Credit Risk Credit Risk Possibility of

Credit Risk

Credit Risk • Possibility of loss from the failure of loan or debt instrument repayments. • Change in the repayment capacity of borrowers or debt instruments that indicates possible failure by bank borrowers. • Banks represent credit risk through rating systems.

Rating Methods • Rating agencies. ü Agencies gather financial and qualitative information to access the possibility of the instrument not repaying the obligations in the future. ü Rating agencies assign codes to indicate the repayment status of firms / instruments that have applied for an evaluation with them. • Internal rating system. ü Banks establish their own procedures and methods to rate their customers.

Risk Rating • Rating grades - (AAA, A, BBB, B, B, C, D) • Qualitative grades - Good loans, Substandard loans, Default loans, Bad loans • Rating Scale - 1, 2, 3, 4, 5, 6 (Good ---- Bad)

Credit Life Cycle

Bank Credit Risk Origination • Business Loans and advances ü Short term ü Long term commitments • Consumer Loans ü Vehicle ü Jewellery ü Consumer durables / White goods • Micro Credit • Off-Balance Sheet Transactions

Loans and Advances • Loans are given through bank accounts from which the customer will not be able to withdraw. • Loan sanctions are mostly through the purpose for which they have been sanctioned. • Example, if the loan sanction is for purchase of machinery, the amount involved will be directly paid to the machinery supplier than the borrower of the bank.

Loans and Advances • Loan payments can also be made on a time basis where payments will be made in stages to the borrower for the purpose for which the loan has been sanctioned. • Loans sanctioned by the bank can be utilized by the customer on a withdrawal basis only if the customer opens an operational account for this purpose. • Advances that are sanctioned are at the disposal of the bank customer and can be withdrawn whenever the customer has a need. Withdrawal is permitted based on the terms of advance sanction.

Working Capital Finance • Working capital finance can be through the sanction of loans or advances. ü Demand loans ü Cash credit facility (advance) • Overdraft facility from banks ü Current accounts (advance) ü Loans against collateral security of fixed deposits, house documents, jewellery or shares.

Credit Worthiness • Influences the loan / bank commitment decision. • Determination of terms and prerequisites for loan decisions. • Type of credit / service to be granted to the customers. • Quantum of loan / service to be offered to the customers.

Credit Worthiness • ‘Bankable’ projects / proposals from the customer. ü Projected cash flows from the proposal. ü Projected investment from the proposal. ü Past data on the performance of the company. • On going performance of the project after the credit sanction by the banks.

Rating Guidelines by Reserve Bank India • Individual banks can use their own internal rating methods to determine credit worthiness of their borrowers. • Banks can define default on credit exposures when a scheduled payment obligation by a borrower is not met within 90 days from the due date.

Exposure Risk for Banks • Loss of value outstanding at the time of default by a borrower. • Loss on default is computed based on - Default percentage (D) - Exposure value for the bank (E) - Recovery rate (R) • Loss on default = D x E x (1 -R)

Credit Risk Evaluation Information Requirement by Banks • Account Number of Applicant • Date of Account Opening • Branch of Applicant Account • Whether Existing Borrowing Customer

Credit Risk Evaluation Information Requirement by Banks Details of Applicants • Name of the entity • Line of business • Registered office address • Name of the contact person • Address of factory / establishment • Address for correspondence • Office contact details • Date of incorporation • Date business commenced • Date of formation • Nature of product / service offered • Type of constitution of the business • Existing activity of the business entity • Proposed activity of the business entity • Name of parent company if any

Credit Risk Evaluation Information Requirement by Banks Purpose of Loan • Expected source of funds • Exposure of the borrowing entity with • Business owner other bank groups • Expected account turnover • Credit facility availed • Return on investment • Credit facility applied • Sale proceeds – Type of facility • Details of Director – Amount • Details of the Board – Purpose • Principal shareholders of the company and their address – Tenor – Primary security – Collateral security – Currency of security

Credit Risk Evaluation Information Requirement by Banks Details of Assets • Land Information on each type of Assets • Purpose of asset • Tools • Imported / Indigenous • Electrical • Supplier • Machinery • Total cost • Other assets • Promoter’s contribution • Loan required

Credit Risk Evaluation Information Requirement by Banks Business Information • Details of collateral • Details of customers of business • Currencies in which business is conducted • Number of employees Existing Credit Facility Details • Types of facility • Limits (value) • Outstanding as on the previous accounting date • Names of banks presently working with • Security lodged • Rate of interest • Repayment terms

Credit Risk Evaluation Information Requirement by Banks Past Performance (Two Future Estimate (Current years) year and next year) • Net Sales • Net profit • Capital (net worth) • Total debt • Imports • Exports

Additional Details Required • Purpose of request detailing various heads under which financial assistance is sought • Organization chart, affiliate information, subsidiaries, and ownership pattern • Copies of IT returns for the last three years • All bank account statement for the last 12 months • All loan account statement for the last 12 months with amortization schedule / sanction letter • Copy of latest sanction letter with existing banker/s • Value of stock / debtors and creditors for the last 6 months • Month wise sales / purchases for the past 12 months (break up showing exports / imports and domestic). • Sales / purchases to/from top 5 buyers / suppliers with contact details • Details of bad debts during the past three years

Additional Details Required • Latest net worth statement of the proprietor / partners / directors / guarantors certified by a Chartered Accountant • Projected financials for the business for the next 3 years. • Photocopy of the documents of property offered as collateral security (agreement for sale and related documents, share certificate, sanction plan, no-objection certificate (NOC) from concerned society) • Detailed project report (expenses, machinery to be purchased, project cost, method of finance, financial projections for the tenor of the term loan sought with necessary assumptions, break even analysis)