– Compliance – Should not violate any law
– Sales – Should be attractive & better than competitor's

• End of the day...what's most important..

“NUMBERS”
 Loan Policy challenges

• The standard products are fairly evolved e.g. a Housing

Loan – no further innovation likely. You can get volumes
only if you offer something extra to the customers i.e.
better rates, more loan, higher eligibilities, etc... each will
have its own risks

• Cracks in the wall does not appear overnight...

 Case study
Too aggressive a loan policy
• A leading Bank (XBank) launched a product similar to Loan Against
Property (LAP) for Business (traders/ manufacturers)
• Product well accepted & scale up was extremely quick..
• XBank created a large portfolio (Rs 1000 cr within 1 yr)
• Almost NIL delinquencies in first 18 months
• Afterwards cracks beginning to appear.. renewals fallen due
• The cracks became wider and wider
• The delinquencies shot up and reached at 75% of portfolio
(compared with industry average of about 5%)

• XBank could not understand why the competitor's products are

doing well whereas similar product from it failed.
• Study undertaken to understand the product positioning
 Case study …cont’d
The reality shock
• XBank was most aggressive player offering CC facility in
this segment. Others were doing Term Loans
• XBank's lending was not based on repayment capacity
(they only checked interest servicing capabilities)
• XBank accepted mortgage of industrial properties; others
don’t
• XBank accepted third party properties; others seldom.
• XBank operated in semi urban/rural markets; others
were largely confined to urban markets
• XBank offered much higher limits (upto Rs.50.0 mn)
• XBank offered higher LTV than many players
• Insistence on 100% limit utilization
 Case study …cont’d
Product positioning–XBank vs
others
Parameter Small ticket Large XBank’s
LAP ticket LAP offering

Eligibility Based on Based on Suited for

surrogates financials lower end
Customer Done by Done by Suited for
sourcing agency the bank Lower end
Assessment Relaxed Strict Suited for
norms Lower end
Credit visits Not done Mandatory Suited for
Lower end
Amount Small Large Upper end
Credit Appraisal
 The Credit Process
• Four basic issues
– Evaluate a borrower’s ability and willingness to
repay
• What risks are inherent in the operations of the
business?
• What have managers done or failed to do in
mitigating those risks?
• How can a lender structure and control its own
risks in supplying funds?
– What is the exact requirement of funds
– What are the principal and secondary source of
repayment
– What is the price at which the bank should make
the loan
 Origination of Loans: Process

• Formal request from the borrower

• Exposure norms and other broad guidelines
• Credit appraisal and rating of the borrower
• Assessment of fund and non-fund based limits
• Pricing
• Loan delivery
• Monitoring of borrower
• Loan accounting and review
 How much money Banks make
in lending business
Loan amount Rs 100

Interest spread 2%
Total annual earning Rs 2
Loss if the loan goes bad Rs 100
No of fresh loans required for covering loss of 50
Rs 100
Thus one bad loan can wipe out the profits of 50 good
loans

Managing risk is a risky business

Need of a separate credit team!
• If a Bank deals in simple parameterized
products that can be understood by anyone
• If it has excellent & well documented policies
• There are other checks –……….
• Then why do we need credit:
– “It is impossible to make anything foolproof because
fools are so ingenious” (Murphy’s law)
– Same policy is being interpreted by different users
as per their convenience
– If everything seems to be going well, you have
obviously overlooked something……
 Financial appraisal –Imp. Ratios
• DSCR/ ISCR
• Current Ratio
• Debt: Equity Ratio
• Inventory/Debtor turnover
• The ratios is just an indicator. There should not
be large fluctuations.
• Ratios is just one of the tools. The final view is
taken based on 360 degree view of the client
 Content of appraisal note
• Exposure table & summary
• Business Group/Promoter background
• Industry Analysis
• Pricing
• Physical performance
• Financial performance
• Comments on financial performance
• Existing banking facilities and their terms
• Project details
• Projections
• Peer comparison
• Limit assessment
• Recommendations
• The document can be as long as 150 pages……..
Assessment of Fund Based (Cash Credit)
Facility ..
• Methods of computing fund Based working
capital
– MPBF (Maximum Permissible Bank Finance)
• Method I
• Method II
• Method III
– Cash Budget Process
– Turn Over Process
 Working capital computation:
MPBF method
Method I II III

A = Current Assets Rs. 300 Rs. 300 CCA –Rs.200

B = Current Liabilities Rs. 100 Rs. 100 Rs. 100

WCG (Working Capital Rs 200 Rs 200 Rs 100

Gap)=A-B
Min NWC 25%*WCG 25%*CA = Rs 25%*CCA =
=Rs 50 75 Rs 50
MPBF = “WCG – Min NWC” Rs 150 Rs 125 Rs 50

•Final MPBF will be as above or actual WCG whichever is lower

•Seasonality in business is ignored
Working capital computation: CMA* format

• The CMA consists of following excel

sheets:
– Existing Banking Limits Availed ( Form-I)
– Operating Statement ( Form-II)
– Analysis of the Balance Sheet ( Form-III)
– Comparative Statement of Current Assets &
Current Liabilities ( Form IV)
– Working Capital Assessment ( Form V)
– Funds Flow Statement( Form VI)
*Credit Monitoring Arrangement
 Working capital computation:
Cash Budget Methods
• Month on month budgeting
• Analysis of cash deficit and surplus
• We get the revenue account deficit and capital account
surplus for each month for next months to arrive at the
over all deficit or surplus of each month.
• Then with the balance out standing of the previous
month, we arrive at the cumulative deficit/surplus up to
that month.
• This would be the drawing power for that month
• Seasonality is taken care of
 Working capital computation:
Turn Over Method
• This method is applied for small business houses. The
assumption of this method is very simple.
• The working capital cycle is 3 months i.e. the sales are
rotated four times a year. The total working capital
requirement is 25 % of the projected sales.
• Out of this total requirement, at least 5% is to be
brought in from long term sources. So the remaining
20% would be minimum amount of fund based
working capital to be given to a company.
• This is mainly followed for fund based working capital
limit of up to Rs 200 lacs.
 Non financial appraisal

• CIBIL
• Dedupe check
– Existing database of defaulters, BIFR, RBI
database, terrorist list…..
• RCU - profile check & document sampling
• Trade references
• FI report
 Retail banking
• Caters largely to individuals, small businesses
• Parameterized products
• Meant for mass market; risk diversification
• Relatively small ticket size
• Mainly Housing Loans, Credit Cards, Personal Loans, auto
loans, CD loans, Small Business Loans

• Now some of the features of retail banking are also coming to

corporate banking
• Also includes liabilities products
 Retail banking in India
• In 1990s, NBFCs/HFCs dominated retail finance market; banks
focused on corporate credit
• RBI tightened regulations; NBFCs failed
• slump in industrial credit large NPAs in corporate banking –
Daewoo, Dabhol Power Corp..
• The credit-to-deposit (C/D) ratio sank all time low Banks’ surplus
funds in Gov securities
• Banks shifted to retail finance
• Low interest rates; rising income levels
• Easy credit fuelled demand for housing, auto, etc..
• Industry and Banking thrived on each other
• Retails loans grew at an average of 35%; housing even faster
Credit appraisal
Dimensions of Credit appraisal

Ability to Pay Creditworthy Intention to Pay

Customer
 Intention to Pay
Background Family, Education, Age etc.

Nativity Ration card, Revenue record

References Family & Trade

Subjective Personal interview & Field credit

Analysis investigation

Payment Track Bank statement, Regularity of

Record payments, Cheque bounces
Ability to pay

Business Assessment

Financial Assessment

Collateral Security
 The Credit Process
Intention to Pay
Ability to Pay
Sanction
Legal Opinion
Valuation Report

Documents
Pre-disbursement
Other Securities

Disbursement Setting up of Limits

Credit appraisal – Housing Loan
• Simplest/Safest of all retail loans
• Type of loans
– For purchase of a property
– For construction
– For repair/renovation
• Assessment
– Property
– Borrower
 Assessment - Property
• For purchase of property
(property owned by seller)
– Clear legal search; Free from all encumbrances
– Earlier sale deeds and flow of title
– Sale agreement
• Stamp duty issue?
– Free hold/NOC for leasehold
– Approved locality
– Valuation report

• For Construction
(property owned by borrower)
– Approved building plan
– Construction estimate
 Credit appraisal - Documents
• Borrower assessment
– Identity /Address proof/Photograph
– Income documents
• Salaried - Salary slip with form 16
• Self employed – Balance Sheet for 3 yrs
• ITR
• PAN card
• Bank Statement
– Repayment track record
– Networth statement and documents
– Income of spouse clubbed
– Guarantor’s identity and income documents
 Important terms & conditions
• Loan to Value (LTV)
– LTV as %age of “Registered Value”
– Varies between 75% to 100%
– LTV can also go upto 150%
• By bundling renovation loan
• LTV should not exceed 80% of “Market Value”
• Fixed Obligations to Income Ratio (FOIR)
– 40% to 60%
– Income – deductions from salary excluded
– Installment of all loans considered for FO
 Important terms & conditions…cont’d
• Tenor – max 25 years
• Amount – Rs.3 to 300 lakh
• Fee and cost
– Processing fee
– Administrative fee
• Cheque drawn on operative account
• Disbursement
– Lump-sum
– Construction linked
Other variants of housing loans
• Balance transfer
• Income surrogate products
– No salary slip, no ITR, no balance sheet
– Based on repayment track record
– Product for self employed individuals
– Relatively low LTV
• Land purchase loans - are less popular
and considered speculative
 Score cards
• Score cards not very popular in housing loan bcoz:
– Its quite secure product
– Fairly simple
– Low defaults

• Punjab National Bank uses a score card to check if the

guarantee is required or not. Parameter are:
– Educational qualifications
– No of years in service
– Stability at current residence
– Spouse’s income
– FOIR
– LTV
– Existing repayment track record available
 Case study- Housing loan
• Prakash is working with ABC Limited which is a well
known company. Income of Prakash during last three
year is as follows:

FY06 FY07 FY08

Fixed Salary 600000 720000 850000

Incentive 550000 365000 459000

Total Income 1150000 1085000 1309000

Case study- Housing loan…cont’d
Prakash owns some residential properties whose rental income
is as under:

FY06 FY07 FY08

Rental Income 60000 72000 84000

Prakash has also taken three loans from various banks & details
of the EMI's are as follows

Car Loan 8500

Personal Loan I 6700
Personal Loan II 7900
Total Loan 23100
Case study- Housing loan…cont’d
Varsha, wife of Prakash is engaged in garment business,
running a small boutique and her income for last three years
is as follows:

FY06 FY07 FY08

Net profit before tax 245000 288000 324000

Prakash is planning to purchase a property in DLF, Gurgoan

having valuation of approx Rs 54 lakh (inclusive of registration
expenses). Prakash has approached XBank for a loan of
Rs 50 Lacs.
Case study- Housing loan…cont’d
Eligibility calculation:
Net disposable income of Prakash:
Salary – latest 850000
Incentive - average of last 3 yrs 458000
Rental Income - latest 84000
Total Income 1392000
Less: Income tax liability 247600
Net Income 1144400
Calculation of net monthly income available for loan servicing
Monthly Income 95366
Less:EMI for other loans 23100
Net Income available for loan servicing 72266
Case study- Housing loan…cont’d
Net Disposable Income of Varsha
Average of business income 285666
Tax Liability 18566
Net Annual Income 267100
Net Income available for loan servicing 22258
Consolidated Monthly income of Prakash &
Varsha available for loan servicing 94525
As per XBank’s norms:

Maximum LTV (Loan to Value) ratio : 80%

Fixed Obligations to Income Ratio (FOIR) : 50%
(FOIR computed on net disposable income)

The loan is for 20 year (at 10% interest rate)

 Case study- Housing loan…cont’d
EMI per lakh for 20 years loan @ 10% rate of
interest= Rs 965
50% of the disposable income 47,263
Max loan can be on the basis of income (A) 49 Lakhs
Eligibility on the basis of value of the security
(B) 43 Lakhs
Loan eligible will be lower of A and B 43 Lakhs
 Field Investigation experience
• About 10 Commercial Vehicle loans in Lucknow
sanctioned with reference from one customer
• Non starter from first installment
• Deals sourced by most seasoned & credible sales
manager
• The house was found locked
• Neighbour’s told house was rented for last one month
• Borrowers vanished from Lucknow
 Field Investigation experience…cont’d
Modus Operandi
• Borrower took house on rent in posh Gomti Nagar of Lucknow
• Rent deal was done through an ad in classifieds. Owner was an
army officer posted in Arunachal Pradesh; rarely visited Lucknow
• Borrower represented that house is his own. Put a name place
outside the house. Started living there; created forged ITR,
Driving license, ration card on same address
• Went to Eicher dealer. Negotiated deals for 10 vehicles
• Total value of deal was Rs 60 lakh; the margin required was 15%
i.e. Rs 9 lakh
 Field Investigation experience…cont’d
Arranging Margin Money
• Borrowers had no margin money
• Approached a property dealer. Identified a house for purchase.
Actual value was Rs 10 lakh
• Approached Xbank. Applied for loan of Rs 20 lakh
• Colluded with empanelled valuer of Xbank; got property
overvalued at Rs 30 lakh
• Housing loan of Rs 20 lakh sanctioned/disbursed
• After paying for property, still had Rs 10 lakh
 Field Investigation experience…cont’d
Getting CV loans sanctioned
• Approached our best sales manager
• Applied for loan of 2 vehicles (max eligibility)
• For FI, the sales manager went to the house
• The house/borrower both were very impressive; also saw
contracts and balance sheet/docs
• Borrower needed 10 vehicles
• Sales Manager saw fantastic business opportunity
• Told him – take loan in names of 5 relatives
• He met all 5 borrowers at same house; He did not feel need to
visit them at their own houses
• Loans were disbursed
 Field Investigation experience…cont’d
Getting CV loans sanctioned
• All loans became non starter; borrower vanished
• Biggest blow in entire UP (one of biggest in Northern India); would
have sent wrong signals in market
• Crack team created; top management arrived in Lucknow; stationed
there for 10 days
• Checked FI reports (CPV-TRC) for all cases
• Again went & met all references; all found dummy
• Load tie up gave 1st clue; borrowers from Shahjanpur
• Met police commissioner; FIR filed
• The team started digging in Shahjanpur
• Borrowers realized that they will be caught
• Borrowers parked vehicles Meerut & informed us to take custody
• Recovered all vehicles in excellent condition
 Field Investigation experience…cont’d
Moral of the story
• Avoid shortcuts
• Stick to the processes; 99% frauds
happens due to non adherence to the
process
• FI/CPV-TRC is a critical process and if we
do that properly, such frauds can definitely
be avoided
 Issues in retail banking
• Fiercely competitive & saturated market
• Rate of interest and margin pressure
• Costs are going up
• Viability getting impacted
• Collections issues – harassment
• Experienced manpower
– Average experience of Pvt Sector bank employees in banking
is about two years
• Outsourcing - Integrity of channel
 Issues in retail banking - Outsourcing

• Major contributor for growth of retail banking and

Private Sector Banks
• The biggest operational risk in Banking
• Hardly any regulation though RBI has come up with
detailed guidelines
• Moving from one from Banks to other
• Banks not taking action against fraudsters
– FIRs never filed; no common database
• At places, the agents becomes more powerful than the
principal
– Rajaram Hegde
 And the biggest issue is……..
• Relaxation (compromise) in credit norms
– High LTVs
– Increased tenor
– Waiver of guarantee
– High FOIR
– Entering high risk locations – distance & customer profile
– Not checking the previous track record of client
– Shifting to sub prime customers
• All banks forced to relax credit norms due to
competition. Credit standard of entire industry
declines; is hurting everyone
 Interest rate –
Fixed & floating
 Floating interest rate
• Floating rate popular largely in housing.
Attempts for floating rate in auto/CV/FE
not encouraging
• Today about 85% of housing loans are on
floating rate
• Such portfolio face higher risk if interest
rates moves up
• Even fixed rates are not fixed
Post sanction monitoring
 Post sanction monitoring -
Retail
• Tractors/ Commercial Vehicles/Auto
– Post Disbursal Asset Verification (PDAV)
– Post Disbursement Documents (PDDs)
– Monthly Portfolio MIS/Collections MIS
• Housing Finance
– Site Visits/progress reports
• Advanced analytics
– Data Warehouse
 Post sanction monitoring -
Corporate
• Credit & Middle Office Group (CMOG)
– Documentation deficiencies –
• “Good Order Index”
– Asset inspections
• Regular Meetings with business groups
– Stock audits
• Seasonal businesses
– Account irregularities
– Early warning reports
• Credit summations trend
• Total transactions
• Round sum transactions
• Same day credit and debit
 Loan Pricing

• Loan pricing =
– Cost of Funds +
– Operating expenses +
– Risk Premium+
– Interest spread

– Cost of Funds (CoF) is not the actual cost. Some

buffer (transfer pricing) is added to the actual COF.
 Loan pricing depends upon
• Objective –
– ABN Amro launched housing loans at 6% (about 4 years
back)
– Priority Sector Lending done at even below “Cost of
Funds” …at 7%
• Tenor – 90 days roll over funds
• Short term loans linked with money market
• Foreign Exchange loans linked with LIBOR
• Detailed calculator will give the pricing
• Regulatory Capital Charge (impact 1-2%)
 Loan Pricing
• Markups:
Index rate (i.e., prime rate) plus a markup of one or more
percentage points.
Cost of funds (i.e., 90-day CD rate) plus a markup.
These methods are simple but may not properly account for loan
risk, cost of funds, and operating expenses.
• Loan pricing models:
Return on net funds employed:
– Marginal cost of capital (funds) + Profit goal = (Loan income - Loan
expense)/Net bank funds employed
– Here the required rate of return is marginal cost of capital (funds) +
Profit goal.
– The profit goal considers the risk of each loan to determine the
markup.
– Loan expense includes all direct and indirect costs of the loan but
not the bank’s interest cost of funds. Net bank funds employed is
the average amount of the loan over its life, less funds provided by
the borrower, net of Fed reserve requirements.
 Pricing Contd…
• Relationship pricing:
– Must consider all investment cash flows in the loan
pricing decision.
• Minimum spread:
– Compare the lending rate to the cost of funds plus a profit
margin.
• Average cost versus marginal cost:
– When market interest rates are changing, average cost could
clearly be incorrect.
– If a loan was match funded by issuing CDs, the marginal cost is
clearly more appropriate.
• Performance pricing:
– Change the loan rate if the firm’s riskiness changes.
• Monitoring and loan review:
– Compliance with loan agreement.
 Collateral
• Definition: Any asset pledged against the performance
of an obligation.
– Does not reduce the risk of the loan per se (which is tied to ability
of the borrower to repay a loan and other factors).
– Reduces bank risk but increases costs of lending and monitoring.
– Characteristics of good collateral:
• Durability is the ability of the asset to withstand wear. Durable
versus nondurable collateral.
• Identification due to physical uniqueness or serial numbers.
• Marketability of the property if resold.
• Stability of value over the period of the loan.
• Standardization by government or industry guidelines in
grading quality of assets.
 Collateral
• Types of collateral:
– Accounts receivable can be used by means of:
• Pledging wherein the firm retains ownership of the receivables and
no notification to the buyer of the goods.
• Factoring wherein the receivables are sold to a factor such as a bank
or finance company. The buyer now pays the factor for the goods.
Factors usually buy receivables on a nonrecourse basis (so they
cannot be returned to the seller by the bank).
• Bankers’ acceptance to finance foreign goods in transit, which is an
account receivable to the exporter. A time draft is created which
must be paid by the importer when goods are finally delivered. The
time draft becomes a negotiable instrument that can be traded in
securities markets after the importer’s bank accepts it.
– Inventory
– Marketable securities
– Real property and equipment
– Guarantees by third parties (e.g., a U.S. government agency)
 Restrictive Covenants

• Protect bank’s interest during term of loan

• Positive covenant examples
– Borrower will provide current financial statements
every quarter
– Borrower will have key person insurance payable to
bank
• Negative covenant examples
– Borrower will maintain certain minimum ratios for
liquidity and debt coverage
– No significant assets will be sold or debt acquired
without prior permission of the bank
 Primary Lending Rate (PLR)
• Reference rate;
• Private Sector Bank’s PLR – app. 16%
– ICICI Bank’s PLR – 16.5%
– ICICI Bank’s COF – 10.69%
• PSU Bank’s PLR – app. 13%
• Most of the loans are below PLR
• Sub PLR does not mean below COF
NPA management
 RBI Guidelines
• Title - Prudential norms for income recognition,
asset classification & provisioning
• NPA – which ceases to generate income for Banks
• Definition of NPA:
– Term Loan - interest/installment overdue > 90 days
– Overdraft/CC account - account remains ‘out of order’
• Renewal exceeding beyond 180 days
– Bills - overdue > 90 days
• Agricultural advances:
– interest/installment overdue for two crop seasons for short
duration crops,
– interest/installment - overdue for one crop season for long
duration crops.
 RBI Guidelines
• “Out of order”
– if outstanding balance remains continuously in
excess of the sanctioned limit/drawing power.
– Non servicing of interest evenif the
outstanding balance in the principal operating
account is less than the sanctioned
limit/drawing power
 Provisioning & income
reversal
• Provisioning: Depending on the security
available and aging of asset, provisioning
ranging from 10% to 100% is done.
• Income reversal: Income from NPA has to
be reversed from the P&L account of the
Bank
 NPA Management
• Standard tools
– Monitoring
– Regular follow up
– Mailers
– Telecalling/SMS
– Personal visits by collections
– Legal recourse – Section 138 of NI Act, etc..
Any fool can lend money.

“The clever part is getting

the borrower to pay you
back.”