1. Credit Appraisal for Term Loan and Working Capital Financing
with special reference to Consortium Banking
SIP project report submitted in partial fulfillment of the requirements for the PGDM
Program
By
Saket Rathi
2010197
Under the Guidance of:
Mr. P.C.Bansal, Chief Manager – CD (O), PNB, New Delhi
Dr. Gajavelli V S / Prof Anant Ram, IMT - Nagpur
Institute of Management Technology, Nagpur
2010 – 2012

2. Acknowledgement
I express my sincere gratitude to Mr. P.C. Bansal, Chief Manager, CD (O), Punjab National Bank,
for guiding me through this project, sharing his knowledge and experience and correcting my
mistakes. Without his guidance and valuable insights, this project would not have seen the light of
day.
I also am very thankful to Mr Somshekharan Nair, Assistant General Manager, CD (O), Punjab
National Bank, for providing valuable insights on the Top – Bottom approach and Bottom – Top
approach of fund disbursement.
I would also like to express my sincere thanks to the library staff for extending their support and
resources for completion of this project.
A special thanks to my faculty guide, Prof. Dr. Gajavelli V.S. and Prof. Anant Ram who has been
the chief facilitator of this project and helped me enhance my knowledge in the field of banking
sector.
Regards
Saket Rathi
2010197
IMT - Nagpur
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3. Certificate of Completion
It is to certify that Mr. Saket Rathi (2010197) has successfully completed Summer Project Study
titled ―Credit Appraisal for Term Loan and Working Capital Financing with special
reference to Consortium Banking” under my guidance. It is his original work, and is fit for
evaluation in partial fulfillment for the requirement of the Two Year Post Graduate Diploma in
Management (Full-time).
P.C.Bansal
Chief Manager, CD (O)
Punjab National Bank
7, Bhikaji Cama Place, New Delhi.
Date: June 04, 2011
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4. 1 Table of Contents
1 Executive Summary ......................................................................................................................... 6
2 Abbreviations .................................................................................................................................. 8
3 Introduction .................................................................................................................................. 10
4 Objectives of the study ................................................................................................................. 11
5 About Banking industry................................................................................................................. 12
6 About Punjab National Bank ......................................................................................................... 13
6.1 Organizational Structure ....................................................................................................... 14
6.2 Delivery Channels in PNB: ..................................................................................................... 15
6.3 Working of the Credit Administration Department (CD) at PNB .......................................... 15
7 Bank Lending – An Overview ........................................................................................................ 16
8 Methodology................................................................................................................................. 20
9 Types of Lending ........................................................................................................................... 21
10 Term Loan ................................................................................................................................. 23
10.1 Features of Term Loan .......................................................................................................... 23
10.2 Term Loan Sanction Procedure ............................................................................................. 24
10.3 Pre-Sanction Inspection ........................................................................................................ 24
11 Working Capital......................................................................................................................... 26
11.1 Data required for assessment of working capital requirement ............................................ 27
11.1.1 Assessment of Fund Based Working Capital ................................................................. 28
11.1.2 Assessment of Non-Fund Based Working Capital Facility............................................. 30
12 Types of Financing..................................................................................................................... 39
13 Case Study: Term Loan - XYZ Energy Pvt. Ltd. ........................................................................... 41
13.1. POWER SECTOR SCENARIO IN INDIA: A PERSPECTIVE ...................................................... 41
13.1.1. Power Supply ................................................................................................................ 41
13.1.2. Peak Demand & Deficit Position ................................................................................... 41
13.2. FUTURE OUTLOOK ............................................................................................................ 44
13.3. POWER SCENARIO – REGION WISE ................................................................................... 50
13.4. POWER SCENARIO IN UTTARAKHAND .............................................................................. 54
13.5. POWER TRADING IN INDIA................................................................................................ 54
14 Conclusion and Recommendations........................................................................................... 94
15 Limitations of the study ............................................................................................................ 96
16 Scope for future improvements ................................................................................................ 97
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5. 17 Glossary ................................................................................................................................... 100
18 References .............................................................................................................................. 103
List of Figures
Figure 1: Operating Cycle ...................................................................................................................... 26
Figure 2: Issuing of Credit ..................................................................................................................... 31
Figure 3: Process of Negotiation ........................................................................................................... 32
Figure 4: Process of Settlement under L/C ........................................................................................... 32
Figure 6: Tier System of Approval of Loans at PNB............................................................................... 99
List of Tables
Table 1: Exposure norms for Commercial Banks in India ...................................................................... 19
Table 2: Operating Cycle ........................................................................................................................ 27
Table 3: Assessment of Limit of Letter of Credit .................................................................................... 33
Table 4: Assessment of Limit of Letter of Guarantee ............................................................................ 34
Table 5: The rating and score matrix ..................................................................................................... 37
Table 5-1: Region-wise power situation........................................................................................... 42
Table 5-2: Existing Installed Capacity (MW) as on 31st March, 2010 .......................................... 44
Table 5-3: Long-term Projected Energy Requirement ................................................................... 45
Table 5-4: Total Energy & Peak Load Availability Vs Installed Capacity ..................................... 47
Table 5-5: Projected Demand & Supply Position at the end of XI Five Year Plan ..................... 48
Table 5-6: Projected Demand & Supply Position at the end of XI Five Year Plan ..................... 48
Table 5-7: State-wise Demand-Supply Position for the Period 2009-10 ..................................... 52
Table 5-8: State-wise Demand Forecast for Northern India ......................................................... 52
Table 5-9: Likely capacity Addition During the XI Plan.................................................................. 53
Table 5-10: Demand-Supply Forecast for the Northern Region in 2011-12 ............................... 53
Table 5-11: Installed Capacity as on 31st March, 2010 ................................................................. 54
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6. 1 Executive Summary
Banks play a critical role in the economic development of an economy. They are important not
only for economic growth but also financial stability. In an economy banks has three major roles
to play i.e. first, they fulfill the financing needs of the corporate sector. Second, they cater to the
needs of the vast number of household savers, providing assured returns on their surplus funds
while maintaining liquidity and safeguarding them from financial risks. Third, they act as a
support for development of financial markets and its participants.
This project titled ―Credit Appraisal for Term Loan and Working Capital Financing with special
reference to Consortium Banking‖ studies the credit appraisal methodology at Punjab National
Bank for a proposal received either for term loan or working capital financing or both for Rs. 35
crore or more and where the borrower wants to avail the facility from a consortium of banks.
Credit appraisal is the process of evaluating a proposal‘s worthiness of being provided with the
type of credit facility the borrower has asked for. This includes the evaluation of current financial
status, appraisal of projected cash flows, fund flows, P&L and Balance sheets, purpose for which
the facility is availed, technical and financial feasibility of the project, credit history, managerial
competence and past experience, etc. in case for a term loan.
As part of the appraisal process, credit rating is done for the proposal and is conducted either by
the bank itself or is get done by approves external agencies.
The purpose of this project is to explain, in a brief and general way, the manner in which risks are
approached by financiers in a project finance transaction. Such risk minimization lies at the heart
of project finance. Efficient management of credit portfolio is of utmost importance as it has a
tremendous impact on the Banks‘ assets quality & profitability. The ongoing financial reforms
have no doubt provided unparallel opportunities to banks for growth, but have simultaneously
exposed them to various risks, which need to be effectively managed.
The concept of Credit Management is undergoing radical changes. Credit Risk in all exposures
calls for precise measuring and monitoring for taking considered credit decisions with suitable
risk mitigants, risk premium, etc. Credit portfolio should be well diversified in various promising
sectors with a cautious approach to be adopted in risky segments.
Also, lending continues to be a primary function in banking. In the liberalized Indian economy,
clientele have a wide choice. External Commercial Borrowings and the domestic capital markets
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7. compete with banks. In another dimension, retail lending- both personal advances and SME
advances- competes with corporate lending for funds and for human resources. But lending by
nature cannot be an aggressive selling activity, disregarding the risks involved. Bank has to be
competitive without compromising on the basic integrity of lending. The quality of the Bank‘s
credit portfolio has a direct and deep impact on the Bank‘s profitability.
The study has been conducted with the purpose of getting in-depth knowledge about the credit
appraisal and credit risk management procedure in the organization for the above said first two
purposes.
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8. 2 Abbreviations
AGM Assistant General Manager
BG Bank Guarantee
CC Cash Credit
CMD Chairman and Managing Director
CO Circle Office
CRMD Circle Risk Management Department
CCA Core Current Assets
CD Credit Administration Department
CARD Credit Audit Review Division
CASA Current Account/Savings Account
CRMC Credit Risk Management Committee
DSCR Debt Service Coverage Ratio
DER Debt-Equity Ratio
DTL Deferred Tax Liability
DPG Deferred Payment Guarantee
DTA Deferred Tax Liability
BD Discount of Bills
ED Executive Director
FACR Fixed Asset Coverage Ratio
FB Fund Based
GM General Manager
HO Head Office
IRMD Integrated Risk Management Division
LCB Large Corporate Branch
LC Letter of Credit
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9. LOC Letter of Credit
MC Management Committee
MPBF Maximum permissible Bank Finance
MCB Mid Corporate Branch
NWC Net Working Capital
NFB Non Fund Based
PMS Preventive Monitoring System
PF Provident Fund
PNB Punjab National Bank
RBI Reserve Bank of India
RMC Risk Management Committee
RMD Risk Management Division
TEV Techno-Economic Valuation
TL Term Loan
WC Working Capital
CO Circle Office
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10. 3 Introduction
Banks are an important cog in the wheel of economic development. One of their main functions is
to make available funds, to enterprises / persons which are short of funds, at reasonable cost. The
major source of income for banks is interest earned on loans and advances disbursed. To disburse
these loans and advances, funds are mobilized by bank through various sources like small savings
from numerous account holders, capital contribution etc. (stake holders) and credit creation.
Banks stand in a very delicate situation where it has to maximize returns on these funds but at the
same time maintain quality of their advances. A bank is approached by many for funds for various
uses and it may approach many for availing funds from it. The bank ascertains credit worthiness
of project and borrower in order to find eligible borrowers to whom it would like to disburse
funds.
To ascertain credit worthiness of project and borrower a comprehensive evaluation is done on
various parameters for example: past financials, techno – economic viability of the project,
management competence, future cash and fund flows, actual requirements, etc. This evaluation
process is known as credit appraisal. Credit appraisal is one of the steps through which banks
safeguard interest of its stake holders.
Funds are required for various purposes, at various intervals and thus there are different ways of
disbursing funds. The broad objective of credit appraisal is to ascertain the worthiness of the
borrower but various methodologies are used for appraising different methods of fund
disbursement.
The current project is divided in three parts. First part explains about the credit appraisal process
for term loan requirements for setting up a project. Second part deals with the credit requirements
arising after completion of the project (working capital requirements). The third part deals in
different banking arrangements under which a borrower can avail credit facilities and a
comparative analysis of the same is done.
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11. 4 Objectives of the study
The primary objective of this study is to ascertain in depth, the process used by PNB for appraisal
of Term Loan and / or of Working capital requirements of the borrowers and various criteria‘s on
which such appraisal is done before sanctioning of loans. The study intends to look into the
intricacies of term loan including risk mitigation for different inherent risks in extending working
capital advances to diversified industries.
The study involves understanding of usage of various projections and financial techniques for
term loan like fund flow / cash flow, profitability schedules, DSCR, sensitivity analysis, Break –
Even Analysis, rate of return on the basis of various calculation techniques, etc., in arriving at a
decision.
The study also looks into various ways of ascertaining Working Capital Requirements of a
borrower and various ways of disbursing it.
Another objective of this project is to study different arrangements under which a borrower can
avail funds from PNB and present a comparative analysis of the same.
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12. 5 About Banking industry
The roots of the modern banking industry can be traced from the fourteenth century in medieval
Europe. Banking in India originated in the last deCDes of the 18th century.
Banks act as payment agents by conducting checking or current accounts for customers, paying
cheques drawn by customers on the bank, and collecting cheques deposited to customers' current
accounts. Banks also enable customer payments via other payment methods such as telegraphic
transfer, EFT, POS, and automated teller machine (ATM).
Banks borrow money by accepting funds deposited on current accounts, by accepting term
deposits, and by issuing debt securities such as banknotes and bonds. Banks lend money by
making advances to customers on current accounts, by making installment loans, and by investing
in marketable debt securities and other forms of money lending.
A bank can generate revenue in a variety of different ways including interest, transaction fees and
financial advice. The main method is via charging interest on the capital it lends out to customers.
The bank profits from the differential between the level of interest it pays for deposits and other
sources of funds, and the level of interest it charges in its lending activities. Profitability from
lending activities has been cyclical and dependent on the needs and strengths of loan customers
and the stage of the economic cycle. Fees and financial advice constitute a more stable revenue
stream and banks have therefore placed more emphasis on these revenue lines to smooth their
financial performance. Banks have expanded the use of risk-based pricing from business lending
to consumer lending, which means charging higher interest rates to those customers that are
considered to be a higher credit risk and thus increased chance of default on loans. This helps to
offset the losses from bad loans, lowers the price of loans to those who have better credit histories,
and offers credit products to high risk customers who would otherwise be denied credit.
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13. 6 About Punjab National Bank
The idea of a swadeshi bank with Indian capital and Indian management representing all sections
of the Indian community gave birth to Punjab National Bank on May 23, 1894. It was formed with
an authorized capital of Rs 2 Lac and started its commercial operations with working capital of Rs
20 thousand on April 12, 1895 in Lahore, Punjab province, now in Pakistan.
The bank withstood turbulent economic times of 1913, when 78 other banks failed. Due to its
good governance it sailed through various economic crisis during 1926 to 1936 and partition of
India and Pakistan.
The registered office of the bank was transferred from Lahore to Delhi on June 20, 1947. During
partition The Bank was forced to close 92 offices in West Pakistan constituting 33 percent of the
total number and having 40% of the total deposits. The Bank, however, continued to maintain a
few caretaker branches.
The Bank then embarked on its task of rehabilitating the displaced account holders. The migrants
from Pakistan were repaid their deposits based upon whatever evidence they could produce. Such
gestures cemented their trusts in the bank and PNB became a symbol of Trust and a name you can
bank upon. It is ranked as one of India's top service brands. PNB has remained fully committed to
its guiding principles of sound and prudent banking. Apart from offering banking products, the
bank has also entered the credit card, debit card; bullion business; life and non-life insurance;
Gold coins & asset management business, etc.
Financial Performance (2010-2011)
Total business of the bank crossed Rs.5.55 lakh crore.Net Interest Income (NII) increased by
39.3% while Net Interest Margin (NIM) improved to 3.96%. Net Profit increased by 13.5% to
reach Rs.4433 crore. Operating Profit was Rs.9056 crore, 23.6% up from last year. PNB continues
to be among leading banks amongst nationalized banks in net profit, operating margins, total
business, deposits, advances, CASA deposits and customer base.
PNB has always looked at technology as a key facilitator to provide better customer service and
ensured that its ‗IT strategy‘ follows the ‗Business strategy‘ so as to arrive at ―Best Fit‖. The Bank
has made rapid strides in this direction. All branches of the Bank are under Core Banking Solution
(CBS) since Dec‘08, thus covering 100% of its business and providing ‗Anytime Anywhere‘
banking facility to all customers including customers of more than 3000 rural & semi urban
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14. branches. Towards developing a cost effective alternative channels of delivery, the Bank with
more than 3700 ATMs has the largest ATM network amongst Nationalized Banks. Bank
continues its selective foray in international markets with presence in 9 countries, with 2 branches
at Hongkong, 1 each at Kabul and Dubai; representative offices at Almaty, Dubai, Shanghai and
Oslo; a wholly owned subsidiary in UK; a joint venture with Everest Bank Ltd. Nepal and a JV
banking subsidiary ―DRUK PNB Bank Ltd.‖ in Bhutan. Bank is pursuing upgradation of its
representative offices in China & Norway and is in the process of setting up a representative
office in Sydney, Australia and taking controlling stake in JSC Dana Bank in Kazakhastan.
6.1 Organizational Structure
The bank has its corporate office at New Delhi and 58 circle office and 4267 branches. The
delegation of power is decentralized up to the branch level for quick decision making. The top-
down approach at PNB can be classified as follows:-
Board of
directors
CMD
ED
GM ( NPA GM GM
GM GM GM GM
(Credit)
& Weak (Retail & (Treasury
(IRMD) (Deposits) (Audit) .......
Account) lending) )
DGM DGM DGM ......
AGM AGM AGM ......
Funtional
Head
Figure 1 Organizational Structure at PNB
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15. Delivery Channels in PNB:
Corporate
Office (HO)
Circle Office Circle Office Circle office
(CO) (CO) (CO)
Large Mid Specialized
Branch
Corporate Corporate Retail Hub branches e.g.
Office (BO) Agriculture
Branches Branches
Figure 2 Delivery channels in PNB
6.2 Working of the Credit Division (CD) at PNB
CD looks after all proposals for all types of loans which fall within the purview of GMs-
HO/ED/CMD/MC/Board. A credit appraisal goes through different level of sanctioning to enforce
internal controls and other practices to ensure that exceptions to policies, procedures and limits are
reported in a timely manner to the appropriate level of management for action.
The bank has introduced ―committee‖ system in credit sanction process where in every loan
proposal falling within vested power is discussed in credit sanction committee. Such committees
have been formed both at head office and Zonal levels.
The CD is assisted by the Risk Management Department (RMD), Technical Department and the
Industry desk for risk analysis and technical feasibility of credit proposals.
Credit Risk Management structure at PNB involves:
 Risk Management division
 Zonal Risk Management department (ZRMD)
 Regional Risk Management Department (RRMD)
 Risk Management committee (RMC)
 Credit risk management committee (CRMC)
 Credit Audit Review Division (CARD)
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16. 7 Bank Lending – An Overview
Banks have different ways of extending credit to different types of borrowers for a wide variety of
purposes. Lending can be for long term or short term. Long term
Principles of Lending and Loan Policy
Principles of Lending
Banks lend from the funds mobilized as deposits from public. A bank acts in the capacity of a
custodian of these funds and is responsible for its safety, security but at the same time is also
required to deliver justified and assured returns over these borrowings. A bank looks into
following aspects before lending:
Safety: the first rule of lending is to ascertain the safety of the advances made. This means
assessment of the repaying capacity of the borrower and purpose of borrowing. It also includes
assessment of contingencies and a fallback plan for the same. This is ensured by taking adequate
security (readily marketable and free of encumbrances) by way of guarantee, collateral, charges
on property, etc.
Liquidity: The second rule of lending is to ascertain how and when the repayment of the
advances made would happen and that the repayment is timely. This is to ascertain availability of
funds in future and make sure that the funds are not locked up for a long period. This helps in
maintaining balance between deposits and advances and to meet depositor‘s obligation.
Profitability: The third rule of lending is to lend at higher rate of interest than borrowing rate.
This is called as interest spread / margin. One has to strike a balance between profitability and
safety of funds. Interest rates must be charged competitively but at the same time spread should be
adequate.
Risk diversion: An old saying says ―never put all your eggs in one basket‖. A lender must lend to
a diversified customer base. Diversification must be made in terms of geographical locations,
borrowers, industry, sector etc. It is done so as to mitigate adverse financial effects of a business
cycle, catastrophe, chain effect etc.
Loan Policy
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17. Banks are basically a lending institution. Its major chunk of revenue is earned from interest on
advances. Each bank has its own credit policy, based on the principles of lending, which outlines
lending guidelines and establishes operating procedures in all aspects of credit management. The
policy is drafted by the Credit Policy Committee and is approved by the bank‘s board of directors.
The credit policy sets standards for presentation of credit proposals, financial covenants, rating
standards and benchmarks, delegation of credit approving powers, prudential limits on large credit
exposures, asset concentrations, portfolio management, loan review mechanism, risk monitoring
and evaluation, pricing of loans, provisioning for bad debts, regulatory/ legal compliance etc. The
lending guidelines reflect the specific bank's lending strategy (both at the macro level and
individual borrower level) and have to be in conformity with RBI guidelines. The loan policy
typically lays down lending guidelines in the following areas:
Credit-deposit ratio: Banks are under an obligation to maintain certain statutory reserves like
cash reserve ratio (CRR – to be kept as cash or cash equivalents), statutory liquidity ratio (SLR –
to be kept in cash or cash equivalents and prescribed securities), etc. These reserves are
maintained for asset – liability management (ALM) and are calculated on the basis of demand and
time liabilities (DTL). Banks may further invest in non – prescribed securities for the matter of
risk diversion. Funds left after providing for these reserves are available for lending. The CPC
decides upon the quantum of credit that can be granted by the bank as a percentage of deposits.
Targeted portfolio mix: CPC has to strike balance between risk and return. It sets the guiding
principles in choosing preferred areas of lending and sectors to avoid. It also takes into account
government policies of lending to preferred / avoidable sectors. The bank assesses sectors for
future growth and profitability and accordingly decides its exposure limits.
Hurdle ratings: A borrower is assessed on various risk aspects to find out its suitability for
extending credit to it. Banks uses a comprehensive risk rating system on which each borrower gets
a score depending upon its strength and weaknesses. This acts as a single point reference and uses
a standardized approach for variety of borrowers. Ratings reveal the overall risk of lending. For
new borrowers, a bank usually lays down guidelines regarding minimum rating to be achieved by
the borrower to become eligible for the loan. This is also known as the 'hurdle rating' criterion to
be achieved by a new borrower.
Loan pricing: Risk-return trade-off is a fundamental aspect of risk management. Borrowers with
weak financial position and, hence, placed in higher risk category are provided credit facilities at a
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18. higher price (that is, at higher interest). The higher the credit risk of a borrower the higher would
be his cost of borrowing. To price credit risks, bank devises appropriate systems, which usually
allow flexibility for revising the price (risk premium) due to changes in rating. In other words, if
the risk rating of a borrower deteriorates, his cost of borrowing should rise and vice versa.
At the macro level, loan pricing for a bank is dependent upon a number of its cost factors such as
cost of raising resources, cost of administration and overheads, cost of reserve assets like CRR
and SLR, cost of maintaining capital, percentage of bad debt, etc. Loan pricing is also dependent
upon competition.
Collateral security: As part of a prudent lending policy, bank usually advances loans against
some security. The loan policy provides guidelines for this. In the case of term loans and working
capital assets, bank takes as 'primary security' the property or goods against which loans are
granted. In addition to this, banks often ask for additional security or 'collateral security' in the
form of both physical and financial assets to further bind the borrower. This reduces the risk for
the bank. Sometimes, loans are extended as 'clean loans' for which only personal guarantee of the
borrower is taken
Role of RBI
The credit policy of a bank should be conformant with RBI guidelines; some of the important
guidelines of the RBI relating to bank credit are discussed below.
Directed credit stipulations
The RBI lays down guidelines regarding minimum advances to be made for priority sector
advances, export credit finance, etc. These guidelines need to be kept in mind while formulating
credit policies for the Bank.
Capital adequacy
If a bank creates assets-loans or investment-they are required to be backed up by bank capital; the
amount of capital they have to be backed up by depends on the risk of individual assets that the
bank acquires. The riskier the asset, the larger would be the capital it has to be backed up by. This
is so, because bank capital provides a cushion against unexpected losses of banks and riskier
assets would require larger amounts of capital to act as cushion.
Credit Exposure Limits
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19. As a prudential measure aimed at better risk management and avoidance of concentration of credit
risks, the Reserve Bank has fixed limits on bank exposure to the capital market as well as to
individual and group borrowers with reference to a bank's capital. Limits on inter-bank exposures
have also been placed. Banks are further encouraged to place internal caps on their sectoral
exposures, their exposure to commercial real estate and to unsecured exposures.
Table 1: Exposure norms for Commercial Banks in India
Exposure to Limit
1. Single Borrower 15% of capital fund (Additional 5% on infrastructure
exposure)
2. Group Borrower 40% of capital fund (Additional 10% on infrastructure
exposure)
3. NBFC 10% of capital fund
4. NBFC – AFC 15% of capital fund
5. Indian Joint Venture/ Wholly owned 20% of capital fund
subsidiaries abroad/ Overseas step down
subsidiaries of Indian corporate
6. Capital Market Exposure
(a) Bank‘s holding of shares in any company The lesser of 30% of paid-up share capital of the
company or 30% of the paid-up capital of the banks
(b) Bank‘s aggregate exposure to capital market 40% of its net worth
(solo basis)
(c) Bank‘s aggregate exposure to capital market 40% of its consolidated net worth
(group basis)
(d) Bank‘s direct exposure to capital market (solo 20% of its net worth
basis)
(e) Bank‘s direct exposure to capital market (group 20% of its consolidated net worth
basis)
7. Gross holding of capital among banks/ FIs 10% of capital fund
Source: Financial Stability Report, RBI, March 2010
Review of Operations
RBI has a policy of reviewing operations of the bank. It conducts inspection every 3 years in
Branch Offices and every year at Head office of a Bank.
Credit control
RBI through its various mechanisms like policy rates, etc. controls the availability of credit in the
economy. It intervenes in the market by changing key policy rates when it finds that there is shortage /
excess credit availability.
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20. 8 Methodology
In order to learn and observe the practical applicability and feasibility of various theories and
concepts, the following sources are being used:
 Discussions with the project guide and staff members.
 Research papers and documents prepared by the bank and its related officials.
 Banks Credit policy and related circulars and guidelines issued by the bank.
 Study of proposals and manuals.
 Website of Punjab national bank and other net sources.
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21. 9 Types of Lending
Lending is broadly classified into two broad categories: fund based lending and non-fund based
lending.
 Fund Based Lending: This is a direct form of lending in which a loan with an actual cash
outflow is given to the borrower by the Bank. In most cases, such a loan is backed by primary
and/or collateral security. The loan can be to provide for financing capital goods and/or
working capital requirements.
 Non-fund Based Lending: In this type of facility, the Bank makes no funds outlay. However,
such arrangements may be converted to fund-based advances if the client fails to fulfill the
terms of his contract with the counterparty. Such facilities are known as contingent liabilities
of the bank. Facilities such as 'letters of credit' and 'guarantees' fall under the category of non-
fund based credit.
Let us explain with an example how guarantees work. A company takes a term loan from
Bank A and obtains a guarantee from Bank B for its loan from Bank A, for which he pays a
fee. By issuing a bank guarantee, the guarantor bank (Bank B) undertakes to repay Bank A, if
the company fails to meet its primary responsibility of repaying Bank A.
Banks carry out a detailed analysis of borrowers' working capital requirements. Credit limits are
established in accordance with the process approved by the board of directors. The limits on
working capital facilities are primarily secured by inventories and receivables (chargeable current
assets).
Working capital finance consists mainly of cash credit facilities, short term loan 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 sales inventories, receivables and cash deficits.
Up to this pre-established amount, disbursements are made based on the actual level of inventories
and receivables. Here the borrower is expected to buy inventory on payments and, thereafter, seek
reimbursement from the Bank. In reality, this may not happen. The facility is generally given for a
period of up to 12 months and is extended after a review of the credit limit. For clients facing
difficulties, the review may be made after a shorter period.
One problem faced by banks while extending cash credit facilities, is that customers can draw up
to a maximum level or the approved credit limit, but may decide not to. Because of this, liquidity
management becomes difficult for a bank in the case of cash credit facility. RBI has been trying to
mitigate this problem by encouraging the Indian corporate sector to avail of working capital
finance in two ways: a short-term loan component and a cash credit component. The loan
component would be fully drawn, while the cash credit component would vary depending upon
the borrower's requirements.
According to RBI guidelines, in the case of borrowers enjoying working capital credit limits of
Rs. 10 crores and above from the banking system, the loan component should normally be 80%
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22. and cash credit component 20 %. Banks, however, have the freedom to change the composition of
working capital finance by increasing the cash credit component beyond 20% or reducing it below
20 %, as the case may be, if they so desire.
Bill discounting facility involves the financing of short-term trade receivables through negotiable
instruments. These negotiable instruments can then be discounted with other banks, if required,
providing financing banks with liquidity.
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23. 10 Term Loan
Term loans also referred as term finance; represent a source of debt finance which is utilized for
establishing or expanding a manufacturing unit by the acquisition of fixed assets. These are
generally repayable in more than one year but less than 10 years. Such loans are raised for
expansion, diversification and modernization of the enterprise. The primary sources of such loans
are financial institutions. These are repayable in fixed monthly, quarterly or half yearly
installments and secured by term loan agreements between the borrower and the bank.
Term loans are generally granted to finance capital expenditure, i.e. acquisition of land, building
and plant & machinery, required for setting up a new industrial undertaking or expansion/
diversification of an existing one and also for acquisition of movable fixed assets. Term loans are
also given for modernization, renovation etc. to improve the product quality or increase the
productivity and profitability.
Term loans are normally granted for periods varying from 3-7 years and in exceptional cases
beyond 7 years. The exact period for which particular loan is sanctioned depends on the
circumstances of the case.
The basic difference between short term facilities and tem loans is that short term facilities are
granted to meet the gap in the working capital and are intended to be liquidated by realization of
assets, whereas term loans are given for acquisition of fixed assets and have to be liquidated from
the surplus cash generated out of earning. There are not intended to be paid out of the sale of the
fixed assets given as security for the loan. This makes it necessary to adopt a different approach in
examining the application of the borrowers for term credit.
10.1 Features of Term Loan
Following are the different features of term loans:
 Currency: Financial institutions give rupee term loans as well as foreign currency term loans.
 Security: All loans provided by financial institutions, along with interest, liquidated damages,
commitment charges, expenses etc. are secured by way of:
(a) First equitable mortgage of all immovable properties of the borrower, both present and
future; and
(b) Hypothecation of all movable properties of the borrower , both present and future,
subject to prior charges in favor of commercial banks for obtaining working capital
advance in the normal course of business
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24.  Interest payment and principal repayment: These are definite obligations which are
payable irrespective of the financial situation of the firm.
 Restrictive Covenants: FIs impose restrictive conditions on the borrowers depending upon
the nature of the project and financial situation of the borrower.
10.2 Term Loan Sanction Procedure
The procedure associated with a term loan sanction involves the following steps:
 Submission of loan application: The borrower submits an application form which seeks
comprehensive information about the project such as:
(a) Promoters‘ background
(b) Particulars of industrial concern
(c) Cost of project
(d) Means of financing
(e) Marketing and selling arrangements
(f) Economic considerations
 Initial processing of loan application: The loan application is reviewed to ascertain whether
it is complete for processing, if it is incomplete then it is sent back to the borrower for
resubmission with all relevant information.
 Appraisal of the proposed project: The detailed appraisal of the project covers the
marketing, technical, managerial, and economic aspects.
 Issue of letter of sanction: If the project is accepted, a financial letter of sanction is approved
to the borrower.
 Acceptance of terms and conditions by the borrowing unit: On receiving the letter of
sanction the borrowing unit convenes its board meeting at which the terms and conditions
associated with the letter of sanction are accepted and appropriate resolution is passed to the
effect.
 Execution of loan Agreement: After receiving the letter of acceptance from the borrowers.
The FI sends the draft of the agreement to the borrower to be executed by the authorized
person
 Creation of Security: The term loans and the DPG assistance provided by the financial
institutions are secured through the first mortgage, by way of deposit of title deeds, of
immovable properties and hypothecation of movable properties.
 Disbursement of loan: Periodically, the borrower is required to submit the information on
the physical progress of the projects, financial status of the projects, arrangements made for
financing the projects, contribution made by the promoters, projected fund flow statement,
compliance with various statutory requirements and fulfillment of disbursement conditions.
 Monitoring: Monitoring of the project is done at the implementation stage as well at the
operational stage.
10.3 Pre-Sanction Inspection
 Once the incumbent is satisfied with the information furnished by the borrower that the
proposal for the term loan is worth consideration, he should inspect the factory or place of
business to check the authenticity of the information supplied. Inspection can bring into
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25. light certain factors which are not revealed by mere study of financial statements. Even in
case of new unit, inspection of factory site is necessary.
 The assets of the concern which are proposed to be charged should be verified physically
and the title of the borrowers on the same should be examined.
 The books of the accounts and other relevant papers should be verified to see if all
liabilities, claims, contingencies, disputes have been admitted by the concern.
 Such an inspection can focus on the unfavorable aspects or weaknesses of the unit and can
help to a large extent in making an assessment of the proposal.
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26. 11 Working Capital
Working capital is defined as the total amount of funds required for day to day operation of a
unit. It can also be referred as the current asset holding of an enterprise. It is often classified as
gross working capital (GWC) and net working capital (NWC). Working capital finance is utilized
for operating purposes, resulting in creation of current assets (such as inventories and receivables).
This is in contrast to term loans which are utilized for establishing or expanding a manufacturing
unit by the acquisition of fixed assets.
Gross Working Capital refers to the fund required for financing total current assets of a business
unit. Net working capital no other hand is the difference between current assets and current
liabilities (including bank borrowings) that is nothing but the surplus of long term sources over
long term uses as such it is known as the liquid surplus available in a unit that can be either
positive or negative. A positive NWC is always desirable because of the fact that it provides not
only margin for the working capital requirement but also improves ability of the borrower to meet
its short term liabilities.
Operating Cycle Method
Every business unit has an operating cycle which indicates that a unit procures ‗raw material‘
from its funds, convert into ‗stock in process‘ which again is converted into ‗finished goods‘
which can be sold for cash and thus transformed into ‗fund‘. Alternatively it can be sold on credit
and on realization thereof gets converted into fund.
Thus every rupee invested in current assets at the beginning of the cycle comes back to the
promoter with the profit element added, after the lapse of a specific period of time. This length of
time is known as operating cycle or working capital cycle.
Figure 3: Operating Cycle
AR
converted Cash
to cash
Cash
Account Sales
Recievabl Order
e
Cash
Goods and Services converted
converted to Account Deliver Produce to Prepaid
Receivables Goods Goods Expenses
or or nd
Service Service
Inventory
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27. In order to keep the operating cycle going on, certain level of current assets are always required,
the total of which gives the amount of total working capital required. Thus total working capital
can be obtained by assessing the level of various components of current assets.
The operating cycle is therefore measured in terms of days of average inventory held for every
major category of working capital components.
Table 2: Operating Cycle
Stages Time Value
I Raw Material Holding Period Value of RM
consumed during the
period
II Stock in Process Time taken in RM + Manufacturing
converting RM into expenses during the
FG period (cost of
production)
III Finished Goods Holding period of FG RM + mfg. exp. +
before being sold adm. Overheads for
the period (cost of
sales)
IV Receivables Credit allowed to RM + mfg. exp .+
buyer adm. Exp. + profit for
the period (Sales)
11.1 Data required for assessment of working capital requirement
For assessing the working capital needs of an organization, bank follows CMA (Credit
Monitoring Arrangement). It is required by banks and other financial institutions, to introspect or
study the minutes of balance sheet and other financial statements of a body corporate for financing
their projects. In other words it is the detailed explanation of the balance sheet and other financial
ratios of the firm or any other corporate.
The CMA includes analysis of following six documents:
i) Existing and proposed banking arrangements
ii) Operating statement
iii) Analysis of Balance Sheet
iv) Buildup of current assets and current liabilities
v) Calculation of MPBF (Maximum Permissible Bank Finance)
vi) Fund Flow Statement
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28. 11.1.1 Assessment of Fund Based Working Capital
While public sector banks in India are nominally independent entities they are subject to intense
regulation by the Reserve Bank of India (RBI). This includes rules about how much the bank
should lend to individual borrowers—the so-called ―maximum permissible bank finance‖. There
are multiple methods as suggested by different committees from time to time. We have discussed
following recommendations by three committees:
1. Simplified Turnover Method (Nayak Committee)
This method of assessing working capital requirement of a firm is given by “Nayak Committee”.
The committee headed by Mr. P.R. Nayak examined the adequacy of institutional credit to SSI
sector and gave its recommendations which are as under:
a. Under this method, bank credit for working capital purposes for borrowers requiring
fund based limits up to Rs. 5 crore for SSI borrowers and Rs. 2 crore in case of other
borrowers, may be assessed at minimum of 25% of the projected annual turnover of
which should be provided by the borrower (i.e. minimum margin of 5% of the annual
turnover to be provided by the borrower) and balance 4/5th (i.e. 20% of the annual
turnover) can be extended by way of working capital finance.
b. The projected turnover or output value may be interpreted as projected gross sales
which will include excise duty also.
c. Since the bank finance is only intended to support the need based requirement of a
borrower, if the available NWC (net long term surplus funds) is more than 5%of the
turnover the former should be reckoned for assessing the extent of bank finance.
2. Maximum Permissible Banking Finance Method (Tandon Committee )
A committee headed by Mr. P.L. Tandon, ex-chairman of PNB, was constituted with view to
suggest improvement in the existing ash credit system. It submitted its report on guidelines for
follow up of credit in August 1974, suggesting three methods of lending. These are as follows:
 1st Method of Lending: 75% of the working capital gap (WCG = Total current assets –
Total current liabilities other than bank borrowings) is financed by the bank and the
balance 25% of the WCG considered as margin is to come out of long term source i.e.
owned funds and term borrowings. This will give rise to a minimum current ratio of
1.17:1. The difference of 0.17 (= 1.17 – 1) represents the borrower‘s margin which is
known as Net Working Capital (NWC).
 2nd Method of Lending: Bank will finance maximum up to 75% of total current assets
(TCA) and borrower has to provide a minimum of 25% of total current assets as the
margin out of long term sources. This will give a minimum current ratio of 1.33:1.
 3rd Method of Lending: This is same as 2nd method of lending, but excluding core current
assets from total assets and the core current assets are financed out of long term funds of
the company. The term ‗core current assets‘ refers to the absolute minimum level of
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29. investment in current assets, which is required at all times to carry out minimum level of
business activity. The current ratio is further improved to 1.79:1.
Examples:
Current Liabilities Current Assets
Creditors for purchase 100 Raw material 200
Other current liability 50 Stock in process 20
Bank Borrowings 200 Finished Goods 90
Receivables 50
Other current assets 10
350 370
1st Method 2nd Method 3rd Method
Total CA 370 Total CA 370 Total CA 370
Less Total CL - Less Core CA from long
Bank Borrowing 150 Less 25% of CA 92 term sources 95
WCG 220 278 275
25% of WCG from Less Total CL - Less 25% from long
long term sources 55 Bank Borrowings 150 term sources 69
Less Total CL - Bank
Borrowings 150
MPBF 165 MPBF 128 MPBF 56
Current Ratio 1.17:1 Current Ratio 1.33:1 Current Ratio 1.79:1
3. Chore Committee
The R.B.I constituted, in April 1979, a working group under the chairmanship of Sri K.B Chore,
to review the system of cash credit with the particular reference to the gap between sanctioned
limit and the extent of their utilization. It was also asked to suggest alternative type of credit
facilities which would ensure greater credit discipline and enable the banks to relate the credit
limits to increase in output or other productive activities.
The committee recommended assessment of working capital requirements have to be mandatorily
assessed based on 2nd method of lending suggested by Tandon Committee except for sick/Units
under rehabilitation.
As such, the banks are presently assessing need based WC financing under 2nd Method of lending.
4. CASH BUDGET SYSTEM
In case of tea, sugar, construction companies, film industries and service sector requirement of
finance may be at the peak during certain months while the sale proceeds may be realised
throughout the year to repay the outstanding in the account. Therefore, credit limits are fixed on
the basis of projected monthly cash budgets to be received before beginning of the season.
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30. Branches should follow the procedure/guidelines issued from time to time through various
Circulars for financing tea, sugar, construction companies, film industries and service sector.
11.1.2 Assessment of Non-Fund Based Working Capital Facility
The credit facilities given by the banks where actual bank funds are not involved are termed as
'non-fund based facilities'. These facilities are divided in three broad categories as under:
 Letters of credit
 Guarantees
 Co-acceptance of-bills/deferred payment guarantees.
Units for the above facilities are also simultaneously sanctioned by banks while sanctioning other
fund based credit limits.
Facilities for co-acceptance of bills/deferred payment guarantees are generally required for
acquiring plant and machinery and may, technically be taken as a substitute for term loan which
would require detailed appraisal of the borrower's needs and financial position in the same manner
as in case of any other term loan proposal.
 Letter of Credit: Letter of credit (LC) is a method of settlement of payment of a trade
transaction and is widely used to finance purchase of raw material, machinery etc. It contains
a written undertaking by the bank on behalf of the purchaser to the seller to make payment of
a stated amount on presentation of stipulated documents and fulfillment of all the terms and
conditions incorporated therein. Letters of credit thus offers both parties to a trade transaction
a degree of security. The seller can look forward to the issuing bank for payment instead of
relying on the ability and willingness of the buyer to pay.
Parties to a Letter of Credit
1. Applicant/Opener: It is generally the buyer of the goods who gets the letter of credit issued
by his banker in favour of the seller. The person on whose behalf and under whose
instructions the letter of credit is issued is known as applicant/ opener of the credit.
2. Opening bank/issuing bank: The bank issuing the letter of credit.
3. Beneficiary: The seller of goods in whose favour the letter of credit is issued.
4. Advising Bank: Notification regarding issuing of letter of credit may be directly sent to the
beneficiary by the opening bank. It is, however, customary to advise the letter of credit
through sane other bank operating at the place/country of seller. The bank which advises
the letter of credit to the beneficiary is known as advising bank.
5. Confirming Bank: A letter of credit substitutes the credit worthiness of the buyer with that
of the issuing bank. It may sometimes happen especially in import trade that the issuing
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31. bank itself is not widely known in the exporter's country and exporter is not prepared to
rely on the L/C opened by that bank. In such cases the opening bank may request other
bank usually in the country of exporter to add its confirmation which amounts to an
additional undertaking being given by that bank to the beneficiary. The bank adding its
confirmation is known as confirming bank. The confirming bank has the same liabilities
towards the beneficiary as that of opening bank.
6. Negotiating Bank: The bank that negotiates the documents drawn under letter of credit and
makes payment to beneficiary.
The function of advising bank, confirming bank and negotiating bank may be undertaken by a
single bank only.
Letter of Credit Mechanism
Any business/industrial venture will involve purchase transactions relating to machine/other
capital goods and raw material etc., and also sale transactions relating to its products. The
customer may be an applicant for a letter of credit for his purchases while be the beneficiary
under other letter of credit for his sale transaction.
The complete mechanism of a letter of credit may be divided in three parts as under:
1. Issuing of Credit: Letter of credit is always issued by the buyer's bank (issuing bank) at
the request and on behalf and in accordance with the instructions of the applicant. The
letter of credit may either be advised directly or through some other bank. The advising
bank is responsible for transmission of credit and verifying the authenticity of signature of
issuing bank and is under no commitment to pay the seller. The advising bank may also be
required to add confirmation and in that case will assume all the liabilities of issuing bank
in relation to the beneficiary as stated already. Refer to diagram given below for complete
process of issuance of credit.
Figure 4: Issuing of Credit
Buyer Seller Sales Contract
Applicant Beneficiary
(1)
(2) (4)
Buyer‘s Advising
Issuance of Letter of
Bank Bank
Credit
Issuing Confirming
(3)
Bank Bank
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32. 2. Negotiation of Documents by beneficiary: On receipt of letter of credit, the beneficiary
shall arrange to supply the goods as per the terms of L/C and draw necessary documents
as required under L/C. The documents will then be presented to the negotiating bank for
payment/acceptance as the case may be. The negotiating bank will make the payment to
the beneficiary and obtain reimbursement from the opening bank in terms of credit. The
entire process of negotiation is diagrammatically represented as under:
Buyer Supply of Goods (5) Seller
Applicant Beneficiary
Payment to Beneficiary (7) Documents for Negotiation (6)
Buyer‘s Documents (8) Advising/
Confirming
Bank Bank
Issuing Reimbursement (9) Negotiating
Bank Bank
Payment to
Beneficiary (7)
Figure 5: Process of Negotiation
3. Settlement of Bills Drawn under Letter of Credit by the opener: The last step involved in letter
of credit mechanism is retirement of documents received under L/C by the opener. On receipt of
documents drawn under L/C, the opening bank is required to closely examine the documents to
ensure compliance of the terms and conditions of credit and present the same to the opener for his
scrutiny. The opener should then make payment to the opening bank and take delivery of
documents so that delivery of goods can be obtained by him. This aspect of L/C transaction is
represented as under:
Figure 6: Process of Settlement under L/C
Buyer
Delivery of Goods (12)
Applicant
Payment (11) Documents (10)
Buyer‘s
Bank
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33. Issuing
Bank
Types of Letter of Credit: Letter of credit may be divided in two broad categories as under:
(i) Revocable letter of credit. This may be amended or cancelled without prior warning
or notification to the beneficiary. Such letter of credit will not offer any protection and
should not be accepted as beneficiary of credit.
(ii) Irrevocable letter of credit. This cannot be amended or cancelled without the
agreement of all parties thereto. This type of letter of credit is mainly in use and offers
complete protection to the seller against subsequent development against his interest.
Letter of credit may provide drawing of documents on following two bases:
(i) Delivery against payment (DP) – Sight: In this case documents are delivered against
payment. The beneficiary is paid as soon as the paying bank or borrower‘s bank has
determined that all necessary documents are in order.
(ii) Delivery against acceptance (DA) – Usance (time): In this case documents are
delivered against acceptance. The borrower pays after certain due date of payment
specified.
Assessment of Limit of Letter of Credit:
Table 3: Assessment of Limit of Letter of Credit
Assessment of Limit of Letter of Credit
Annual Raw Material Consumption A
Annual Raw Material Procurement through ILC/ FLC B
Monthly Consumption C
Usance D
Lead Time E
Total Time F=D+E
LC Time Required G=F*C
 Bank Guarantee
A contract of guarantee can be defined as a contract to perform the promise, or discharge the
liability of a third person in case of his default. The contract of guarantee has three principal
parties as under:
o Principal debtor: The person who has to perform or discharge the liability and for
whose default the guarantee is given.
o Principal creditor: The person to whom the guarantee for due fulfilment of contract by
principal debtor. Principal creditor is also sometimes referred to as beneficiary.
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34. o Guarantor or Surety: The person who gives the guarantee.
Bank provides guarantee facilities to its customers who may require these facilities for various
purposes. The guarantees may broadly be divided in two categories as under:
o Financial guarantees: Guarantees to discharge financial obligations to the customers.
o Performance guarantees: Guarantees for due performance of a contract by customers.
Table 4: Assessment of Limit of Letter of Guarantee
Assessment of Limit of Letter of Guarantee
Outstanding Bank Guarantee as per audited balance sheet A
Add bank guarantee required during the period B
Less estimated maturity or cancellation of bank guarantee C
during the period
Requirement of bank guarantee D=A+B-C
 Bills Co-Acceptance: It is same as letter of credit. The difference is that the letter of credit
is accepted by buyer as well by co-accepting bank.
 Deferred Payment Guarantee (DPG): A deferred payment guarantee is a contract under
which a bank promises to pay the supplier the price of machinery supplied by him on
deferred terms, in agreed installments with stipulated interest in the respective due dates,
in case of default in payment thereof by the buyer. As far as the buyer of the plant and
machinery is concerned, it serves the same purpose as term loan. The advantage to the
buyer is that he is benefited to the extent of savings in interest charges accruing on account
of opting equipment financing under installment payment system less the guarantee.
Risk Management
Risk management is the identification, assessment and prioritization of risks followed by
co-ordinate and economical application of resources to minimize, monitor and control the
probability or impact of unfortunate events.
The risk that a borrower might fail to meet its obligations towards the bank in accordance with the
agreed terms and conditions, is the credit risk contracted during sanctioning of loan. It is the risk
of default of on the part of borrower, which could be due to either inability or unwillingness to
repay his debts.
Factors determining credit risk:
 State of Economy
 Wide swing in commodity prices
 Trade restrictions
 Fluctuations in foreign exchange rates and interest rates
 Economic sanctions
 Government policies
Some company specific factors are:
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35.  Management Expertise
 Company Policies
 Labour Relations
The internal factors within the bank, influencing credit risk for a bank are:
 Deficiencies in loan policies/ administration
 Absence of prudential concentration limits
 Inadequate defined lending limits for loan officers or credit committees
 Deficiencies and appraisal of borrower‘s financial position
 Excessive dependence on collateral without ascertaining its quality/ reliability
 Absence of loan review mechanism
The risk management philosophy & policy of the Bank is an embodiment of the Bank‘s approach
to understand measure and manage risk and aims at ensuring sustained growth of healthy asset
portfolio. This would entail in reducing exposure in high risk areas, emphasizing more on the
promising industries, optimizing the return by striking a balance between the risk and the return
on assets and striving towards improving market share to maximize shareholders‘ value.
Following procedure is followed at PNB, HO for risk rating:
 The head office of the bank at Bhikaiji Cama place receives the proposals of various
organizations demanding loans.
 They receive a copy of the company‘s financial results. The branches also send their rating
after some initial screening to the head office for vetting.
 These branches obtain the data from the proposal and the discussions with other banks in
the consortium. They can also contact the company for further clarifications
 The auditor‘s report and notes to accounts serve as a useful guide. The past records of
company‘s transactions with the bank (if any) are also considered.
 The officials at the HO study and check the financials and the subjective parameters. Then
the final rating is done after making suitable amendments.
The credit risk rating tool has been developed with a view to provide a standard system for
assigning a credit risk rating to the borrowers of the bank according to their risk profile. This
rating tool is applicable to all large corporate borrower accounts availing total limits (fund based
and non-fund based) of more than Rs. 12 crore or having total sales/ income of more than Rs. 100
crore.
The Bank has robust credit risk framework and has already placed credit risk rating models on
central server based system ‗PNB TRAC‘, which provides a scientific method for assessing credit
risk rating of a client. Taking a step further during the year, the Bank has developed and placed
on central server score based rating models in respect of retail banking. These processes have
helped the Bank to achieve fast & accurate delivery of credit; bring uniformity in the system and
facilitate storage of data & analysis thereof. The analysis also involves analyzing the projections
for the future years.
This credit risk rating captures risk factors under four areas:
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36. 1. Financial evaluation (40%)
2. Business or industry evaluation (30%)
3. Management evaluation (20%)
4. Conduct of account (10%)
 Financial evaluation
Under this, various parameters are taken and based on the financial data scores are assigned
during the risk rating process.
The financial evaluation involves past financials classified based on industry comparison and
absolute comparison.
Following are some of the parameters, which have been explained in detail:
A. Liquidity Parameter
a. Current Ratio
b. Debt Service Coverage Ratio
B. Profitability Parameter
a. Return on Investment
C. Operating Efficiency Parameter
D. Other Parameters
a. Future risk expectations
b. Cash flow adequacy
c. Transparency in financial statements of the company
d. Quality of the inventory
e. Reliability of the debtors
f. Quality of investment / loans and advances to other companies
g. Trends in the financial performance over the past few years
 Business evaluation
It involves the evaluation of the operating efficiency of the concerned company under which
various factors are considered which is extremely important for risk rating purposes. These
could be raw material/ cost of production or it could be credit period availed and allowed. All
these factors help in judging the efficiency in operating the business.
 Market Position
Evaluating the market position for the purpose of risk rating is extremely important to judge
the competitive position of the company and analyzing the input related risk, product related
risk, price competitiveness and other market factors and then giving scores for the purpose of
calculating the aggregate market position.
 Management evaluation
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37. It is done by comparing the targets set with the targets achieved by the management during the
year. Subjective assessment is also done based on the factors risk like track record or sincerity
of the management.
 Conduct of Account Evaluation
This evaluation involves PMS rating. PMS is a macro level monitoring tool. In other words, it
is a close actions oriented follow up of the health of borrower. It aims to minimize the loan
losses by capturing early warning signals of deterioration and taking preventive action. It has a
memory of one year and reporting frequently is linked to credit rating.
How to rate
The ratios of the company are compared with the benchmark ratios and rating is given to the
company up to 2 decimal points based on its position within the benchmark values.
Procedure for evaluation at PNB is as follows:
1. Each industry has its own risk and depending on it, a suitable risk factor is chosen and
industry risk is adjusted into the score of rating.
2. These areas cover different parameters based on which the past and the future performance
of the company are evaluated.
3. The combined scores of these areas are calculated.
4. Then based on the weight age assigned (given in brackets above) the overall score is
calculated.
5. This overall score is used to determine the ratings as illustrated in following table:
Table 5: The rating and score matrix
Rating Category Description Score obtained Grade
AAA Minimum risk Above 80.00 AAA
Between 77.50 - 80.00 AA+
AA Marginal risk Between 72.50 – 77.50 AA
Between 70.00 – 72.50 AA-
Between 67.50 – 70.00 A+
A Modest risk Between 62.50 – 67.50 A
Between 60.00 – 62.50 A-
Between 57.50 – 60.00 BB+
BB Average risk Between 52.50 – 57.50 BB
Between 50.00 – 52.50 BB-
Between 47.50 – 50.00 B+
Marginally
B Between 42.50 – 47.50 B
acceptable risk
Between 40.00 – 42.50 B-
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38. C High risk Between 30.00 – 40.00 C
D Caution risk Below 30.00 D
Based on the above table rating is done. Once the rating is done, the rate of interest at which the
bank will be lending the money is determined. Normally, a company with higher rating is given
loan at a lower interest as compared to company with lower ratings. This is because the risk
involved with higher rated company is lower.
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39. 12 Types of Financing
Consortium Financing
Where the entire credit needs of the borrower is financed by a group of banks by forming a
consortium. It promotes collective application of banking resources.
Merits: To bank:
1. A single bank carries a disproportionate credit risk when it finances single handedly a
huge sum to a large borrower. Consortium financing helps to spread this risk among a
number of banks who are members of the consortium.
2. Consortium financing leads to a better credit appraisal in as much as the expertise of all
the member banks can be contributed for appraising the proposal.
3. Smaller banks which cannot alone finance huge limits to the large borrowers can still join
in financing by becoming the member of consortium. Financing large borrowers being a
profitable proposition helps in increasing their profitability.
4. It stops unhealthy practices of snatching good large borrowal accounts by one bank from
other by offering unwanted counter offers with respect to interest and service charges.
5. All banks lend on same terms and conditions regarding the security, rate on interest,
margin, etc. i.ee no one has superior rights or more favorable propositions.
To borrower:
1. A borrower availing credit from a consortium does not suffer from scarcity of credit due to
credit squeeze of its sole banker.
2. Internal competition among the participating banks to have larger share in the consortia
enables a borrower having good fundamentals to enjoy lower interest and service charges
3. Borrower enjoys same interest and service charges from all the banks normally set at a
level below prevailing rates.
Demerits: To Bank
1. Bank is under an obligation to share information with other lending institutions.
2. Bank does not have superior rights in case of a default.
3. Bank has to fall in line w.r.t. terms and conditions set out by the lead bank although
adequate propositions are made for its reservations.
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40. 4. Bank cannot move out of consortia within first 2 years without approval of other members
of the consortia and existing/new member is willing to take its share.
5. In case of a dispute Lead Bank or the bank having 2nd highest share in the consortium will
be the final authorities in cases of differences of opinion and their views will prevail in all
cases of disputes among the members relating to terms and conditions.
To Borrower
1. Borrower cannot negotiate terms and conditions with individual banks depending upon the
size of business it is providing to them.
2. All members of the consortium have superior rights than other lenders which affects it
borrowing capacity in the open market.
Multiple Banking
Where the credit requirements of a borrower are met by more than one bank and each bank lends
independently on its own terms and conditions, regarding the security, rate of interest, margin etc.,
this system of financing is called Multiple Banking Arrangements.
Advantages: To bank:
1. Bank lends under its own terms and conditions regarding the security, rate of interest,
margin, etc. and may ask for superior rights.
2. The bank is independent of other lending institution.
3. The bank is under no obligation to share proprietary data with other lending institution.
To Borrower
1. Borrower can decide the level of business it wants to give to a particular bank depending
upon the services provided.
2. Borrower has the possibility of getting surplus credit facility from the banks collectively.
3. Borrower can negotiate for terms and condition.
Demerits: To Bank
1. There is a possibility of over financing to the borrower.
2. More vigilant and robust monitoring mechanism has to be in place to have better control
over excessive financing cases.
3. Bank is unknown to the conduct of the borrower with other lending banks and thus not in
the position to take preventive steps.
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41. 13 Case Study: Term Loan - XYZ Energy Pvt. Ltd.
13.1. POWER SECTOR SCENARIO IN INDIA: A PERSPECTIVE
13.1.1. Power Supply
Despite significant growth in electricity generation over the years, the shortage of power
continues to exist primarily on account of growth in demand for power outstripping the
capacity additions in generation. The problem is further exacerbated during peak hours
leading to heavy load shedding by utilities. The power supply position is characterized by
acute shortages both in terms of the demand met during peak time and overall energy
supply.
13.1.2. Peak Demand & Deficit Position
The historic demand-supply scenario for Peak Capacity in India is as follows:
Graph 13-1: Peak Supply & Deficit Position as of March 31, 2010
140000
(15747)
120000 (18073) (13124)
(13897)
100000 (11463)
(9508) (10254)
(9252) (9945)
80000
MW
60000
40000
20000
0
9TH PLAN 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10
END
Peak Supply Peak Deficit
(Source: CEA)
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42. 13.1.3. Total Energy Requirement & Deficit Position
The historic total Energy requirement and the growing deficit therein is as follows:
Graph 13-2: Total Energy Availability & Deficit Position as of March 31, 2010
900000 (83807)
(85303)
800000 (73338)
(66092)
700000 (52938)
(43258)
600000 (48093) (39866)
(39187)
500000
(MU)
400000
300000
200000
100000
0
9TH PLAN 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10
END
Energy Availability Energy Deficit
(Source: CEA)
The energy shortage has increased from 7.5 % in 2001-02 to 10.1 % during 2009-10;
the peaking shortage has grown from 11.8 % in 2001-02 to 13.3 % in 2009-10 mainly
due to increase in industrial and commercial demand and shortage of coal and natural
gas for power generation.
13.1.4. Region wise Peak Demand and Energy Requirement & Shortages
The region wise power situation for the five regions in India is given below:
Table 13-1: Region-wise power situation
Peak Energy
Gap Shortage Shortage
Demand Requirement Gap (MU)
(MW) (%) (%)
(MW) (MU)
Northern 37159 -5720 -15.4% 253803 -29356 -11.6%
Western 39609 -7023 -17.7% 258551 -35398 -13.7%
Southern 32082 -3029 -9.4% 220557 -14032 -6.4%
Eastern 13963 -1078 -7.7% 88040 -3986 -4.5%
N Eastern 1760 -315 -17.9% 9349 -1034 -11.1%
(Source: CEA)
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43. Major shortage in terms of energy and peak power is observed in Western Region and
Nothern Regions.
13.1.5. Installed Capacity
The Indian power sector has grown significantly since 1947 and the power generating
capacity has increased from 1,362 MW in 1947 to about 1,56,000 MW as on March 31,
2010.
13.1.6. Region wise installed capacity (MW)
Existing region wise installed capacity (MW) as on 31st March, 2010 is depicted below:
Graph 13-3: Existing Installed Capacity (MW) as on March 31, 2010: Region-wise
2288.90 MW 75.27 MW
21319.46 MW 42189.33 MW
Northern
Western
Southern
Eastern
N.Eastern
43300.50 MW Islands
50225.03 MW
Source: CEA
The Western, Southern and Northern regions have the major concentration of the
electrical loads and hence the highest generating capacities.
13.1.7. Fuel wise installed capacity (MW)
The fuel wise installed capacity (MW) as on 31st March, 2010 is depicted below:
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44. Graph 13-4: Existing Installed Capacity (MW) as on 31st March, 2010: Fuel-wise
Hydro Nuclear R.E.S. Gas Diesel Coal
R.E.S., 10%
Nuclear, 3%
Coal, 53%
Thermal, 64%
Diesel, 1% Gas, 10%
Hydro, 23%
Coal based thermal power still continues to be the backbone of the power supply in
India. GoI is contemplating to increase capacity addition in gas, hydro, nuclear power
and other Renewable energy sources by 2030 so as to reduce carbon emission and to
reduce dependability on coal as the reserve would be depleting.
13.1.8. Region wise and Fuel wise installed capacity (MW)
The region wise and fuel wise installed capacity is given below:
Table 13-2: Existing Installed Capacity (MW) as on 31st March, 2010
Thermal
Region Nuclear Hydro R.E.S. Total
Coal Gas DSL Total
Northern 21275.00 3563.26 12.99 24851.25 1620.00 13310.75 2407.33 42189.33
Western 28145.50 8143.81 17.48 36306.79 1840.00 7447.50 4630.74 50225.03
Southern 17822.50 4392.78 939.32 23154.60 1100.00 11107.03 7938.87 43300.50
Eastern 16895.38 190.00 17.20 17102.58 0.00 3882.12 334.76 21319.46
N.East 60.00 766.00 142.74 968.74 0.00 1116.00 204.16 2288.90
Islands 0.00 0.00 70.02 70.02 0.00 0.00 5.25 75.27
(Source: CEA)
The Northern region is largely dependent on coal based Thermal power and Hydro
Power to meet its electricity demand.
13.2. FUTURE OUTLOOK
13.2.1. Capacity Addition Program
Historically, India has achieved about 50% of the capacity addition envisaged through its
various Five Year Plans.
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45. 13.2.1.1. Actual capacity addition vis-a-vis the target in last 5 year plans
The actual capacity addition vis-a-vis the target in last four 5 year plans is as under:
Graph 13-5: Actual Capacity Addition Vs Target Capacity Addition
1,00,000 70.00%
60.00%
80,000
50.00%
60,000 40.00%
40,000 30.00%
20.00%
20,000
10.00%
0 0.00%
8th Plan 9th Plan 10th Plan 11th Plan (underway)
Target (MW) Achievement (MW) Percentage Achievement
(Source: CEA)
A number of Eleventh Plan projects are already behind schedule; CEA has revised the
capacity addition in Eleventh Plan to 62,488 MW as against the Planning Commission
target of 78,700 MW.
13.2.2. Demand Forecast (All India – 17th EPS)
CEA in its 17th EPS has given detailed estimates of the growth in power demand, region-
wise and for the country as a whole. The summary is given below:
Table 13-3: Long-term Projected Energy Requirement
Peak Load ( MW ) Energy Requirement ( MU )
Region
2011-12 2016-17 2021-22 2011-12 2016-17 2021-22
Northern 48,137 66,583 89,913 2,94,841 4,11,513 5,56,768
Western 47,108 64,349 84,778 2,94,860 4,09,805 5,50,022
Southern 40,367 60,433 80,485 2,53,443 3,80,068 5,11,659
Eastern 19,088 28,401 42,712 1,11,802 1,68,942 2,58,216
North Eastern 2,537 3,760 6,180 13,329 21,143 36,997
All India 1,52,746 2,18,209 2,98,253 9,68,659 13,92,066 19,14,508
(Source: 17th EPS)
According to the 17th EPS, India's peak demand will reach 152,746 MW with an energy
requirement of 968 billion units (BUs) by the year 2012. By the year 2016-17, the peak
demand will reach 218,209 MW and energy requirement will touch nearly 1,392 BUs.
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46. 13.2.3. Supply Forecast for All India at the end of the XI Plan
To cater to this demand, huge capacity addition is being planned. As of now, nearly
78,700 MW of new power plants are under various stages of implementation /
conceptualisation.
13.2.3.1. Planned capacity additions during the XI plan period (2007-12)
The planned capacity additions during the XI plan period (2007-12) is given below:
Graph 13-6: Likely capacity additions during the XI plan - Fuel wise
RES
0% Hydro
Nuclear, 3,380 , 4%
Coal, Nuclear
52,850 ,
Hydro, 67% RES
Thermal
15,627 , Coal
59,693
20%
76% Diesel, - , 0% Gas
Diesel
Gas, 6,843 , 9%
(Source: CEA)
13.2.3.2. Region-wise, Fuel-wise capacity addition in the XI Plan
The Region-wise, Fuel-wise capacity addition in the XI Plan is as follows:
Graph 13-7: Likely capacity additions during the XI plan - Region wise
25,000
20,210
20,000
14,060
15,000 13,000 Hydro
10,886
Thermal
10,000 7,488
Nuclear
5,000 2,940 3,151 2,724
1,170 1,094 1,537
440 0 0 0
-
Northern Western Southern Eastern North Eastern
(Source: CEA)
In case all of the above planned capacity additions come up as per the envisaged
schedule, the total installed capacity of the country will nearly reach 2,11,029 MW at the
end of XI plan.
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