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					Table of contents

    Sr. No                          Particulars       Page No.
      1      Executive Summary                           6
      2      Objective and methodology                   7
      3      Indian Economy                              8
                Challenges for Indian Economy            9
      4      Contribution of various sectors to GDP      10
      5      Banking Industry                            13
      6      Small and Medium Industry                   15
                Slowdown in SME                          16
                Opportunity for SME                      18
                Production and Investment in SME         20
                SME units                                21
                Employment Generation                    22
                SME exports                              23
                Growth of SME's                          24
      7      RBI definition and MSMED Act                26
      8      SME financing                               28
                Challenges                               29
      9      Standard Chartered Bank                     31
                Product profile                          33
                Business strategy                        38
                Lending at SCB                           39
     10      Credit risk for a bank                      40
                Lending to SME's                         42
     11      Credit proposal for SME's                   43
                Acceptable criterion                     43
     12      Appraisal of long term finance project      55
     13      Financial statement analysis                57
                Historical & peer group analysis         62
     14      SME rating                                  64




1
    15   Overview of credit analysis    69
    16   Credit risk management         71
            External credit rating      72
            Internal credit rating      72
    17   Segmentation                   75
            Basis of SME segmentation   76
    18   Sector analysis                77
    19   Conclusion                     78
    20   Bibliography                   79




2
Executive Summary
In India, our environment hitherto was totally regulated (State controlled) and directed
with reference to our industry, banking etc. High tariff walls due to shortage of foreign
exchange and forced restriction on imports, protected indigenous Industries and
created a suppliers' market, where the consumer had no or very limited choice. Similarly
Banks operated in an atmosphere where everything was directed and controlled
externally (albeit either by RBI or Finance Ministry), the need for studying risk was never
felt. Lack of product-quality in Industry or poor service and lack of efficiency in service-
centers were never felt seriously, as there was no competition and no alternative choice
before the consumer.


But with dismantling of State control over every sector of economy, with deregulation
(i.e. supply, demand and prices) to shape on the basis of market forces, Indian Industry
and Indian Banking have now come to face a new challenge. Competition results in the
survival of the fittest. In the liberalized environment, competing with the high-tech new
generation Banks, the erstwhile commercial banks have to re-orient themselves to the
changed situation.

Lending which was the primary function of banking has gained lot of importance as it
determines the profitability of the bank. A bank can lend successfully only when a
borrower’s credit worthiness is accurately assessed. This method of analysis required
varies from borrower to borrower. It also varies in function of the type of lending being
considered. The lending can differ in the way credit given to retail customers or
corporate customers, secured or unsecured, long term or short term etc.

The process of lending, the various analysis involved in giving credit to a customer are
detailed. Focus is on financial ratio analysis, non financial analysis and different models
used by banks in the lending process.




3
Objective of the report
     To have in depth understanding of the evaluation of credit and risk with core
       focus upon, how credit is evaluated considering all risk by studying its basics and
       analyzing the factors affecting it.

     Understanding the Financing of the working capital requirement of SME.

     To have the basic understanding of the SME industry.

     Understanding of the various products than can be offered to the SME.

     SME Lending process.




Methodology
     The methodology used was first to visit the RBI website and study their directives
      on SME lending.

     Then study the balance sheets, income statements, cash flow statement as done
      by the analyst.

     Then understand the industry risk analysis, financial risk analysis and
      management risk analysis done by the credit analyst.

     Read through the previous proposals for the various corporate credit products
      and understand the method of assessment and appraisal.

     Do a comparative analysis and to understand the strategies followed by different
      banks to cater SMEs.




4
Indian Economy
The economy of India is as diverse as it is large, with a number of major sectors
including manufacturing industries, agriculture, textiles and handicrafts, and services.
Agriculture is a major component of the Indian economy, as over 66% of the Indian
population earns its livelihood from this area.
Over the years the Indian government has taken an economic approach that has been
influenced, in part, by the Socialist movements. The Indian national government has
maintained a high and authoritative level of control over certain areas of the Indian
economy like the participation of the private sector, foreign direct investment, and
foreign trade.




Indian economy will begin to recover from the middle of this year, thanks to the fiscal
and monetary measures taken up by the government. Factors likely to contribute
include that India is relatively less dependent on exports, its export profile is not heavily
dependent on electronic or automotive shipments and the domestic fiscal and policy
response has been aggressive and effective.

In the 2008/09 fiscal, India's economy grew 6.7 percent; it’s weakest in six years. In the
previous three fiscal years, it grew at more than 9%.




5
Challenges for Indian Economy in 2009
     Getting inflation under control.
     Spreading the benefits of growth more equitably.
     Completing investment projects which are essential for long term development
       of economy.
     Dealing with global financial uncertainty, which will make capital flows and
       exports more difficult.




6
Contribution of various sectors to GDP




India gross domestic product (GDP) means the total value of all the services and goods
that are manufactured within the territory of the nation within the specified period of
time. The economy of India is the twelfth biggest in comparison to that of others in the
whole world, for it has the GDP of US$ 1.09 trillion in 2007. The country has the second
fastest major growing economy in the whole world with the GDP growing at the rate of
9.4% in 2006- 2007.
The graph is the sectoral contribution of agriculture, industry and services in FY08, FY09
and FY10 (F). The outlook for the fiscal 2009-10 is seen as even worse with the growth
projections made at 6.5 per cent as the effect of job cuts, negative production growth
rate and stagnant US and EU economies would be felt on the Indian economy.

The Central Statistical Organization (CSO) has classified the economy into three main
sectors as follows:

    1. Primary Sector

       It includes the following sectors –
             Agriculture

            Forestry

            Fishing

            Mining

            Quarrying

7
    2. Secondary Sector

       It includes the following sectors –
             Manufacturing

             Construction

             Electricity

             Gas and Water supply



    3. Tertiary Sector

       It includes the following sectors –
             Trade , Transport , Communication and storage

             Financing and insurance ,Real estate and ownership of dwellings and
                Business services

             Public administration, Defense and other services.

Sectoral Contribution to GDP (in PERCENTAGE) at constant prices (1999-2000)

YEAR               PRIMARY           SECONDARY        TERTIARY              TOTAL
                   SECTOR            SECTOR           SECTOR
1950-51            55                16               29                    100
1990-91            35                25               40                    100
2007-2008          21.7              24.1             54.2                  100
                                            Source Statistical outline of India 2006-07



Let us focus now on the Tertiary Sector

There has been a rapid growth in the Tertiary sector or the service sector since 1950-
1951. The share of the tertiary sector in the GDP of India has increased from 29 % in
1950-51 to 54.24% in 2007-08




8
Contribution

       Trade, Transport, Communication and storage –The trade, transport and
        communication contribute nearly 50% of the tertiary sector to the GDP of India.
        In 2007-08 this contributed about 26% of the total GDP.
       Banking, Insurance, Real Estate and Business Services –the contribution of this
        sector has increased substantially during the 1990s dude to the liberalization of
        banking and insurance sector. In 2007-08 the sector contributed about 14% of
        GDP
       Public Administration, Defense and other services –There has been a steady
        growth in this sector during the planning period .In 2007-08, this sector
        contributed about 14.2% of the GDP




9
Banking Industry
Banking industry in India has evolved lately under the impact of the stimulus packages
announced by the Government. According to the Annual Policy 2008-09 of the Reserve
Bank of India (RBI), the central bank, key monetary aggregates have witnessed some
growth in 2008-09. This is reflected in the changing liquidity positions arising from
domestic and global financial conditions and the policy initiatives taken by the
government. Also, reserve money variations during 2008-09 have largely reflected an
increase in currency in circulation and reduction in the cash reserve ratio (CRR) of
banks.

Taking into account all banks in India, there are overall 56,640 branches or offices,
893,356 employees and 27,088 ATMs. Public sector banks made up a large chunk of the
infrastructure, with 87.7 per cent of all offices, 82 per cent of staff and 60.3 per cent of
all automated teller machines (ATMs).




The Credit Scenario
The year-on-year (y-o-y) aggregate bank deposits stood at 21.2 per cent as on January
2, 2009. Bank credit touched 24 per cent (y-o-y) on January 2, 2009 as against 21.4 per
cent on January 4, 2008. The year-on-year (y-o-y) growth in non-food bank credit at
23.9 per cent as on January 2, 2009 was higher than that of 22.0 per cent as on January
4, 2008. Increase in total flow of resources from the banking sector to the commercial
sector was also higher at 23.4 per cent as compared with 21.7 per cent a year ago. The
incremental credit-deposit ratio rose to 81.4 per cent as on January 2, 2009, as against
63.1 per cent as on January 4, 2008. Also, during 2008-09 so far, the total flow of
resources to the commercial sector from banks stood at US$ 58.83 billion up to January
2, 2009. Scheduled commercial banks’ credit to the commercial sector expanded by
27.0 per cent (y-o-y) as on November 21, 2008, as compared with 23.1 per cent a year
ago.

There has been variation in credit expansion across bank groups. Credit expansion as
on January 2, 2009 for public sector banks stood at 28.6 per cent, scheduled
commercial banks (SCBs) including the regional rural banks (RRBs) at 24 per cent,
foreign banks at 6.9 per cent and private sector banks at 11.8 per cent, according to the
Annual Policy for 2008-09 of Reserve Bank of India.

10
Several measures initiated by the Reserve Bank have resulted in banks reducing their
deposit and lending rates between November 2008 and January 2009. The range for
deposit rates for public sector banks varied from 5.25 to 8.5 per cent, foreign at 5.25 to

7.75 per cent and private sector banks at 4 to 8.75 per cent. In the post-crisis quarter
caused due to collapse of Lehman Brothers, large corporate like Infosys moved their
deposits to State Bank of India (SBI), the country's largest bank. Infosys has revealed
that it transferred deposits of nearly US$ 200.61 million from ICICI Bank to SBI last year.

Deposits as on January 2, 2009 for public sector banks stood at 24.2 per cent,
scheduled commercial banks (SCBs) including the regional rural banks (RRBs) at 21.2
per cent, foreign banks at 12.1 per cent and private sector banks at 13.4 per cent,
according to the Annual Policy for 2008-09 of the Reserve Bank of India.

The prime lending rates of public sector banks stood at 12 to 12.5 per cent, private
sector banks at 14.75 to 16.75 per cent and foreign banks 14.25 to 15.50 per cent as on
January 2009.

Bank loans rose 18.1 per cent on year-on-year basis as on March 13, the RBI has said in
its Weekly Statistical Supplement released on March 27, 2009. Outstanding loans rose
to US$ 541.82 billion in the two weeks to March 13. The non-food credit rose to US$
530.19 billion in the two weeks, while food credit stood at US$ 9.61 billion in the same
period.

Since October 2008, the central bank has cut the cash reserve ratio, or the proportion
of deposits that banks set aside, and the repo rate, or the rate at which it lends to
banks, by 400 basis points each to inject liquidity into the system and activate a lower
interest rate regime. Also, the reverse repo rate has been lowered by 200 basis points
to discourage banks from parking surplus funds with RBI. Till April 7, 2009, the CRR had
further been lowered by 50 basis points, while the repo and reverse repo rates have
been lowered by 150 basis points each. Public sector banks have pruned their
benchmark prime lending rates (BPLRs) by 150-200 basis points. Also, in April 2009,
private sector banks such as Axis and Bank of Rajasthan have reduced their BPLRs by 50
basis points. Only few foreign banks such as Citibank have pared home loan rates by 50
basis points to 13.75 per cent.

The rupee depreciated during 2008-09, reflecting varied developments in international
financial markets and portfolio outflows by foreign institutional investors.




11
Government Initiatives
Apart from the bank rate cuts announced in the stimulus packages, cash withdrawals
from bank will not attract tax from April 1, 2009 following abolition of the banking cash
transaction tax (BCTT) in the Union Budget 2008-09. The total collection of BCTT stood
at US$ 120.36 million in 2008-09. Also, inter-ATM usage transaction became free of
charges effective April 1, 2009.




12
Small and Medium Enterprises

SMEs are companies whose turnover falls below certain limits. SMEs are having
different definition at different places in world. For example in Germany SMEs should
have employee limit of 50, in Belgium it is 100. Now international organizations have
started to standardize the concept. Now such businesses are recognized as small and
medium depending on the capital and number of people employed in the company. In
most economies, smaller enterprises are much greater in number. In the European
nations, SMEs comprise approximately 99% of all firms and employ between them
about 65 million people. In many sectors, SMEs are also responsible for driving
innovation and competition. Globally SMEs account for 99% of business numbers and
40% to 50% of GDP.
In India, the Small and Medium Enterprises (SMEs) sector plays a pivotal role in the
overall industrial economy of the country. It is estimated that in terms of value, the
sector accounts for about 39% of the manufacturing output and around 33% of the total
export of the country. Further, in recent years the SME sector has consistently
registered higher growth rate compared to the overall industrial sector. The major
advantage of the sector is its employment potential at low capital cost. As per available
statistics, this sector employs an estimated 31 million persons spread over 12.8 million
enterprises and the labor intensity in the SME sector is estimated to be almost 4 times
higher than the large enterprises.




Is slowdown impacting Indian SMEs?

It looks like the small and medium businesses in India will be hit hard with the slow
economy. Banks are turning down loan requests not only for individuals on personal
loans but even for small and medium enterprises (SMEs). Despite many companies
transacting with the banks for decades, banks are rigid in lending money owing to the
tight credit situation.

While unlimited phone calls from private banks offering loans for personal use and
businesses still continue to bother us, PSU banks are firm on not entertaining such
requests. The situation by and large seems to be pretty tight.



13
According to a recent survey from a City-based consulting firm, India has the second
largest population of SMEs among BRIC countries and the US. The total size of the Indian
SME space today is about 35 million units and the sector contributes more than 60
percent to the Indian GDP.

The estimates state that the SME contribution to GDP has been growing at a steady rate
of CAGR 12 percent over the last seven years. Research firms have been constantly
indicating increased spending by SMEs showcasing an upward trend.

Going by the wide reach and tie-ups with global companies, Indian SMEs have been
indicating faster growth on the path to becoming large enterprises. Their increasing
spend on plant and machinery, robust IT infrastructure, setting up branch offices,
increasing the work force, have all stood testimony to their rapid growth. Increase in
spending means requirement of more money. And, a majority of the SMEs depend
heavily on financial institutions for investments and capital borrowing.

In spite of the Reserve Bank of India announcing measures to release funds and
directing banks not to stop lending, many PSU banks are refraining from extending
financial assistance by denying sanctioning of working capital and overdrafts citing
reasons of liquidity crunch. This will surely hit the SMEs and emerging enterprises, who,
unlike large corporate cannot bank on their internal accruals and investment portfolio.

Even as policymakers and regulators have been assuring of economic situation being
under control, the impact of the present condition in the financial market is definitely
being felt by the SME sector.

Case in point: A small scale unit in Bangalore, which is doing business with a PSU for the
last eight years and showing good growth year-on-year with satisfying profit margins, is
on an expansion mode. The bank, which hitherto supported the entrepreneur with all
financial help, has put on hold the request of the firm's proprietor for an ad-hoc limit of
a mere Rs. 10 lakh to execute a project in the next three months.

The reason quoted by the chief manager of the bank was, "We have stopped lending
any form of loans and raising the credit limit due to the current economic slowdown."
Such instances are being heard from across the country.




14
SMEs are finding opportunity in this global slowdown
     1. Getting the right talent for less

        As small organizations cannot afford to lose the skill sets of a valued teammate,
        not to mention risk demoralizing the rest of their workforce, small industries are
        actually proving themselves as a safer bet. This is encouraging lots of people
        working with big giants who lost their jobs to join such firms. E.g. small IT firms
        are getting people worked for companies such as Adobe, Sapient, Magic
        software etc and that too for less payment. So actually with talent coming for
        less and stability and growth taking precedence over a big employer brand, SMEs
        are actually making hay these days.


     2. Taking advantage of low Real Estate prices

        Every problem presents an opportunity. For many SMEs high rentals had been a
        block to expansion when the going was good. So companies are looking at
        relocating to cheaper office options to take advantage of the slump in the Real
        Estate market.


     3. Domestic market turned savior for export stung SMEs

        The global slowdown affected most of the export oriented SMEs working in
        areas such as Textiles, Automobile, IT sector etc. For SMEs unpredictable
        exchange rates, demand volatility, unstable economy making domestic market
        an attractive bet. SMEs are concentrating more on domestic market and joining
        hands with big players to tackle the situation.


     4. Search for the new opportunities

        Industries are searching for new avenues to make up for the slump in exports.
        E.g. SME units at Meerut are joining hands with big players to provide equipment
        in bulk for the Commonwealth games. Also what has worked as a bonus for small
        scale units like Sports goods manufacturers is the expansion of modern retail
        chains like Big Bazaar, Vishal Mega Mart, Reliance Retail, More etc which source
        low cost sports goods.


15
     5. The advantage SMEs enjoying is that their branding efforts start from a clean slate
         this opens up new options and strategies for brand building.



     6. SMEs realized the importance of credit cover due to increasing default cases of
         some prime customers in America and Europe. In India Export Credit Guarantee
         Corporation (ECGC) provides credit risk insurance cover to exporters against loss
         in exporting goods and services.




16
Production and investment in SMEs
The total production of the SMEs showed a phenomenal growth in FY07 as compared to
the previous year. The production at current prices experienced a growth rate of
around 18% against 15.8% in the previous year, thereby raising its share to India’s GDP
up to15.5% during the year. Economic activities such as export market, growing
domestic consumption, conducive policy measures, improving production methods,
technology, development of SME clusters have fuelled production and hence their
share to India’s GDP. SMEs have maintained an equal growth rate vis-à-vis the overall
industrial sector during FY03-07, which grew at a CAGR of around 17%.




The SME sector has also registered a consistently higher growth rate than the overall
manufacturing sector. In fact, it plays a dual role since the output produced by SMEs is
not only about final consumption but also a source of capital goods in the form of
inputs to heavy industries.




17
SME Units in India




With globalization, all forms of production of goods and services are getting increasingly
fragmented across countries and enterprises. With large players adopting different
models of business that include involvement of the their traditional partners, suppliers
or distributors at a different level, SMEs now are now experiencing a new model of
functioning in the value chain. The past few years has seen the role of the SME segment
evolve from a traditional manufacturer in the domestic market to that of an
international partner. The restructuring of production at the international level through
increased outsourcing is having significant effects on small and medium entrepreneurs
in a positive as well as negative manner. Demand in terms of new niche products and
services are providing more opportunities for SMEs that are in a better position to take
advantage of their flexible nature of operations. However, at the same time they have
realized their drawback in terms of inadequate availability of managerial and financial
resources, lack of working capital, personnel training and inability to innovate on a
faster pace.




18
Employment Generation




The combined effect of market liberalization and deregulation has forced the SME
segment to change their business strategies for survival and growth. Some of the
changes that SMEs are focusing include acquiring quality certifications, increasing use of
ICT, creating e-business models and diversification to meet the increasing competition.
Globalization, economic liberalization and the WTO regime would undoubtedly open up
a unique opportunity for the largest business community, i.e. SMEs through effective
involvement in international trade by streamlining certain factors, such as, access to
markets, access to technology, access to skills, finance, development of necessary
infrastructure, SME-tax friendly environment, exchanges of best practices to name a
few.




19
SME exports growing in tandem with total exports




 SMEs constitute an important segment of India’s industrial production with a
contribution to 33% of its exports. During FY03-06, India’s total merchandise exports in
US dollar terms witnessed a CAGR growth of 25%, while in the same period SME exports
grew at a CAGR of 24%. The remarkable contribution of SMEs in generating employment
in the country has been instrumental in addressing issues pertaining to poverty and
inequality of income. As per the Third All India Census on Small Scale Industries-2001-
02, highly populated states such as Madhya Pradesh, Uttar Pradesh, West Bengal,
Maharashtra, Karnataka and Jharkhand together contributed to around 55.4% of the
total exporting units in India. In terms of distribution of value of exports from the SME
sector, states like Punjab, Haryana, Uttar Pradesh, Tamil Nadu and Maharashtra
together contributed 64.75% of total exports.

The composition of export basket of SME’s in India, it has both traditional and non-
tradition commodities in nature. There are few commodity groups which are exclusively
exported by SMEs such as sports goods, cashew, Lac etc. In the commodity group of
engineering goods, SMEs constitute around 40% of the total exports of this commodity
group. Similarly, SMEs in basic chemicals & pharmaceuticals finished leather and leather
products and marine products account for around 44%, 69% and 50% of the export
share in their respective commodity groups. In view of the Government of India’s
ambitious target of average GDP growth rate of 9% during the 11th Five Year Plan, SMEs
have to play a vital role in achieving this target. It is imperative for the government to
address the major issues plaguing the sector and take further inclusive growth oriented
policy initiatives to boost the sector. This includes measures addressing concerns of
credit, fiscal support, cluster-based development, infrastructure, technology, and
marketing among others.



20
Growth of SME’s
There are good reasons for the optimism. In the past five years, small companies have
performed better than their larger counterparts. Between 2001 and 2006, companies
with net turnover of Rs 1 crore-50 crore saw a rise of 701 per cent in net profit,
compared to 169 per cent for large companies with turnover of over Rs 1,000 crore.




          Smaller Companies have grown more than larger ones

          SME's with turnover of          Net Sales   Operating Profit   Net Profit


          Rs. 1 crore - 50 crores         175         301.6              701.8
          Rs. 50 crores - 100 crores      125         101                961.1
          Rs. 100 crores - 200 crores     102.5       115.5              713.7
          Rs. 200 crores - 300 crores     79.6        90.8               365.9
          Rs. 300 crores - 400 crores     86.6        97.9               153.7
          Rs. 400 crores - 500 crores     89.2        89.7               559
          Rs. 500 crores - 1000 crores    63.1        61.1               143.8
          > 1000 crores                   86.4        92.4               169.9
          TOTAL                           89.1        65.6               206.8
                                                      Source: Business world



Companies with a turnover of Rs 50 crore-100 crore did even better, raking in profit
growth of 961 per cent over the five years. Smaller companies have also outperformed
larger ones in the growth of net sales and operating profits. Operating and net profit
margins of smaller companies, too, have expanded more than those of the larger ones.
(Although there is no agreement on what constitutes an SME, private and foreign banks
define SMEs as companies with turnover between Rs 10 crore and Rs 700 crore.)




21
     Smaller Companies' share of sales and profits has gone up

                                      2006                                2001
                                      Net      Operating     Net          Net       Operating     Net
     SME's with turnover of
                                      Sales    Profit        profit       Sales     Profit        profit


     Rs. 1 crore - 50 crores          175      301.6         701.8        3.2       2.3           -2.2
     Rs. 50 crores - 100 crores       125      101           961.1        3.1       2.9           0.7
     Rs. 100 crores - 200 crores      102.5    115.5         713.7        5.8       4.9           1.4
     Rs. 200 crores - 300 crores      79.6     90.8          365.9        4.4       3.5           1.9
     Rs. 300 crores - 400 crores      86.6     97.9          153.7        3.5       3.7           4.1
     Rs. 400 crores - 500 crores      89.2     89.7          559          2.6       3.2           1.2
     Rs. 500 crores - 1000 crores     63.1     61.1          143.8        8.8       9.8           9
     > 1000 crores                    86.4     92.4          169.9        68.6      69.7          84.1
                                                                       Source: Business world




     Margin Growth has been better for Smaller Companies

                                              2006                           2001
                                              Operating          Net         Operating          Net
     SME's with turnover of                   Profit             Profit      Profit             Profit


     Rs. 1 crore - 50 crores                  18.7               8.3         12.8               -3.8
     Rs. 50 crores - 100 crores               14.7               5.4         16.4               1.2
     Rs. 100 crores - 200 crores              15.9               5.1         14.9               1.3
     Rs. 200 crores - 300 crores              14.7               6           13.8               2.3
     Rs. 300 crores - 400 crores              19.9               8.7         18.8               6.4
     Rs. 400 crores - 500 crores              21.5               8.3         21.4               2.4
     Rs. 500 crores - 1000 crores             19.6               8.3         19.8               5.6
     > 1000 crores                            18.5               9.6         17.9               6.7
     Total                                    18.2               8.8         17.6               5.4
                                                                 Source: Business world




22
RBI definition of SME
At present, a small scale industrial unit is an undertaking in which investment in plant
and machinery, does not exceed Rs.1 crore, except in respect of certain specified items
under hosiery, hand tools, drugs and pharmaceuticals, stationery items and sports
goods, where this investment limit has been enhanced to Rs. 5 crore. A comprehensive
legislation which would enable the paradigm shift from small scale industry to small and
medium enterprises is under consideration of Parliament. Pending enactment of the
above legislation, current SSI/ tiny industries definition may continue. Units with
investment in plant and machinery in excess of SSI limit and up to Rs. 10 crore may be
treated as Medium Enterprises (ME).




The MSMED Act 2006
Enterprise        Engaged             in Engaged In Providing/ Remarks
                  Manufacturing        / Rendering of Services
                  Preservation        of
                  Goods(incl. Processing
                  Units)
Micro Enterprise Not to Exceed Rs. 25 Not to Exceed Rs. 10 1. Separate threshold
                 Lakhs.                  Lakhs.              investment      limits
Small Enterprise More than Rs.25 lakhs More than Rs.10 lakhs proposed by the Act
                 but does not exceed Rs. but does not exceed for    Manufacturing
                 5 Crores.               Rs. 2 Crores.       and Services Sectors.

Medium            More than Rs.5 Crore More than Rs. 2 Crore 2. Micro Enterprises
Enterprise        Rupees but does not Rupees but does not newly       introduced
                  exceed Rs. 10 Crore. exceed Rs. 5 Crore.   under   both     the
                                                                  sectors.




23
The enactment of the Micro, Small and Medium Enterprises Development (MSMED) Act,
2006 was a landmark initiative taken by the Government of India to enable the SMEs’
competitive strength, address the issues and challenges and reap the benefits of the
global market. SME policy initiatives at the national and state level are aimed at
strengthening the role of SMEs at the base as well as at the higher level.

SMEs always represented the model of socio-economic policies of Government of India
which emphasized judicious use of foreign exchange for import of capital goods and
inputs; labor intensive mode of production; employment generation; no concentration
of diffusion of economic power in the hands of few (as in the case of big houses);
discouraging monopolistic practices of production and marketing; and finally effective
contribution to foreign exchange earning of the nation with low import-intensive
operations. It was also coupled with the policy of de-concentration of industrial
activities in few geographical centers.

It can be observed that by and large, SMEs in India met the expectations of the
Government in this respect. SMEs developed in a manner, which made it possible for
them to achieve the following objectives:

        High contribution to domestic production
        Significant export earnings
        Low investment requirements
        Operational flexibility
        Location wise mobility
        Low intensive imports
        Capacities to develop appropriate indigenous technology
        Import substitution
        Contribution towards defense production
        Technology – oriented industries
        Competitiveness in domestic and export markets




24
SME financing
The financing options that are available to SMEs presently can be listed as

Long-Term

 Debts
 Term Loans
 Leasing and Hire Purchase
 Development Institutions
 Bonds



Short-Term
 Working Capital
 Inter- corporate Deposits
 Trade Credit
 Bills Discounting
 Public Deposit


Foreign Funding


Miscellaneous
 Foreign currency loans
 Term loan assistance
 Venture capital loan




25
Challenges faced by SME financing

There are many challenges which the banks face while SME Financing


 Absence of credit information system

 Inadequacy of collateral

 Higher cost of follow-up

 Disproportionate Requirement of Financial Assistance

 Concealment of background or other operational details

 Poor repayment records

The first OECD ministerial conference on SMEs and Globalization which was held in
Bologna in December 2000, identified and discussed some of the critical issues
regarding SMEs, Such as: Innovation’s vital role on SME competitiveness, SME’s key
roles in national innovation systems, the importance of improving access to information
and financing that facilitates the SME’s innovation process, and the relevance of clusters
and networking to stimulate innovative and competitive SMEs.

Some of the problems/ challenges the SMEs facing are:
    Unable to capture market opportunities, which require large production facilities
      and thus could not achieve economies of scale, homogenous standards and
      regular supply.
    Experiencing difficulties in purchase of inputs such as raw materials, machinery
      and equipments, finance, consulting services, new technology, highly skilled
      labor etc.
    Small size hinders the internalization of functions such as market research,
      market intelligence, supply chain, technology innovation, training, and division of
      labor that impedes productivity.
    Unable to Compete with big players in terms of product quality, range of
      products, marketing abilities and cost.


26
        Absence of a wide range of Financing and other services that is available to raise
         money and sustain the business.
        Absence of Infrastructure, quality labor, Business acumen and limited options
         opportunities to widen the business.
        Poor IT and Knowledge infrastructure.
        Poor access to timely and adequate credit
        Technological obsolescence
        Marketing constraints / Lack of skilled
        Plethora of rules and regulations
        Shortcoming in management
        Failure to select right activities or projects

Now let’s see as to what exactly SME are looking in form their Bankers

      Loyal and lasting banking relationships

      Doorstep banking

      Reliable Service Quality

      Comfort/ Relationship with bank staff

      Proximity to delivery channels

      Low delivery cost

      Combination of personal and business banking



Stages of Financial Demands

Normal operations - Working capital financing, Equipment leasing, discounting
receivables and trade credit.

Expansion plans - Reinvestment of surplus funds, term lending and equity investments.




27
Standard Chartered Bank
The Standard Chartered Group was formed in 1969 through a merger of two banks: The
Standard Bank of British South Africa founded in 1863 and the Chartered Bank of India,
Australia and China, founded in 1853.
Both companies were keen to capitalize on the huge expansion of trade and to earn
the handsome profits to be made from financing the movement of goods from Europe
to the East and to Africa.
The Chartered Bank
The Chartered Bank was founded by James Wilson following the grant of a Royal
Charter by Queen Victoria in 1853 and opened first branches in Mumbai (Bombay),
Calcutta and Shanghai in 1858, followed by Hong Kong and Singapore in 1859. The
Chartered Bank played a major role in the development of trade with the East which
followed the opening of the Suez Canal in 1869 and the extension of the telegraph to
China in 1871. In 1957 Chartered Bank bought the Eastern Bank together with the Ionian
Bank's Cyprus Branches. This established a presence in the Gulf.

The Standard Bank
The Standard Bank was founded in the Cape Province of South Africa in 1862 by John
Paterson and commenced business in Port Elizabeth, South Africa, in January 1863. It was
prominent in financing the development of the diamond fields of Kimberley from1867
and later extended its network further north to the new town of Johannesburg when gold
was discovered there in 1885.In 1965; it merged with the Bank of West Africa
expanding its operations into Cameroon, Gambia, Ghana, Nigeria and Sierra Leone.

In 1969, the decision was made by Chartered and by Standard to undergo a friendly
merger. All was going well until 1986, when a hostile takeover bid was made for the
Group by Lloyds Bank of the United Kingdom. When the bid was defeated, Standard
Chartered entered a period of change. Provisions had to be made against third world
debt exposure and loans to corporations and entrepreneurs who could not meet
their commitments. Standard Chartered began a series of divestments notably in the
United States and South Africa, and also entered into a number of asset sales.

From the early 1990s, Standard Chartered focused on developing its strong franchises in
Asia, the Middle East and Africa using its operations in the United Kingdom and North
America to provide customers with a bridge between these markets. It also focused on
consumer, corporate and institutional banking and on the provision of treasury services
areas in which the Group had particular strength and expertise.

28
In the new millennium Standard Chartered acquired Grind lays Bank from the ANZ
Group and the Chase Consumer Banking operations in Hong Kong in 2000.

2005 and 2006 were historic years for Standard Chartered as it achieved several
milestones with a number of strategic alliances and acquisitions that extended the
customer base or geographic reach and enhanced the product range.
Global Network

Standard Chartered has a network of over 1,400 branches in more than 50 countries and
territories across the globe, making it one of the world's most international banks. The
Indian Story

The Chartered Bank opened its first overseas branch in India, at Kolkata, on 12 April
1858. Eight years later the Kolkata agent described the Bank's credit locally as splendid
and its business as flourishing, particularly the substantial turnover in rice bills with the
leading Arab firms. When The Chartered Bank first established itself in India, Kolkata
was the most important commercial city, and was the centre of the jute and indigo trades.
With the growth of the cotton trade and the opening of the Suez Canal in 1869, Bombay
took over from Kolkata as India's main trade centre.

Today the Bank's branches and sub-branches in India are directed and administered from
Mumbai with Kolkata remaining an important trading and banking centre offering a
variety of services like the following:
 Personal Banking
 Private Banking
 SME Banking
 Wholesale Banking




29
Product profile

With years of banking experience, Standard Chartered is undoubtedly in a strong position
to help growing businesses sail through the complexities they may face. As an
international bank with offices in more than 50 countries, the bank provides the global
reach and international recognition that the business deserves.SME Banking offers one of
the widest ranges of banking products and services in the market today. Managing a
growing business demands time and energy. Relationship managers of Standard
Chartered understand the business requirement and help customers manage their
business better. The product offering of SME banking includes the following


1. Business Installments Loans

This is an unsecured (collateral free) loan to businesses with turnover ranging from INR 40
Lakh to INR 30 Crore. This loan is useful for professionals, proprietors, partnership firms
and private limited companies. It helps businesses take giant strides by fulfilling their
requirements be it working capital requirements, business expansion, etc.

Benefits of Business Installment Loan Include
 Easy to apply
 Higher loan amount up to INR 30 Lakh
 No collateral/ security required
 Quick turnaround time




2. Trade Service And Working Capital

This loan is useful for professionals,proprietors, partnership firms and private limited
companies           with         turnover        ranging         from       1       crore
to INR 110 crore. This total trade solution offered against primary security of stock and
book debts assists the customers through the complexity of international trade by
leveraging on the bank’s extensive international network. Services provided are




30
Export Services
(i) Credit bills negotiation
(ii) Pre-shipment export financing
(iii) Export Letter of Credit advising
(iv) Letter of Credit confirmation

 Import Services
(i) Letter of Credit
(ii) Shipping Guarantee
(iii) Import Financing
(iv) Custom bonds and Guarantees

Benefits of Trade Services and Working Capital Include

 Limit Size up to INR 22 crores
 Leverage on the bank’s extensive International network across more than 50
  countries
 Attractive interest rates
 A dedicated Relationship Manager to cater to your needs
 One stop shop for all Trade Services

3. Express Trade
This loan is useful for professionals, proprietors, partnership firms and
private limited companies with turnover ranging from INR 1 crore to INR 30 crore. It
provides the right resources to trade on a larger scale, and to achieve an even greater
success, in short time periods for importers, exporters and domestic retailers. It also
provides customers with the expertise to structure a financing solution best suited to their
working capital payment terms and pricing needs. The range of trade services offered
include
Export Services

(i) Credit bills negotiation

(ii) Pre-shipment export financing

(iii) Export Letter of Credit advising

(iv) Letter of Credit confirmation




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Import Services

(i) Letter of Credit

(ii) Shipping Guarantees

(iii) Import Financing

(iv) Custom bonds and Guarantees

Benefits of Express Trade Include

 Only 20% cash margin
 Lending up to INR 2.7 crore
 Express approval within 7 days
 Flexibility of usage in different trade products
 Simple Credit and Trade documentation
 Customize the product according to working capital terms and pricing needs
 Leverage on the bank’s extensive International network across more than 50
countries




4. International Trade Account
In today’s global economy, the International Trade Account              provides        a
comprehensive range of service to give provide import or export
businesses the competitive edge and helps in managing their cash flows better. It is
specially created to make business transactions easy and economical. The services offered
include

 Current account facilities

 Trade & remittance services

 Foreign exchange services




32
Benefits of International Trade Account Include

 Integrated Offering

Convenient Current Account bundled with trade products and foreign exchange Services.

 Cost Savings
(i) Freedom to choose your trade tariffs
(ii) Preferential foreign exchange rates

 Expert Advisory
(i) Access to a dedicated Relationship Manager


5. Term Loan
Term loan is for the acquisition of commercial property, purchase of fixed assets and
business expansion, including loan against property to business with turnover ranging
from INR 1 Crore to INR 110 Crore is offered. This loan is useful for professionals,
proprietors, partnership firms and private limited companies.

Benefits of Term Loan Include

 Longer tenor of up to 10 years
 Attractive interest rates
 A dedicated Relationship Manager to cater to the business needs
 Quick turnaround time

6. Forex Services

Standard Chartered offers the control to hedge FOREX risk of businesses. The services
offered include

 Payment in foreign currency to the vendors/ suppliers
 Quotations for over 100 currencies offered
 An access to a global team of onshore traders specializing in pricing illiquid and
restricted currencies who provide solutions to address specific needs
 Online Treasury (OLT) which offers the convenience of executing FOREX
 Transactions from desktop


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Benefits of Online Treasury Include

 Ease of operation using an office internet connection
 Instant, real-time foreign exchange prices for over 100 currency pairs
 The security of a digital certificate is used
 Transactions for Spot and Forward hedge against currency fluctuations is offered


7. Loan/Overdraft against Property
Loan/ Overdraft facility aims to fulfill the short term and long term business requirements
of the SME customers, be it working capital requirement or business expansion by
unlocking a property potential. It is a flexible product offering that allows a combination
of a Term Loan and Overdraft facility against residential or commercial property which is
useful for professionals, Sole Proprietors, Proprietorship Firms, Partnership Firms or a
Private Limited Company with an annual turnover in the range of INR 90 lakh to INR 45
crore.


Benefits of Business Installment Loan Include

 Loan up to 75% of the market value of the property
 Flexibility to opt for pure Term Loan or a combination of Term Loan & Overdraft
 Loan up to a maximum of INR 3.15 crore
 Tenure up to 12 years
 Overdraft facility up to a maximum of 50% of the total sanctioned limit
 Attractive interest rates


The above services are offered to SME after evaluation of predetermined criteria and as
per RBI guidelines and procedures established by Standard Chartered.




34
Medium enterprise and risk assessment

Business Strategy

1) To provide complete range of financial services to SME business entities which are
   progressive and well reputed in the local market, good promoter and track record.
2) Increased focus on liabilities income and fee based business by focus on trade and
   FX products and ensure a portfolio RAR at a minimum of 4.5%
3) Deepening of existing relationships by cross selling of basket of cash, trade, FX and
   insurance
4) Focus on FX business
5) All group and local compliance requirements to be met
6) Segmentation approach: It is proposed to follow a differentiated approach for
   customers in ME segment. As per the new approach customers have been divided
   into eight segments based on the turnover, NAR and exposure and account handling
   approach
    Portfolio approach is to be adopted for ‘accounts with low exposure and low
       NAR’. All PM managed account approvals permitted in country.
    Relationship approach to be adopted for ‘accounts with high exposure and high
       NAR’.

When the accounts are reviewed, account by account analysis would be done and
allotment or Exit decision would be taken on the basis of risk-return profile. Account
classification would be jointly decided by Credit and business.




35
Lending at Standard Chartered Bank




36
Credit risk for a bank
Credit risk is defined as the probability / potential that the borrower or counter party may
fail to meet its obligations in accordance with agreed terms. It involves inability or
unwillingness of a borrower or counter party to meet commitments in relation to lending,
trading, hedging, settlement and other financial transactions.

Credit risk is made up of two components:
    Transaction risk or Default risk that represents the risk arising from individual credit
        exposures and

      Portfolio risk that represents the risk inherent in the portfolio of credit assets.
       (concentration of assets, correlation among portfolios etc)

Credit risk faced by the bank depends on both external and internal factors. External factors
arise from situations that are beyond the control of the bank but the consequences of
which need to be managed in order o mitigate the impact on the bank. On the other hand
internal factors are unique to the bank that is within the control of the bank.


Sources of Credit Risk
     1. Direct lending risk: It lies in the products like loans and advances, overdrafts, bills
        discounted, etc. It is the risk that the dues will not be paid on time.

     2. Contingent lending risk: It lies in products like letters of credit, guarantees, etc. It
        is the risk that contingent exposures get converted into actual obligations and
        that these obligations may not be repaid on time.

     3. Issuer risk: It is the risk of financial loss due to the degradation in the credit
        rating of the issuer of the debt instrument. It is also the risk that the bank may
        not be able to sell the instrument within a predetermined holding period.

     4. Pre-settlement risk: It is the risk that the counter-party with whom the bank has
        a reciprocal agreement may fail before settlement of the contract e.g. In
        forwards, futures and options. As a result the bank faces the risk of default on
        the settlement date and hence may have to undertake fresh transactions,
        leading to replacement cost.




37
     5. Settlement risk: It is the risk where the bank delivers its part of the contract but
        the other bank does not fulfill its obligation. This risk arises out of time lags in
        settlement of another currency in another time zone.

The bank needs to identify all sources of credit risk and monitor aggregated exposures
to a borrower or counter-party on a bank-wide basis.




38
Basic principles of lending to SME’s
Banks are in business to maximize value for its shareholders.
Consequently, when a bank lends money, it attempts to lend money to those
applicants that are deemed as the best from the applicant pool. The process by which a
lender appraises the creditworthiness of the prospective borrower is called credit
appraisal. This normally involves appraising the borrower’s payment history and
establishing the quality and sustainability of his income.

The bank assesses credit risk of any borrower based on the 5 "C's" of Credit:

Capacity to repay is the most significant of the five factors. The lender will have to
determine the sources of income that the applicant possesses to repay the loan. The
main consideration will be cash flow generated from the business. The lender will also
consider contingency sources of income i.e., marketable securities, money market
accounts and other assets that can be quickly liquidated into cash.

Capital is the money that has been invested by the business owner into his/her
business. The amount of invested capital by the owner is indicative of the owner's stake
and confidence in the viability of his/her business.

Collateral is pledged assets to guarantee the security of a loan. Collateral is deemed as
a second source of income in the event that the borrower cannot repay the loan.
Assets that are typically accepted as collateral are fixed assets of a business i.e.,
equipment, plant and property. Banks typically will file a UCC (Uniform Commercial
Code) lien on collateralized assets. Banks also consider working capital like accounts
receivable and inventory, to be feasible sources of collateral. But, typically banks will
usually discount the value of working capital (being that the market value is neither
fixed nor certain) at a certain percentage of estimated market value.

Conditions focus on the intended purpose of the loan. How will the proceeds from the
loan be utilized i.e. to purchase equipment, working capital? Will the use of the loan
contribute to the future economic growth of the business? Also banks consider the
local market and economic conditions both within your industry and other industries
that affect your business e.g., your suppliers and customers.

Character is the personal impression that a prospective borrower makes to a potential
lender or investor. A person's educational background, industrial experience and credit
history with other creditors will be considered.


39
Credit proposal for SME’s
The financial consultants of the bank prepare credit proposal. The company approaches
the bank and briefs them about their requirement (term loan, cash credit etc.) based
on which the credit proposal is prepared.


Acceptable Criteria

 Company turnover
     Minimum turnover
    Manufacturers and retail traders : INR 9.2 M
    Wholesale traders : INR 32.2 M
    Professional :INR 4.6 M

       Maximum turnover
       Max INR: 1100M

 Business Vintage
    Minimum 3 years of operation
    Minimum 3 years of audited financials

     Lower Vintage acceptable if – Facility fully secured by Cash/marketable securities or,
     they are the part of a large group of company

 Target Market
    Individuals /sole proprietorships
    Registered firms
    Private Limited companies
    Listed Companies

 Acceptable collateral
   Cash
   Marketable Securities
   Standby letter of credit
   Bank Guarantee
   Property – Flats ,shops , warehouse ,office units




40
 Primary Security-working capital facilities
    Working capital facilities shall be secured by a hypothecation for primary charge
      on stock and book debts

 Age
   In case of financing of multiple facilities working capital financing for individuals,
      lending would be considered against cash/marketable securities /property for
      businessmen and professionals with age < 70 years. For such cases if the primary
      borrower is more than 60 years of age , a personal guarantee from at least one
      son/daughter (who are active in the day to day business) of the borrower is
      required .

 Personal Guarantees
    Personal guarantees is required from 51 % of the shareholders
    Personal guarantees will be joint and several, from partners in case of partnership
      firms comprising at least 51 % of holdings.
    For private or public limited companies , personal guarantees are required to the
      extent of promoters holding , subject to a minimum of 51 %
    Additionally –Personal guarantee shall be required for all applications where
      property is provided as security irrespective of the amount of LGD.
    Personal Guarantee will not be required for applications collateralized fully by
      cash /marketable securities.




41
           Before the work starts on the proposal the company requires a set of documents.
           These documents are




                    Document                                                Remarks


Last 3 years Audited balance sheet                   Credit Grading
Plus 2 years Estimated



Last 6 Months Bank statements                        Helps in tracking the payments made and received
                                                     by the SME, check the churning in the current
                                                     account, history of the bounces and normal conduct

PAN Card of Both the Individual and the SME          Used for CIBIL check

                                            The IT returns must be filled proper and all the
IT Returns –Last 3 years of the SME and the transactions should be clearly shown.
Company

                                                     To have information about all the activities of the
Memorandum of association                            SME and its areas of interest in the Object clause.

                                                     Share of holding in the company, promoter directors,
Latest list of Directors                             signing authorities.

                                                     Concentration risk and reference
Top 5 Suppliers and Buyers

                                                     This is required in case the primary borrower is more
Brief history of the businessmen and professionals   than 60 years of age. It is done to take a personal
                                                     guarantee from at least one son/daughter (who are
                                                     active in the business).



           42
After receiving the above documents the work on the credit proposal starts.
Relationship managers and Credit analysts responsibility is to ensure that at the time of
customer call, all the evidences are clear:

     1. There has to be appropriately experienced management which is evidenced by
        the past record in the line of business.
     2. A premise adequate for business purpose and it is suitably located.
     3. Visit/s by the RM to the customer office/business are required and documented.
     4. There has to be check on the application/ end use of funds and repayment
        source, KYC.
     5. KYC documentation for all the new customers to be obtained before the
        business is booked.
     6. Environment friendly- lending is not to be made to industries/ products
        manufacturers as specified by RBI and SCB Group risk policies, in particular, the
        Group environmental and Social Risk policy. Lending not to be made to
        industries/ product manufacturers employing child labor.
     7. The companies should be going concern only.
     8. All the accounts should be closely scrutinized for items such as inter company
        transactions and borrowing, loans to directors/shareholders and inconsistencies.


The main sections of a credit proposal are

     1. Nature of request

This section lists out the request of the company. For example


Nature of proposal                     Fresh sanction
Limits (Rs. in lacs)                   Existing         Proposed      +/-
Fund Based (Working Capital)           0                0             0
Fund Based (Others)                    0                0             0
Non Fund Based (Working Capital)       0                0             0
Non Fund Based (Others)                0                0             0
Total (FB + NFB)                       0                0             0




43
This section lists out the fund based and non-fund based requirements of the company.
In the fund based requirements there is cash credit limits or working capital demand
loan, export credit limits, bill-discounting limits etc. In the non-fund based limits there
is bank guarantee limits, letter of credit limits etc.

     2. Basic details of the borrower

This section lists out the some of the details about the company. They are

     a. Name of the company and the group it belongs: If the borrower is a group
        concern then the bank can get corporate guarantee from the main company.
     b. Constitution of the company to know if the company is public or private limited
        and its date of incorporation.
     c. The corporate office address and the location of its manufacturing units if the
        borrower is a manufacturing concern.
     d. The line of activity of the company detailing the products it manufactures or
        trades and the industry it belongs.
     e. If the company has been dealing with the bank then the date from which the
        company is availing the facilities from the bank.

These basic details provide some necessary information to start the credit appraisal
process.

     3. Management of the company

This section tells about the top administration that manages the company. As they are
the major decision makers for the firm a proper investigation about the management
of the firm becomes necessary. This section details the board of directors/ partners and
the various positions they hold in the company. A brief note is also written on the
background of these directors/ partners, which is in general their qualification and
experience in business.

The management of the company is of great importance to the credit appraisal team
and especially for SMEs.




44
The main points looked into are:

          a. Is the management competent enough on running the firm
          b. Is there any type of differences between the partners/ directors of the firm
          c. Are any major director/ partner planning to leave the firm as there may be a
             chance that many customers may move with the director/ partner to other
             firms.
          d. Is any director/partner in the defaulter list of RBI or CIBIL.

     4. Ownership pattern

This section tells about the percentage shares held by the promoters, the financial
institutions, foreign institutional investors, public and others.

     5. Stock market perception

If the borrowing company is a public limited company then it’s important for the credit
analyst to know what the stock market feels about the company. The following details
are put in this section.

     a.   Par value of the share.
     b.   Name of the stock exchange where the scrip is listed.
     c.   Current market price of the share.
     d.   52 week high and low
     e.   P.E. ratio of the company
     f.   P.E. ratio of the industry
     g.   Volumes traded in a day

     6. Background of the company

This section tells about the promoters of the company and the main purpose of starting
the firm. This section tells about the profile of the products it manufactures or trades
as well as the market standing of these products. The various overseas ventures or any
other business collaboration that may have an effect on the performance of the
company is mentioned in this section.




45
     7. Group details and profile

This section details about the group concerns and a brief note about their financial
performance. For example, certain important information about the sales, net profit,
net worth of the company, the gearing ratio and the current ratio.

     8. Borrowing arrangements

This section gives a detail of the current borrowing arrangements of the firm. The
working capital arrangement as well as the term borrowing arrangements with the
various banks is given in this section.

a. Working capital arrangements

 Type of Banking:          Consortium Banking
 As On :                                              (Rs. in lacs)
                                                                      Sharing
                           FB Limits NFB Limits Total Limits
 Name of the Bank                                                     pattern (%)   IRAC status
                           E     P    E     P     E        P          E     P
 Exim Bank of India                                                                 Standard
 Total (Our Bank)                                                                   Standard
 Grand Total                                                                        -
 E-     Existing      P-       Proposed

In the working capital arrangements, the current WC limits of each bank are given
detailing the fund based and non- fund based limits the existing and proposed. A note
on the primary security offered as well as the collateral security offered is also
mentioned.

For a loan for working capital or cash credit limit the above section is important. The
credit analyst looks at the various banking arrangements the company has. He also
looks into the actual need or the maximum permissible bank finance as per the
estimates to determine if the banks are over funding the firm. If there is excess funding
then the company might use the funds for some other purpose other than the
business.

 b. Term Loan arrangements


46
 As On :                                          (Rs. in lacs)
 Name of the Bank /FI                     Limit          O/s         IRAC status
 Abudhabi Commercial Bank                                            Standard
 Exim Bank                                                           Standard
 IDBI                                                                Standard
 Sub-total (from other banks / FI)                                   -
 Total (Our Bank)
 Grand Total                                                         -

The credit analyst looks the term loan arrangement of the borrower with other banks.
Here the limit extended by different banks and the outstanding amount along with the
repayment schedule is given in this section. The analyst looks into the conduct of the
account to see if there is any default by the borrower at any stage of the loan period.
The analyst takes default in payment very seriously and the reasons are probed deeply.

     9. Industry analysis

Apart from a micro analysis of the company, the overall assessment of the industry in
which the company works is important. This assessment gives the credit analyst an
insight into the macro environment and the potential risk for the company. As the
economic and business environment in which a company is working is constantly
changing it becomes all the more important for the bank to assess the industry.

The industry is assessed in four parameters

      a.   Demand – Supply gap
      b.   Government policies
      c.   Input related risks
      d.   Extent of competition

After assessing the industry, the analyst sees how the company is geared to tackle the
future risks of the business. The analyst also sees how proactive the company is, to
take advantage of the opportunities on offer.




47
     10. Business analysis

a. Product profile

In this section the product profile of the company is looked into. The main products of
the company are noted and sales in value and volume terms for each product are
noted. The data collected should be atleast for the last two years. The analyst looks
into the composition of the products and the percentage share of each product. This
will help in knowing which product is doing well in the market and which one is not.

The analyst can also look into the production capacity of the company to see if the
company is fully utilizing its existing capacity.

b. Sales growth

Here the sales growth and the PBDIT growth of the company are analyzed. The data
presented should be for atleast three years. The recent growth rates are calculated and
the reasons for the variations are looked into. The recent growth rates and the industry
outlook form the basis of the future sales projections of the company. The analyst sees
that the sales projection given by the company is realistic or not.

11. Financial analysis

The financial analysis forms the main part of the assessment of any company. A
detailed analysis of the financial statements as well as ratio analysis is done to ascertain
the financial standing of the company. These financial statements are not studied in
isolation nor are they studied for one year. A trend analysis is done to analyze the
deviation or movement of the company.

The financial statements scrutinized are

      1. Balance sheet
      2. Income statement/ P & L statement

The tools for financial analysis

      1. Ratio analysis
      2. Cash flow analysis




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BALANCE SHEET

Balance sheet is a statement showing the assets and the liabilities of the firm at a
particular point of time. In simple terms, balance sheet means a list of everything a firm
owns and owes at a particular point of time. Normally the values shown are at historic
cost but where the current market price is less than cost the valuation is made on the
net realizable value.

Liability side

Net worth: It is made up of share capital and reserves.

Share capital: The bank is interested in the paid up capital as this constitutes the
amount actually collected by the company from its shareholders.

Reserves and surplus: Reserves arise out of undistributed past profits. For the banker,
reserves are at par with owned funds. The banks look whether the reserves are
retained in the business or the funds are deployed outside. Revaluation reserve is not
included by the banks as it doesn’t result in any inflow of funds.

Secured loans: Here the banks look at the security offered by the company and the
repayment schedule. The amount repayable during the year is treated as current
liability. All short term loans are also treated as current liability. Loans by directors to
the company are treated as quasi equity and added to networth of the company.

Unsecured loans: The bank would be interested in the maturity profile of these loans
to ascertain the liquidity position of the company.

Current liabilities and provisions: It forms an important part of the working capital and
a very important constituent while calculating the working capital limits by the bank.
Working capital loan is treated as a current liability and is deducted from the secured
loans and added the current liabilities.

Contingent liability: These are possible liabilities on the occurrence of a certain event.
These include claims against the company not acknowledged as debt, bills discounted
but not matured, guarantee issued etc. They are given as a footnote in the balance
sheet. Some contingent liabilities occur in the natural course of business but some
contingent liabilities like huge disputed taxes should be looked into.




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Asset side

Fixed assets: Assets are normally shown at their original cost less depreciation. The
bank makes sure that the assets are depreciated regularly and funds are set aside so
that they are available at the time of replacement of assets.

Investments: Huge funds blocked in investments are not taken lightly by the bank as
those funds are used by others.

Current assets and loans and advances: Sunk inventory is excluded from the closing
inventory as also the debtors due for more than six months. They are treated as
noncurrent assets.

Miscellaneous expenditure: The amount appearing under this head is deducted from
the owners fund to determine the owner’s stake in the business.




INCOME STATEMENT

It is a statement showing the income and expenses of the firm at a particular period of
time. It shows the amount of profit or loss the firm has earned at the end of the year
but a deeper analysis is necessary as there could be a loss but it could be for valid
reasons. Likewise there can be substantial profits but it could be from income arising
from other than core business of the firm. Therefore a complete reliance on the income
statement may give misleading conclusions. So apart from the P/L figures, the bank
scrutinizes the efficiency of the unit in the capacity utilization, streamlining of
expenses, increase in sales volume, cash generation capacity etc.

Analysis of the income statement should involve the financial statements of atleast
three years so that it gives a clearer picture of the current position. The trends could be
reasonably established and future projections estimated.

Sales: Sales should show an upward trend but the reasons should be ascertained. A
detailed analysis is given in the credit proposal section.

Cost of sales and gross profit: Gross profit of the last three years may be compared and
it may also be compared with the industry level. Among the various heads of expenses,
consumption of raw materials is analyzed. Levels of closing stock should be watched
and normal holding levels ensured.


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Operating profit: It is an indicator of profits generated through main business of the
firm. Therefore it is the operating profit figure is important to bankers for their credit
decision.

Net profit / loss: The derivation of this figure should be checked into. Banks check the
income and expenses to make sure that they are incurred in the normal course of the
business. Any intention to divert from the main activity should be looked into. The
study of the appropriation account is equally important. Whether the management is
strengthening their reserve position or declaring higher dividends despite forbidding
financial position shows their attitude towards the business.




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Appraisal of long term finance project
It is sanctioned for acquiring fixed assets i.e. land, machinery etc. It is normally
repayable in installment spread over three to five years. Repayment of a term loan
should be out of profit.
While sanctioning the term loan detailed analysis is made on following aspects of project:-
           1. Managerial competence
           2. Technical feasibility
           3. Commercial viability
           4. Economical viability
           5. Financial viability

Managerial competence
     It covers marketing processes and its suitability

Technical feasibility
        Feasibility of technical processes and its suitability
        Technological advancement
        Adequacy of machinery and scale of operations
        Availability of proper infrastructure with resources

Commercial viability
      Viability of project in recent scenario
      Market share of company in industry
      Strength of the competitors
      Future growth and product innovation of the company and industry

Economical viability
       Government rules and regulation about industry and specific with company
       Taxes, duties and other statutory obligation on company
       Whether the company is foreign exchange earner



Financial viability
        Checking of three-five years financial statements
        Checking of Income tax returns
        Calculation of following ratios
                Profitability Ratios


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                  Liquidity ratios
                  Interest coverage ratios
                  ROCE
                  Capital employed ratios
                  Price earnings ratios

Debt Service Coverage Ratio:
After ascertaining the profit, the next step is repaying capacity of the unit. This is done by
calculating DSCR, which is given as
         DSCR = __Net profit tax + Depreciation + Interest on TL__
                  Installment on term loan + interest on term loan
The ideal ratio for DSCR is 2:1. However for SSI is 1.5:1. It is not necessary that DSCR should
be 2:1 or 1.5:1 for each year of repayment. The average DSCR of entire repayment period
may be 2:1 or 1.5:1 respectively.

The DSCR helps in identifying repayment period and installment amount. Where DSCR is
low, repayment period is extended and vice versa. The installment can be decided by the
DSCR as per that particular year. The repayment period and installment are linked to future
accrual of the unit.

Projected fund flow/ cash flow statement:
Cash flow statement covering the entire period of loan are studied to ensure that sufficient
funds will be available year to implement the project and to pay back the loan

Projected balance sheet:
Projected balance sheet for the entire period of the term loan is prepared from the
projected cash flow statements. These balance sheets are analyzed to calculate future
liquidity, solvency, activity, profitability and turnover ratios.




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Financial statement analysis
 Ratio Analysis
  Interpreting and analyzing financial statements enables to discover what a company’s
financial position is. Ratio analysis is a device which is used to
     Compare the performance of a company this year with last year

        Compare the performance of a company with its competitors.

        Detect specific weaknesses

        Determine a company’s liquidity (ability to meet debts)

        Determine a company’s profitability

        Provide an indicator of trends.


Financial ratios can be divided into five categories
    1. Liquidity ratios
    2 Turnover ratios
    3 Leverage ratios
    4 Profitability ratios
    5 Valuation ratios

1. Liquidity Ratios: Liquidity refers to the ability of a firm to meet its obligations in the
short-run, usually one year. Liquidity ratios are generally based on the relationship
between current assets (the sources for meeting short-term obligations) and current
liabilities. The important liquidity ratios are:

      The Current Ratio: A simple measure that estimates whether the business can
       pay debts due within one year from assets that it expects to turn into cash within
       that year. A ratio of less than one is often a cause for concern, particularly if it
       persists for any length of time.

         Current Ratio = Current Assets
                         Current Liabilities




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      The Quick Ratio: Not all assets can be turned into cash quickly or easily. Some -
       notably raw materials and other stocks - must first be turned into final product,
       then sold and the cash collected from debtors. The Quick Ratio therefore adjusts
       the Current Ratio to eliminate all assets that are not already

        Quick Ratio =    Current Assets – Stock
                           Current Liabilities

2. Turnover Ratios: Turnover ratios, also referred to as activity ratios or asset
management ratios, measure how efficiently the assets are employed by a firm. These
ratios are based on the relationship between the level of activity, represented by sales
or cost of goods sold, and levels of various assets. The important turnover ratios are:
inventory turnover, average collection period, receivable turnover, fixed assets
turnover, and total assets turnover.

      Stock Turnover Ratio: Stock turnover measures how fast the inventory is moving
       through the firm and generating sales. Inventory turnover reflects the efficiency
       of inventory management.

        Stock Turnover =      Cost of Goods Sold
                              Average Inventory

      Debtor’s Turnover Ratio: This ratio shows how many times sundry debtors
       (accounts receivable) turnover during the year.

        Debtor’s Turnover =        Net Credit Sales
                                Average Sundry Debtors

      Average Collection Period: The average collection period represents the number
       of days’ worth of credit sales that is locked in sundry debtors.


        Average Collection Period =       Average Sundry Debtors
                                          Average Daily Credit Sales

     The average collection period and debtors’ are related as follows:
      Average Collection Period =                 365
                                          Debtors’ Turnover




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      Fixed Assets Turnover: this ratio measures sales per rupee of investment in fixed
       assets.

        Fixed Assets Turnover =              Net Sales
                                     Average Net Fixed Assets

      Total Assets Turnover: Akin to the output-capital ratio in economic analysis, the
       total assets turnover is defined as:

        Total Assets Turnover =            Net Sales
                                       Average Total Assets

3. Leverage Ratios: Leverage ratios help in assessing the risk arising from the use of debt
capital. Two types of ratios are commonly used to analyze financial leverage: structural
ratios and coverage ratios. Structural ratios are based on the proportions of debt and
equity in the financial structure of the firm. The important structural ratios are debt-
equity ratio and debt-assets ratio. Coverage ratios show the relationship between debt
servicing commitments and the sources of meeting these burdens. The important
coverage ratios are interest coverage ratio, fixed charges coverage ratio, and debt
service coverage ratio.

      Debt – Equity Ratio: the debt equity ratio shows the relative contributions of
       creditors and owners.


        Debt Equity Ratio = Debt
                            Equity
      Debt – Assets Ratio: the debt-asset ratio measures the extent to which
       borrowed funds support the firm’s assets.


        Debt – Assets Ratio =     Debt
                                  Assets

      Interest Coverage Ratio: Also called the times interest earned, this ratio enables
       to know whether a firm can easily meet its interest burden even if profit before
       interest and taxes suffer a considerable decline or not.

        Interest Coverage Ratio =          Profit before Interest and Taxes
                                                     Interest

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      Fixed Charges Coverage Ratio: This ratio shows how many times the cash flow
       before interest and taxes covers all fixed financing charges.

        Fixed Charges Coverage Ratio =
        Profit before Interest & Taxes + Depreciation
                      Debt Interest

      Debt Service Coverage Ratio: Used by banks in India, the debt service coverage
       ratio is defined as:

        Debt Service Coverage Ratio =
        Profit after Tax + Dep. + Non Cash Charges + Interest + Lease Rental
                     Interest + Lease Rental +Repayment of Loan

4. Profitability Ratios: Profitability reflects the final result of business operations. There
are two types of profitability ratios: profit margins ratios and rate of return ratios. Profit
margin ratios show the relationship between profit and sales. The most popular profit
margin ratios are: gross profit margin ratio and net profit margin ratio. Rate of return
ratios reflect the relationship between profit and investment. The important rate of
return measures are: return on assets, earning power return on capital employed and
return on equity.

      Gross Profit Margin Ratio: This ratio tells us something about the business's
       ability consistently to control its production costs or to manage the margins its
       makes on products its buys and sells.

        Gross Profit Margin Ratio=      Gross Profit
                                         Net Sales

      Net Profit Margin Ratio: This ratio shows the earnings left for shareholders as a
       percentage of net sales. It measures the overall efficiency of production,
       administration, selling, financing and pricing.

        Net Profit Margin Ratio =    Net Profit
                                     Net Sales

      Return on Assets: ROA is an odd measure because its numerator measures the
       return to shareholders whereas its denominator represents the contribution of
       all investors.

        Return on Assets =        Profit after Tax
                                Average Total Assets

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      Earning Power: Earning power is a measure of business performance which is
       not affected by interest charges and tax burden. It abstracts away the effect of
       capital structure and tax factor and focuses on operating performance.

        Earning Power =      Profit before Interest and Taxes
                                 Average Total Assets



      Return on Capital Employed: ROCE is the post-tax version of earning power. It
       considers the effect of taxation, but not the capital structure. It is internally
       consistent.

        Return on Capital Employed:       Profit before Interest and Tax (1 – Tax rate)
                                                      Average Total Assets

      Return on Equity: It measures the profitability of equity funds invested in the
       firm. It’s very important measure because it reflects the productivity of
       ownership (or risk) capital employed in the firm.

        Return on Equity =             PAT – Preference Dividend
                                 Equity Share Cap. + Reserves & Surplus

5. Valuation Ratios: Valuation ratios indicate how the equity stock of the company is
assessed in the capital market. Since the market value of equity reflects the combined
influence of risk and return, valuation ratios are the most comprehensive measures of a
firm’s performance. The important valuation ratios are: price-earnings ratio, yield, and
market value to book value ratio.

      Price Earnings Ratio: The price earnings ratio or the price earnings multiple is a
       summary measure which primarily reflects growth prospects, risk characteristics
       shareholder orientation, corporate image and degree of liquidity

        Price Earnings Ratio =   Market Price per share
                                  Earnings per share

      Yield: this is a measure of the rate of return earned by shareholders.

        Yield = Dividend + Price change
                       Initial Price




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      Market Value to Book Value: This ratio reflects the contribution of a firm to the
       wealth of society.

        Market Value to Book Value =      Market Value per share
                                          Book Value per share




Historical and Peer Group Analysis
  Useful information can be obtained by comparing ratios from the same company over
time (from historical data) or comparing the dame ratios in similar companies (from
industry studies from sources such as ratings agencies)

  These techniques help to establish whether a company is becoming more or less
efficient over time and more or less efficient than the competition.
  The advantage of using historical ratio analysis from the same company is that the
information is easily obtained and directly comparable. The disadvantages include the
fact that the results may have been influenced by different economic conditions,
different production methods, inflation, or changes in accounting policies.
  For peer group analysis, it is often difficult to find similar companies with which to
make a comparison. Smaller companies may have adopted different accounting policies
or have different product ranges. Typically a bank compares the financial ratios
calculated on the spreadsheet with published data, such as lists of industry standard
ratios. Another approach is that banks use the data published by credit rating agencies
or financial databases available in the market which enables the analysis of the company
vis-à-vis its competitors.




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60
SME ratings and importance of ratings
What is a credit rating?

 A credit rating is an opinion on the relative degree of risk associated with timely
payment of interest and principal on a debt instrument. A simple alphanumeric symbol
is normally used to convey a credit rating.

Credit ratings will benefit the SME sector

Over the years, the Indian financial system has come to regard credit ratings as an
integral part of the framework for credit and investment decisions relating to larger
enterprises. Today, as the banking sector increasingly focuses on lending and providing
other financial services to the small and medium enterprises (SME) sector, ratings can
play the same pivotal role as they do for larger enterprises. Ratings can make SMEs’
access to financial services more efficient by providing benchmarks and improving
transparency. Independent agency ratings for SMEs, based on high standards of
analytical rigour, can provide greater confidence to lenders, and consequently broaden
the range of financial resources available to SMEs.

Benefits for lenders and SMEs

The rapid growth of the SME sector creates exciting lending opportunities for banks and
financial institutions. A credit rating takes a significant chunk of the perceived
uncertainty out of their lending decisions, and reduces time and transaction costs in the
system. The Indian rating industry has established its credibility in providing in-depth
and unbiased analysis; ratings are therefore highly respected by lenders.

SMEs can leverage their ratings for negotiating better borrowing rates and
strengthening their relationships with bankers. Ratings can also facilitate faster
processing of credit facilities, as rating reports provide most of the information banks
need for approving loans. Further, SMEs can use ratings to enhance their credibility with
other counterparties too, such as technology providers, suppliers, and customers.




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Benefits for the sector as a whole

For the SME sector as a whole, ratings can provide an important impetus in raising
standards through better financial discipline, disclosure and governance practices.
Surveys among larger enterprises clearly show that managements feel ratings have
provided value that goes well beyond the rating symbol. In the SME sector too, ratings
can be an important feedback tool for managements. An interactive rating process helps
managements gain unique perspectives on business and financial issues and on best
practices, from rating experts who have in-depth sector knowledge and understanding
of risk. A rating exercise can help SMEs better understand what initiatives they need to
take to improve their operating and financial positions. Additionally, as the number of
rated players in the SME sector increases, there will be greater transparency, as more
and more information is demanded and made available.

SME ratings -- a viable proposition

There are certain misconceptions about SME credit ratings. Firstly, lenders and investors
often assume that SMEs will only get low ratings because of their smaller size. At CRISIL,
we recently had an opportunity to analyze over 5000 SMEs. Our analysis shows that
there were a healthy number of companies with considerable business strengths
underpinned by the leadership of first generation entrepreneurs who had built strong
brands and demonstrated the ability to withstand competition, including from large
global players. The combination of business and management strength indicates that
there will be several players in the sector with strong credit profiles. Several large and
highly successful companies today, were SMEs only a decade ago. Sun Pharma
Industries, Moser Baer India, Satyam Computer Services, Marico Industries and
Maharashtra Seamless are some examples. Rating agencies are forward-looking in their
analysis, and expectations are built into ratings.

Secondly there are several questions on information risk – will SMEs be able to provide
quality, reliable information required for a credit rating exercise? Our interaction with
SMEs has revealed that most players are willing to share reliable financial and
operational information for a credit rating, as they see the tangible benefits that ratings
provide. Many SMEs enjoy business relationships with large domestic and global
companies, and hence already have a track record of maintaining and providing high-
quality business and financial information.




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The third misconception is that SMEs will find fees of rating agencies unaffordable. In its
efforts to develop the credit markets, the ratings industry in India has never allowed
fees to be a constraint. In fact the rating fee is by far the lowest element of the cost of
raising funds, and there is no reason why this should not be so for the SME sector as
well. The National Small Industries Corporation has recently launched an attractive
scheme for Small Scale Industries, providing a subsidy of as much as 75% of the rating
fees. Clearly, ratings have the potential to transform the way SMEs are integrated into
the financial system. But rating agencies must recognise the special initiatives they will
need to take in this regard. They need to launch outreach initiatives, educating the SME
sector on the benefits of ratings. Rating agencies also need to have specialised teams
and analytical tools customised for the SME sector.

The significant transformation of the banking industry in India is clearly evident from
the changes that have occurred in the financial markets, institutions and products.
While deregulation has opened up new vistas for banks to argument revenues, it has
entailed greater competition and consequently greater risks. Cross- border flows and
entry of new products, particularly derivative instruments, have impacted significantly
on the domestic banking sector forcing banks to adjust the product mix, as also to
effect rapid changes in their processes and operations in order to remain competitive
in the globalize environment. These developments have facilitated greater choice for
consumers, who have become more discerning and demanding compelling banks to
offer a broader range of products through diverse distribution channels. The traditional
face of banks as mere financial intermediaries has since altered and risk management
has emerged as their defining attribute.

Currently, the most important factor shaping the world is globalization. The benefits of
globalization have been well documented and are being increasingly recognized.
Integration of domestic markets with international financial markets has been
facilitated by tremendous advancement in information and communications
technology. But, such an environment has also meant that a problem in one country
can sometimes adversely impact one or more countries instantaneously, even if they
are fundamentally strong.

There is a growing realization that the ability of countries to conduct business across
national borders and the ability to cope with the possible downside risks would
depend, interalia, on the soundness of the financial system. This has consequently
meant the adoption of a strong and transparent, prudential, regulatory, supervisory,
technological and institutional framework in the financial sector on par with
international best practices.


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All this necessitates a transformation: a transformation in the mindset, a
transformation in the business processes and finally, a transformation in knowledge
management. This process is not a one shot affair; it needs to be appropriately phased
in the least disruptive manner.

The banking and financial crises in recent years in emerging economies have
demonstrated that, when things go wrong with the financial system, they can result in
a severe economic downturn. Furthermore, banking crises often impose substantial
costs on the exchequer, the incidence of which is ultimately borne by the taxpayer. The
World Bank Annual Report (2002) has observed that the loss of US $1 trillion in banking
crisis in the 1980s and 1990s is equal to the total flow of official development
assistance to developing countries from 1950s to the present date. As a consequence,
the focus of financial market reform in many emerging economies has been towards
increasing efficiency while at the same time ensuring stability in financial markets.

From this perspective, financial sector reforms are essential in order to avoid such
costs. It is, therefore, not surprising that financial market reform is at the forefront of
public policy debate in recent years. Financial sector reform, through the development
of an efficient financial system, is thus perceived as a key element in raising countries
out of their 'low level equilibrium trap'. As the World Bank Annual Report (2005)
observes, ‘a robust financial system is a precondition for a sound investment climate,
growth and the reduction of poverty ’.

Financial sector reforms were initiated in India a decade ago with a view to improving
efficiency in the process of financial intermediation, enhancing the effectiveness in the
conduct of monetary policy and creating conditions for integration of the domestic
financial sector with the global system. The first phase of reforms was guided by the
recommendations of Narasimhan Committee.

        The approach was to ensure that ‘the financial services industry operates on the
         basis of operational flexibility and functional autonomy with a view to enhancing
         efficiency, productivity and profitability'.
        The second phase, guided by Narasimham Committee II, focused on
         strengthening the foundations of the banking system and bringing about
         structural improvements. Further intensive discussions are held on important
         issues related to corporate governance, reform of the capital structure, (in the
         context of Basel II norms), retail banking, risk management technology, and
         human resources development, among others.



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Since 1992, significant changes have been introduced in the Indian financial system.
These changes have infused an element of competition in the financial system, marking
the gradual end of financial repression characterized by price and non-price controls in
the process of financial intermediation. While financial markets have been fairly
developed, there still remains a large extent of segmentation of markets and non-level
playing field among participants, which contribute to volatility in asset prices. This
volatility is exacerbated by the lack of liquidity in the secondary markets. The purpose
of this paper is to highlight the need for the regulator and market participants to
recognize the risks in the financial system, the products available to hedge risks and the
instruments, including derivatives that are required to be developed/introduced in the
Indian system.

The financial sector serves the economic function of intermediation by ensuring
efficient allocation of resources in the economy. Financial intermediation is enabled
through a four-pronged transformation mechanism consisting of liability-asset
transformation, size transformation, maturity transformation and risk transformation.




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Overview of credit analysis
 Need for credit analysis
Credit analysis is done in order to lessen the credit risk faced by a bank. Credit risk is
defined as the possibility of losses associated with diminution in the credit quality of
borrowers or counterparties. In a bank's portfolio, losses stem from outright default
due to inability or unwillingness of a customer or counterparty to meet commitments
in relation to lending, trading, settlement and other financial transactions.
Alternatively, losses result from reduction in portfolio value arising from actual or
perceived deterioration in credit quality. Credit risk emanates from a bank's dealings
with an individual, corporate, bank, financial institution or a sovereign. Credit risk may
take the following forms

        In the case of direct lending: principal/and or interest amount may not be repaid;
        In the case of guarantees or letters of credit: funds may not be forthcoming from
         the constituents upon crystallization of the liability;
        In the case of treasury operations: the payment or series of payments due from
         the counter parties under the respective contracts may not be forthcoming or
         ceases;
        In the case of securities trading businesses: funds/ securities settlement may not
         be effected;
        In the case of cross-border exposure: the availability and free transfer of foreign
         currency funds may either cease or the sovereign may impose restrictions.

Role of credit analysis
The extent of the credit analysis is determined by
    The size and nature of the enquiry,

      The potential future business with the company,

      The availability of security to support loans,

      The existing relationship with the customer.




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The analysis determines whether the available information is adequate for decision
making purposes, of if additional information is required. The analysis therefore covers a
wide range of issues.
For evaluating a loan proposal for a company, it is necessary to
     Obtain credit and trade references,

      Examine the borrower’s financial condition,

      Consult with legal counsel regarding a particular aspect of the draft loan
       agreement


Framework of Credit Analysis

Credit analysis includes financial and non-financial factors, and these factors are all
interrelated. These factors include:
     The environment

      The industry

      Competitive position of the firm

      Financial risks the company has

      Management/business risks

      Loan structure and documentation issues.




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Lending process
RBI Guidelines for Credit Risk Management Credit Rating
Framework

A Credit-risk Rating Framework (CRF) is necessary to avoid the limitations associated
with a simplistic and broad classification of loans/exposures into a "good" or a "bad"
category. The CRF deploys a number/ alphabet/ symbol as a primary summary indicator
of risks associated with a credit exposure. Such a rating framework is the basic module
for developing a credit risk management system and all advanced models/approaches
are based on this structure. In spite of the advancement in risk management techniques,
CRF is continued to be used to a great extent. These frameworks have been primarily
driven by a need to standardize and uniformly communicate the "judgment" in credit
selection procedures and are not a substitute to the vast lending experience
accumulated by the banks' professional staff.

Broadly, CRF can be used for the following purposes:

     1. Individual credit selection, wherein either a borrower or a particular exposure/
        facility is rated on the CRF
     2. Pricing (credit spread) and specific features of the loan facility. This would largely
        constitute transaction-level analysis.
     3. Portfolio-level analysis.
     4. Surveillance, monitoring and internal MIS

These would be relevant for portfolio-level analysis. For instance, the spread of credit
exposures across various CRF categories, the mean and the standard deviation of losses
occurring in each CRF category and the overall migration of exposures would highlight
the aggregated credit-risk for the entire portfolio of the bank.

Types of Credit Rating
Credit rating can be classified as:
        1 External Credit Rating.
        2 Internal Credit Rating.




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External Credit Rating:
        A credit rating is not, in general, an investment recommendation concerning a
given security. In the words of S&P,” A credit rating is S&P's opinion of the general
creditworthiness of an obligor, or the creditworthiness of an obligor with respect to a
particular debt security or other financial obligation, based on relevant risk factors.” In
Moody's words, a rating is, “an opinion on the future ability and legal obligation of an
issuer to make timely payments of principal and interest on a specific fixed-income
security.”
         Since S&P and Moody's are considered to have expertise in credit rating and are
regarded as unbiased evaluators, there ratings are widely accepted by market
participants and regulatory agencies. Financial institutions, when required to hold
investment grade bonds by their regulators use the rating of credit agencies such as S&P
and Moody's to determine which bonds are of investment grade.
         The subject of credit rating might be a company issuing debt obligations. In the
case of such “issuer credit ratings” the rating is an opinion on the obligor’s overall
capacity to meet its financial obligations. The opinion is not specific to any particular
liability of the company, nor does it consider merits of having guarantors for some of
the obligations. In the issuer credit rating categories are
     a) Counter party ratings

     b) Corporate credit ratings

     c) Sovereign credit ratings

       The rating process includes quantitative, qualitative, and legal analyses. The
quantitative analysis is mainly, financial analysis and is based on the firm’s financial
reports. The qualitative analysis is concerned with the quality of management, and
includes a thorough review of the firm’s competitiveness within its industry as well as
the expected growth of the industry and its vulnerability to technological changes,
regulatory changes, and labor relations.



Internal Credit Rating:
        A typical risk rating system (RRS) will assign both an obligor rating to each
borrower (or group of borrowers), and a facility rating to each available facility. A risk
rating (RR) is designed to depict the risk of loss in a credit facility. A robust RRS should
offer a carefully designed, structured, and documented series of steps for the
assessment of each rating.



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Customers shall be analyzed on MFA and scored on ESC on the basis of audited
financials.
Lending to SME working capital/customers is based on LGD (loss given default).SME
banking will calculate the loss given default (LGD) for the customer based on the
‘product recovery rate’ (PRR), ‘collateral recovery’(CRR) and credit grade.

Credit shall enforce the underwriting standards and a high level of discipline is to be
maintained by the SME team to identify and highlight exceptions as part of the annual
review process.

Internal credit check on the business and owners should be clear. Dedupe and CIBIL
checks will be initiated by the RM/PM as per in country credit bulletin to ensure that the
customer is now delinquent with other businesses of SCB/other banks/FIs.
The borrowers including directors, majority shareholders and guarantors should not
appear in the defaulters list of RBI.

The following are the steps for assessment of rating:
Objectivity and Methodology: The goal is to generate accurate and consistent risk rating,
yet also to allow professional judgment to significantly influence a rating where it is
appropriate. The expected loss is the product of an exposure (say, Rs. 100) and the
probability of default (say, 2%) of an obligor (or borrower) and the loss rate given
default (say, 50%) in any specific credit facility. In this example,
The expected loss = 100*.02*.50 = Rs. 1
A typical risk rating methodology (RRM)

     o Initial assign an obligor rating that identifies the expected probability of default
       by that borrower (or group) in repaying its obligations in normal course of
       business.

     o The RRS then identifies the risk loss (principle/interest) by assigning an RR to
       each individual credit facility granted to an obligor.


The obligor rating represents the probability of default by a borrower in repaying its
obligation in the normal course of business. The facility rating represents the expected
loss of principal and/ or interest on any business credit facility. It combines the
likelihood of default by a borrower and conditional severity of loss, should default occur,
from the credit facilities available to the borrower.




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Documentation - Term Loan Agreement
  The loan agreement is the legal document that defines the relationship between the
borrower and the lending bank or banks. The loan agreement gives the bank the right to
terminate the loan agreement if any of the following events occur:
    o Nonpayment of principal

     o Nonpayment of interest

     o Acceleration of other indebtedness (cross default)

     o Voluntary or involuntary bankruptcy.

These events are known as ‘events of default’ and the mechanism in the loan
agreement used to control them are known as loan agreement covenants.




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Segmentation of SME (clusters)
Let us first see the needs/ benefits of segmentation of SME
 Market demand and market potential can be measured
 Customer behavior is similar within segments and different from other segment
 Ease of implementation can be achieved at local level
 Helps in strategy formation and implementation.
 Design products and services to meet customer needs
 Redirect bank efforts to better serve profitable and attractive customers
 Develop communications most applicable to newly targeted segments
 Select effective channel strategies
 Use relevant advertising and promotional vehicles to achieve maximum reach



Without an effective and dynamic segmentation strategy
 Resources are being used ineffectively
 Highest profit customers–current and potential–may be at risk
 Value destroyers erode profitability
 Product offerings are sub-optimal
 Channels are misaligned versus customer requirements and profitability




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Basis of SME Segmentation
Traditionally SME segmentation is based on the turnover of the company, turnover
criteria varying from bank to bank. Such simplistic segmentation criteria, however
ignores critical factors such as -Business Scope and legal structure of the firm. The SME
strategy and services offerings is closely linked to Scope of business i.e. whether the
SME is a Retailer, Wholesalers, a Supermarket, Real estate developers/owner, Self
employed professionals Garage Owners, Small manufacturers, a Hotel/Hotel Chains
owner, Restaurants owners or mom-n-pop shops. Similarly the legal entity of the firm
viz. proprietorship, partnership or limited liability companies have different degrees of
control structure within the organization and SME banking offering needs to meet this
requirement Service segmentation based on broader parameters helps meet the
specific needs and also betters the chances of cross-selling.

Segmentation of SME in India on a General Basic
1. Auto Components
2. Chemicals and Petrochemicals
3. Engineering Goods
4. Food and Agro Products
5. Gems and Jeweler
6. IT & Its-BPO
7. Leather and Leather Products
8. Pharmaceuticals
9. Plastic, Plastic Goods and Plastic Processing
10. Textiles




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Sector analysis
1. Economy Analysis
  It is important to do an economic analysis before lending. The rates are which credit is
offered is determined by the demand and supply of funds in the market. Usually higher
interest rates are charged for loans when there is high inflation in the economy. It is also
important to know the growth rate of the economy because if the economy grows at a
faster rate, the companies also grow at a fast rate and there is more need for funds.


2. Industry Analysis
  The industry sector in which the borrower operates has a significant impact upon the
way the business is managed. It also produces different financing and asset structures in
the balance sheet of the businesses. The terms of trade which exist between the buyer
and the seller in the industry and the methods by which the contract of sale are
controlled both legally and practically will all have and e effect upon borrower’s activity
in the industry and a financial implication in its business.


3. Business Analysis
 The nature of the market in which the customer operates or in which its products are
sold is important to understand. It has a major influence on the level and style of activity
and the financial results. In investigating the market the analyst is be able to establish a
point of view of both macro and micro- economic elements that may affect the future of
the debtor or obligor. In addition significant understanding of the potential
effectiveness of plans and strategies can be achieved when comparing the obligor’s view
of market compared to independently sourced information.
 In business analysis, specific analysis is done by understanding the product, the growth
of the business in which the firm is operating, its corporate strategy and plans, its
business plans and its management.




74
Conclusion
Lending which is the most important function in any bank involves assessing the
creditworthiness of a customer. It involves financial and non financial analysis. Ratio
analysis and cash flow forecasting is a financial measure whereas non financial analysis
include economy analysis, industry analysis and business analysis.
Banks use different credit analysis models such as traditional credit analysis, numerical
scoring model, sequential credit analysis, pattern recognition systems etc. Statistical
tools like discriminant analysis, regression analysis, linear and non linear regression are
used to a great extent for credit analysis.




75
Bibliography
Websites Referred
 http://www.standardchartered.co.in
 http://www.rbi.org.in
 http://en.wikipedia.org
 http://www.csub.edu/ssricrem/SPSS/SPSS11-5/11-5.htm
 http://www.ats.ucla.edu/stat/spss/whatstat/whatstat.htm
 http://www.investorwords.com/
 http://dictionary.bnet.com/
 http://financial-dictionary.thefreedictionary.com
 http://www.ffiec.gov/


Books Referred
 Standard Chartered pdf.




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