Credit Appraisal & Rating For SME Loans

CREDIT APPRAISAL AND RATING FOR SME LOANS

Puneet Sahoo
Roll No:-11202214 (MBA-2011-13) 11202214@ksom.ac.in

Dr. B.C.M Patnaik

KIIT UNIVERSITY Email id:- bcmpatnaik@ksom.ac.in

NIRAJ.P. Nangrani
DENA BANK Chief Credit Manager

SCHOOL OF MANAGEMENT, KIIT UNIVERSITY BHUBNESWAR-751024

Credit Appraisal & Rating For SME Loans

Certificate from the Organisation

This is to certify that Mr. PUNEET SAHOO, Rollno:11202214 has completed his Summer Internship at DENA BANK and has submitted his project report titled CREDIT APPRAISAL & RATING OF SME LOAN This Report is the result of his/her owns work and no part of it earlier comprised any other report, monograph, dissertation or book. This Project was carried out under my overall supervision.

Date: -------------Place:-MUMBAI ------------------------Mr.Niraj.P.Nangrani

Credit Appraisal & Rating For SME Loans

Certificate by the Candidate

I hereby declare that this project report titled Credit Appraisal & Rating For SME Loans submitted towards fulfillment of Master of Business Administration degree of KIIT University of Bhubaneswar is an original work done by me and is done with genuine studies and observations carried out by me in Thane Regional Office of Dena Bank.

Name: Puneet Sahoo Date: 30th June 2012 Place: Mumbai

Credit Appraisal & Rating For SME Loans

Credit Appraisal & Rating For SME Loans

Acknowledgement
I am overwhelmed in all humbleness and gratefulness to acknowledge my depth to all those who have helped me to put these ideas, well above the level of simplicity and into something concrete. I would first thank my project guide Mr Niraj.P.Nangrani (Chief Credit Manager, RO, Thane), Mr Partho Narayan Dash (Manager Credit, RO, Thane ), Mr. M.L.Behera (Regional Manager, RO, Thane),Mr.Chetan Joshi (DRM,RO,Thane) Mr.Soumendra Kumar Dalal (Manager HR),. They were always there to show the right track when I needed help. With the help of their valuable suggestions, cooperation, guidance and encouragement, I was able to perform this Project. I would like to express my gratefulness to my faculty guide Dr B.C.M.Patnaik of School of Management (KIIT, Bhubneswar) for guiding me throughout the project. Her valuable contributions in this project, worthy suggestions and overall guidance gave meaning to the project. Last but not the least, I would also like to thank my parents who were the initial instigator and early on provided advice and encouragement, generously shared their views, ideas and data. I am unable to mention many others who have helped me greatly but it gives immense pleasure to appreciate and thank all those without whose encouragement and help this project would never have been completed.

Credit Appraisal & Rating For SME Loans

EXECUTIVE SUMMARY

The first task of every bank is to analyze credit.The creditworthiness of a borrower is the first step towards disbursal of any kind of facilities. The fact that loans are the most important asset of any banks portfolio is justified by sound credit analysis. There is always an undercurrent of risk attached to bank loans. A loan default could be the outcome of faulty judgment, systemic risk and tainted individuals. Credit analysis is required for determining the probability of payment and involves overall evaluation of character, capacity and capital. It is short-term analysis and most often the only analysis used in determining whether or not to approve a customer for credit terms.This study is aimed at analyzing and understanding the credit analysis process and the tasks attached to it. The credit analyst in the bank prepares an exhaustive Business Credit Application as it includes sufficient information about the client, its peers as well as the market and gives a better understanding of how lenders evaluate creditworthiness of the borrower. For, this project the credit application of S.P.Chemi Equipments was analyzed. This company proposes a Cash Credit Facility of Rs 42.00lacs and also a Fresh Bank Guarantee limit of Rs 20.00lacs. The various components in the credit application have been taken and carried out in the step-wise procedure. The various risks attached to the companies viz. industry, financial, business, security, management and environmental & social were analyzed and stated. The risk are to be analyzed periodically and the amount sanctioned is to be supervised and the disbursement has to be made in a phased manner.

Credit Appraisal & Rating For SME Loans

CONTENTS
1. OBJECTIVES & SCOPE 2. THEORETICAL PERSPECTIVE INTRODUCTION TO BANKING SECTOR CLASSIFICATION OF BANKING SECTOR DENA BANK INTRODUCTION TO SME CHALLENGES OF SME CREDIT APPRAISAL CREDIT RATING SUMMARY OF THE LOAN

3. METHODOLOGY 4. LIMITATIONS 5. FINDINGS & ANALYSIS 6. CONCLUSION 7. BIBLIOGRAPHY 8. ANNEXURE

Credit Appraisal & Rating For SME Loans

OBJECTIVES AND SCOPE

This project was completed keeping in mind the following objectives: To study the credit products/facilities offered by the bank. To gain an exhaustive knowledge of the credit analysis process, the compilation of a business credit application and the overall loan disbursement process flow. To get hands on experience in a corporate environment. To judge the creditworthiness of the borrower. The various steps involved in the disbursement of loan and also the recovery of loan amount. The process of Credit rating of a particular company. To ensure that the project report is useful and could become a source of reference for the bank.

THEORETICAL PERSPECTIVE

Credit Appraisal & Rating For SME Loans

Introduction To Banking Sector:A snapshot of the banking industry:The Reserve Bank of India (RBI), as the central bank of the country, closely monitors developments in the whole financial sector. The banking sector is dominated by Scheduled Commercial Banks (SBCs). As at end March 2002, there were 296 Commercial banks operating in India. This included 27 Public Sector Banks (PSBs), 31 Private, 42 Foreign and 196 Regional Rural Banks. Also, there were 67 scheduled co-operative banks consisting of 51 scheduled urban cooperative banks and 16 scheduled state co-operative banks. Net banking, phone banking, mobile banking, ATMs and bill payments are the new buzz words that banks are using to lure customers. With a view to provide an institutional mechanism for sharing of information on borrowers / potential borrowers by banks and Financial Institutions, the Credit Information Bureau (India) Ltd. (CIBIL) was set up in August 2000. The Bureau provides a framework for collecting, processing and sharing credit information on borrowers of credit institutions. SBI and HDFC are the promoters of the CIBIL.

Classification of Banks:The Indian banking industry, which is governed by the Banking Regulation Act of India 1949 can be broadly classified into two major categories, non-scheduled banks and scheduled banks. Scheduled banks comprise commercial banks and the co-operative banks. In Terms of ownership, commercial banks can be further grouped into nationalized banks, the State Bank of India and its group banks, regional rural banks and private sector banks (the old / new domestic and foreign). These banks have over 67,000 branches spread across the country. The Indian banking industry is a mix of the public sector, private sector and foreign banks. The private sector banks are again spilt into old banks and new banks.

SCENARIO OF BANKING SECTOR:General Banking Scenario:The pace of development for the Indian banking industry has been tremendous over the past decade. As the world reels from the global financial meltdown, Indias banking sector has been one of the very few to actually maintain resilience while continuing to provide growth opportunities, a feat unlikely to be matched by other developed markets around the world. FICCI conducted a survey on the Indian Banking Industry to assess the competitive advantage

Credit Appraisal & Rating For SME Loans

offered by the banking sector, as well as the policies and structures required to further stimulate the pace of growth. The predicament of the banks in the developed countries owing to excessive leverage and lax regulatory system has time and again been compared with somewhat unscathed Indian Banking Sector. An attempt has been made to understand the general sentiment with regards to the performance, the challenges and the opportunities ahead for the Indian Banking Sector. A majority of the respondents, almost 69% of them, felt that the Indian banking Industry was in a very good to excellent shape, with a further 25% feeling it was in good shape and only 6% of the respondents feeling that the performance of the industry was just average. In fact, an overwhelming majority (93.33%) of the respondents felt that the banking industry compared with the best of the sectors of the economy, including pharmaceuticals, infrastructure, etc. Most of the respondents were positive with regard to the growth rate attainable by the Indian banking industry for the year 2009-10 and 2014-15, with 53.33% of the view that growth would be between 15-20% for the year 2009-10 and greater than 20% for 2014-15.

DENA BANK

Credit Appraisal & Rating For SME Loans

History: Dena Bank was founded on 26th May, 1938 by the family of Devkaran Nanjee under the name Devkaran Nanjee Banking Company Ltd. It became a Public Ltd. Company in December 1939 and later the name was changed to Dena Bank Ltd. In July 1969 Dena Bank Ltd. along with 13 other major banks was nationalized and is now a Public Sector Bank constituted under the Banking Companies (Acquisition & Transfer of Undertakings) Act, 1970. Under the provisions of the Banking Regulations Act 1949, in addition to the business of banking, the Bank can undertake other business as specified in Section 6 of the Banking Regulations Act, 1949.

Vision:DENA BANK will emerge as the most preferred Bank of customer choice in its area of operations, by its reputation and performance

DENA BANK will provide its:Customers - premier financial services of great value, Staff - positive work environment and opportunity for growth and achievement, Shareholders - superior financial returns, Community - economic growth.

Milestones: One among six Public Sector Banks selected by the World Bank for sanctioning a loan of Rs.72.3 crores for augmentation of Tier-II Capital under Financial Sector Developmental project in the year 1995. One among the few Banks to receive the World Bank loan for technological up gradation and training.

Launched a Bond Issue of Rs.92.13 crores in November 1996. Maiden Public Issue of Rs.180 Crores in November 1996. Introduced Tele banking facility of selected metropolitan centers.

INTRODUCTION TO SME :-

Credit Appraisal & Rating For SME Loans

In the Indian context, the small and medium enterprises (SME) sector is broadly a Term used for small scale industrial (SSI) units and medium-scale industrial units. Any industrial unit with a total investment in its fixed assets or leased assets or hire-purchase asset of up to Rs 10 million, can be considered as an SSI unit and any investment of up to Rs 100 million can be termed as a medium unit. An SSI unit should neither be a subsidiary of any other industrial unit nor be owned or controlled by any other industrial unit. An SME is known by different ways across the world. In India, a standard definition surfaced only in October 2, 2006, when the Ministry of Micro, Small and Medium Enterprises, Government of India, imposed the Micro, Small and Medium enterprises Development (MSMED) Act, 2006. This definition, however was changed according to the changing economic scenario and thus has separate definitions to it. For instance, an SME definition for manufacturing enterprises is different from what an SME definition for service enterprises has to say. 1. MICRO ENTERPRISES Micro (Manufacturing) Enterprise: Enterprise engaged in the manufacturing / Production or preservation of goods and whose investment in plant machinery (original cost excluding land and building does not exceed Rs 25lacs irrespective of the location of the unit. Micro (Service) Enterprise: Enterprise engaged in the providing/ rendering of service and whose investment in equipments(original cost excluding land building furniture fittings and other not directly related to the service rendered or as may be under the MSME development Act 2006 ) does not exceed Rs10lacs. 2. SMALL ENTERPRISES Small (Manufacturing) Enterprises: Enterprise engaged in the manufacturing / Production or preservation of goods and whose investment in plant machinery (original cost excluding land and building and the items specified by the ministry of SSI vide its notification No. S.O.1722 (E) Dated October 5, 2006 as furnished in annexure 1) does not exceed Rs 5crore.

Small (Service) Enterprises:

Credit Appraisal & Rating For SME Loans

Enterprise engaged in the providing/ rendering of service and whose investment in equipments(original cost excluding land building furniture fittings and other not directly related to the service rendered or as may be under the MSME development Act 2006 ) does not Exceed Rs 2crore. The Small and Micro (Service) Enterprises shall include small road and water transport operators, small business professional and self employed persons and all other service enterprises. 3. MEDIUM ENTERPRISES Medium (Manufacturing) Enterprises: Enterprise engaged in the manufacturing/ Production or preservation of goods and whose investment in plant machinery (original cost excluding land and building and the items specified by the ministry of SSI vide its notification No. S.O.1722 (E) Dated October 5, 2006) is more than 5crore but does not exceed Rs 10crore. Medium (service) Enterprises: Enterprise engaged in the manufacturing/ Production or preservation of goods and whose investment in plant machinery (original cost excluding land and building and the items specified by the ministry of SSI vide its notification No. S.O.1722 (E) Dated October 5, 2006) is more than 2crore but does not exceed Rs 5crore.

Challenges faced by SME:The challenges being faced by the small and medium sector may be briefly set out as Follows Small and Medium Enterprises (SME), particularly the tiny segment of the small enterprises have inadequate access to finance due to lack of financial information and non-formal business practices. SMEs also lack access to private equity and venture capital and have a very limited access to secondary market instruments. SMEs face fragmented markets in respect of their inputs as well as products and are vulnerable to market fluctuations. SMEs lack easy access to inter-state and international markets. The access of SMEs to technology and product innovations is also limited. There is lack of awareness of global best practices.

Credit Appraisal & Rating For SME Loans

SMEs face considerable delays in the settlement of dues/payment of bills by the large scale buyers. With the deregulation of the financial sector, the ability of the banks to service the credit requirements of the SME sector depends on the underlying transaction costs, efficient recovery processes and available security. There is an immediate need for the banking sector to focus on credit and SMEs Credit appraisal means an investigation/assessment done by the banks before providing any Loans & advances/project finance & also checks the commercial, financial & technical viability of the project proposed, its funding pattern & further checks the primary & collateral security cover available for recovery of such funds.

Credit Analysis:The credit analysis process analyses both the financial as well as the non-financial aspect of companies. The companys overall financials are analyzed for proper understanding of the companys business and its performance. It also includes the fundamental peer analysis for assessing the companys as well as industry trends and prospects. The process also defines the risk appetite of the bank in relation to the credit profile of the customer. Further assessment of requirements of customer is made and the facilities that can be provided are structured. The different segments that are considered for analysis of a company are: Industry Analysis The industry analysis is basically done for judging the present and future trend of the industry in which the company operates and whether the trend augurs well for the company. The various factors affecting an industry like suppliers, customers, unorganized players etc are all considered for this analysis. Business Analysis The business analysis is done to measure the strength and efficiency of the business operations of the company. Financial Analysis In this analysis the financials of the company are thoroughly reviewed and different ratios related to the solvency, profitability, debt service capacity etc are computed and analyzed for determining the strength and efficiency of the business unit. Management Analysis In this analysis the experience and efficiency of the management is considered. Their decision making capabilities and past performance are all taken into consideration. The bank needs to see whether a member in the board is PEP (Politically Exposed Person) and there is a capable successor to the owner, etc

Credit Appraisal & Rating For SME Loans

Brief overview of Credit Appraisal:Credit Appraisal is a process to ascertain the risks associated with the extension of the credit facility. It is generally carried by the financial institutions, which are involved in providing financial funding to its customers. Credit risk is a risk related to non-repayment of the credit obtained by the customer of a bank. Thus it is necessary to appraise the credibility of the customer in order to mitigate the credit risk. Proper evaluation of the customer is performed this measures the financial condition and the ability of the customer to repay back the Loan in future.. Thus, the customer's cash flows are ascertained to ensure the timely payment of principal and the interest. It is the process of appraising the credit worthiness of a Loan applicant. Factors like age, income, number of dependents, nature of employment, continuity of employment, repayment capacity, previous Loans, credit cards, etc. are taken into account while appraising the credit worthiness of a person. Every bank or lending institution has its own panel of officials for this purpose. However the 3 C of credit are crucial & relevant to all borrowers/ lending, which must be kept in mind, at all times. Character Capacity Collateral And also there are also some many 5 parameters which must kept in mind at a time of lending money .They are: About company

About promoters Existing experience Education Family background

Credit Appraisal & Rating For SME Loans

Occupation Years of business

About project Financial feasibility

a) Sales growth b) Profit c) PAT margin d) Leverage ratio e) Stock turnover ratio f) Debtors days g) Creditors days h) Operating cycle days i) Liquidity j) DSCR

About industry analysis Market study industry performance growth margin production capacity market feedback

Credit Appraisal & Rating For SME Loans

risk and mitigation If any one of these are missing in the equation then the lending officer must question the viability of credit. There is no guarantee to ensure a Loan does not run into problems; however if proper credit evaluation techniques and monitoring are implemented then naturally the Loan loss probability / problems will be minimized, which should be the objective of every lending Officer. Credit is the provision of resources (such as granting a Loan) by one party to another party where that second party does not reimburse the first party immediately, thereby generating a debt, and instead arranges either to repay or return those resources (or material(s) of equal value) at a later date. The first party is called a creditor, also known as a lender, while the second party is called a debtor, also known as a borrower. Credit allows you to buy goods or commodities now, and pay for them later. We use credit to buy things with an agreement to repay the Loans over a period of time. The most common way to avail credit is by the use of credit cards. Other credit plans include personal Loans, home Loans, vehicle Loans, student Loans, small business Loans, trade. A credit is a legal contract where one party receives resource or wealth from another party and promises to repay him on a future date along with interest. In simple Terms, a credit is an agreement of postponed payments of goods bought or Loan. With the issuance of a credit, a debt is formed.

Brief overview of Loan: Loans can be of two types fund base & non-fund base:
Fund Base includes: Cash credit Term Loan

Non-fund Base includes: Letter of Credit Bank Guarantee Bill Discounting

Fund Base:A. Working capital

Credit Appraisal & Rating For SME Loans

The objective of running any industry is earning profits. An industry will require funds to acquire fixed assets like land, building, plant, machinery, equipments, vehicles, tools etc., & also to run the business i.e. its day-to-day operations. Funds required for day to-day working will be to finance production & sales. For production, funds are needed for purchase of raw materials/ stores/ fuel, for employment of labor, for power charges etc. financing the sales by way of sundry debtors/ receivables. Capital or funds required for an industry can therefore be bifurcated as fixed capital & working capital. Working capital in this context is the excess of current assets over current liabilities. The excess of current assets over current liabilities is treated as net, for storing finishing goods till they are sold out & for working capital or liquid surplus & represents that portion of the working capital, which has been provided from the long-Term source. B. Term Loan A Term Loan is granted for a fixed Term of not less than 3 years intended normally for financing fixed assets acquired with a repayment schedule normally not exceeding 8 years. A Term Loan is a Loan granted for the purpose of capital assets, such as purchase of land, construction of, buildings, purchase of machinery, modernization, renovation or rationalization of plant, & repayable from out of the future earning of the enterprise, in installments, as per a prearranged schedule. From the above definition, the following differences between a Term Loan & the working capital credit afforded by the Bank are apparent: The purpose of the Term Loan is for acquisition of capital assets. The Term Loan is an advance not repayable on demand but only in installments ranging over a period of years. The repayment of Term Loan is not out of sale proceeds of the goods & commodities per se, whether given as security or not. The repayment should come out of the future cash accruals from the activity of the unit. The security is not the readily saleable goods & commodities but the fixed assets of the units. It may thus be observed that the scope & operation of the Term Loans are entirely different from those of the conventional working capital advances. The Banks commitment is for a long period & the risk involved is greater. An element of risk is inherent in any type of Loan because of the uncertainty of the repayment. Longer the duration of the credit, greater is the attendant uncertainty of repayment & consequently the risk involved also becomes greater. However, it may be observed that Term Loans are not so lacking in liquidity as they appear to be. These Loans are subject to a definite repayment program me unlike short Term Loans for working capital (especially the cash credits) which are being renewed year after year. Term Loans would be repaid in a regular way from the anticipated income of the industry/ trade.

Credit Appraisal & Rating For SME Loans

These distinctive characteristics of Term Loans distinguish them from the short Term credit granted by the banks & it becomes necessary therefore, to adopt a different approach in examining the applications of borrowers for such credit & for appraising such proposals. The repayment of a Term Loan depends on the future income of the borrowing unit. Hence, the primary task of the bank before granting Term Loans is to assure itself that the anticipated income from the unit would provide the necessary amount for the repayment of the Loan. This will involve a detailed scrutiny of the scheme, its capital assets. Financial aspects, economic aspects, technical aspects, a projection of future trends of outputs & sales & estimates of cost, returns, flow of funds & profits.

Non-fund Base:A. Letter of credit The expectation of the seller of any goods or services is that he should get the payment immediately on delivery of the same. This may not materialize if the seller & the buyer are at different places (either within the same country or in different countries). The seller desires to have an assurance for payment by the purchaser. At the same time the purchaser desires that the amount should be paid only when the goods are actually received. Here arises the need of Letter of Credit (LCs). The objective of LC is to provide a means of payment to the seller & the delivery of goods & services to the buyer at the same time. Definition: A Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at the request & on the instructions of the customer (the applicant) or on its own behalf, Is to make a payment to or to the order of a third party (the beneficiary), or is to accept & pay bills of exchange (drafts drawn by the beneficiary); or Authorizes another bank to effect such payment, or to accept & pay such bills of exchanges (drafts); or Authorizes another bank to negotiate the Terms & conditions of the credit are complied with. against stipulated document(s), provided that

B. Bank Guarantees: A contract of guarantee is defined as a contract to perform the promise or discharge the liability of the third person in case of the default. The parties to the contract of guarantees are:

Credit Appraisal & Rating For SME Loans

Applicant: The principal debtor person at whose request the guarantee is executed Beneficiary: Person to whom the guarantee is given & who can enforce it in case of default. Guarantee: The person who undertakes to discharge the obligations of the applicant in case of his default. Thus, guarantee is a collateral contract, consequential to a main co applicant & the beneficiary. Purpose of Bank Guarantees: Bank Guarantees are used to for both both preventive & remedial purposes. The guarantees executed by banks comprise both performance guarantees & financial guarantees. The guarantees are structured according to the Terms of agreement, viz., security, maturity & purpose. Branches may issue guarantees generally for the following purposes: In lieu of security deposit/earnest money deposit for participating in tenders; Mobilization advance or advance money before commencement of the project by the contractor & for money to be received in various stages like plant layout, design/drawings in project finance; In respect of raw materials supplies or for advances by the buyers; In respect of due performance of specific contracts by the borrowers & for obtaining full payment of the bills; Performance guarantee for warranty period on completion of contract which would enable the suppliers to period to be over; realize the proceeds without waiting for warranty) To allow units to draw funds from time to time from the concerned indenters against part execution of contracts, etc.Bid bonds on behalf of exporters Export performance guarantees on behalf of exporters favoring the Customs Department under EPCG scheme. The banking sector is also taken as a proxy for the economy as a whole. The performance of bank should therefore, reflect Trends in the Indian Economy. Due to the reforms in the financial sector, banking industry has changed drastically with the opportunities to the work with, new accounting standards new entrants and information technology. The deregulation of the interest rate, participation of banks in project financing has changed in the environment of banks.

Credit Appraisal & Rating For SME Loans

MSME Development Act (2006)

In line with the announcement in the policy package Government of India brought in a special act called THE MICRO SMALL AND MEDIUM ENTERPRISES DEVELOPMENT ACT, 2006 which was passed on 16th June 2006 to provide for facilitating the promotion and development and enhancing the competitiveness of micro , small and medium enterprises and for matters connected therewith or incidental thereto. The act has come in force w.e.f 2nd October 2006. With the passing of MSME development Act 2006 there has been clarity as per the definition of micro, small and medium enterprises. Under provision of act steps are also being taken to support SME sector with the View to increasing their competitiveness and also to provide legal protection with this development in the year 2006 the growth in SME sector shall be accelerated visibly in the ensuing period.

Objective of the Policy: The SME sector is growing and in the process there is opening up opportunities for Bank for lending. Therefore, Banks have been focusing to broaden their SME loan portfolio because lending to SME is profitable and divides risk of NPAs into number of small units. The policy aims to make Banks functionary at various level aware of this fact and also move aggressively to take a fair market share to build up and appropriate and sound SME portfolio. However to face competition and facilitate growth, the policy shall be constantly evolving measures to foster growth, remain competitive and also to mitigate risk involve and thus build up a quality portfolio. The policy also aims to strength arms of field functionary to acquire new account and thus increase borrower base. The policy also aims at helping operational unit/ field functionaries to build up quality credit portfolio. Nayak Committee (1991-92) Nayak Committee was set up by RBI in December 1991 to look into the aspects of adequacy of the credit that was being advanced to the SSI sector and also the time involved in processing loan applications. Nayak Committee found that the SSI sector was receiving advances only to the extent of 8.1% of their annual output, which was way below the normative requirement of 20%. Based on the recommendations of the Nayak Committee RBI advised banks to grant working capital to the extent of 20% of the projected annual turnover. RBI also issued a number of circulars advising banks to process loan applications without delay and also set up specialized bank branches to provide SSI loans in areas where there is a high concentration of SSI units.

Credit Appraisal & Rating For SME Loans

Seven Point Action Plan The Nayak Committee recommendations were incorporated in the Seven Point Action Plan that was announced by the Finance Minister in the Budget speech of 1995-1996 to enhance the flow of credit to the SSI sector. The recommendations incorporated included the following: Setting up of specialized SSI bank branches Adequate powers to be delegated to the branch and regional levels Banks to conduct sample surveys of their performing SSI accounts to find out whether Steps to be taken for sanctioning of composite loans, covering both term loans and Sensitization of bank managers towards the working of the SSI sector. Simplification of procedural formalities by banks for SSI entrepreneurs. Regular meetings to be held by the banks at both zonal and regional levels with the SSI

they were getting adequate credit. working capital, to SSI entrepreneurs as far as possible.

entrepreneurs. General Lending Methods: The following existing method of lending would be followed for working capital facilities: 1) 2) Turnover Method Modified MPBF Method

The entire fund based exposure to the SME sector upto Rs.5 crores are to be assessed in accordance with the turnover method (Nayak Committee Method) and above Rs. 5crore are to be assessed in accordance with the Modified MPBF (Maximum Permissible Bank Finance) method. Cash credit and Term loan are included in fund based. In working capital limit by way of cash credit against stock (margin-25%) and receivable (margin-50%) to be approved. Letter of credit (LC) and Bank guarantee are included in Non fund based. Procedure for Lending

Credit Appraisal & Rating For SME Loans

First step of the lending procedure is either customer approaches the Bank or the Bank approaches the customer. The discussion over different products available with the Bank and the customer requirement is done and required conditions are discussed with the customer. The Next step is the submission of required documents by the customer. The bank asks for the list of documents that has to be submitted. Then depending upon the analysis of the financial data provided by the customer the Banks sets MPBF level for the customer. If the MPBF limit or the total loan amount requirement of customer exceeds the permissible capacity of the Branch Manager such proposals are transferred to Regional Office for further analysis. The RO does the site visit of the party for inspection of collateral security and for measuring other risk factors, for SME the representative of the Bank does the rating of the SME depending on which the interest rate of the advance is decided. The RO studies the proposal and only on the recommendation of the Regional Manager the proposal is either financed or it is rejected.

Credit Appraisal Process:1. Receipt of Application from applicant. 2. Receipt of documents(Balance Sheet,Different Govt Registration No, MOA,AOA, and properties documents 3. Pre-sanction visit by Bank Officers.
4. Check for RBI defaulters list,willfull deafaulters list,CIBIL data,ECGC,Caution list,etc

5. Title clearance reports of the properties to be obtained from empanelled Advocates.

6. Valuation reports of the properties to be obtained from empanelled valuer/engineers 7. Preparation of financial data 8. Proposal preparation

9. Assessment of proposal 10. Sanction/approval of proposal by appropriate sanctioning authority 11. Documentations, agreements, mortgages

Credit Appraisal & Rating For SME Loans

12. Disbursement of Loan 13. Post sanction activities such as receiving stock statements, review of accounts, renew of accounts, etc (On regular basis)

Loan administration pre- sanction process:Appraisal, Assessment and Sanction functions A. Appraisal Preliminary appraisal

Sound credit appraisal involves analysis of the viability of operations of a business and the capacity of the promoters to run it profitably and repay the bank the dues as and when they fall. Towards this end the preliminary appraisal will examine the following aspects of a proposal. Banks lending policy and other relevant guidelines/RBI guidelines, Prudential Exposure norms, Industry Exposure restrictions, Group Exposure restrictions, Industry related risk factors, Credit risk rating, Profile of the promoters/senior management personnel of the project, List of defaulters, Acceptability of the promoters, Compliance regarding transfer of borrower accounts from one bank to another, if applicable; Government regulations/legislation impacting on the industry; e.g., ban on financing of industries producing/ consuming Ozone depleting substances;

Detailed Appraisal:-

Credit Appraisal & Rating For SME Loans

The viability of a project is examined to ascertain that the company would have the ability to service its Loan and interest obligations out of cash accruals from the business. While appraising a project or a Loan proposal, all the data/information furnished by the borrower should be counter checked and, wherever possible, inter-firm and interindustry comparisons should be made to establish their veracity.

The financial analysis carried out on the basis of the companys audited balance sheets and profit and loss accounts for the last three years should help to establish the current viability. In addition to the financials, the following aspects should also be examined: The method of depreciation followed by the company-whether the company is following straight line method or written down value method and whether the company has changed the method of depreciation in the past and, if so, the reason therefore; Whether the company has revalued any of its fixed assets any time in the past and the present status of the revaluation reserve, if any created for the purpose; Record of major defaults, if any, in repayment in the past and history of past sickness,

Apart from financial ratios, other ratios relevant to the project; Trends in sales and profitability, past deviations in sales and profit projections, and estimates/projections of sales values; Production capacity & use: past and projected; Estimated requirement of working capital finance with reference to acceptable build up of inventory/ receivables/ other current assets; Projected levels: whether acceptable; and Compliance with lending norms and other mandatory guidelines as applicable.

Project financing:If the proposal involves financing a new project, the commercial, economic and financial viability and other aspects are to be examined as indicated below: Statutory clearances from various Government Depts. / Agencies Licenses/permits/approvals/clearances/NOCs/Collaboration agreements, as applicable

Credit Appraisal & Rating For SME Loans

Details of sourcing of energy requirements, power, fuel etc. Pollution control clearance Cost of project and source of finance Build-up of fixed assets (requirement of funds for investments in fixed assets to be critically examined with regard to production factors, improvement in quality of products, economies of scale etc.) Estimates of sales, cost of production and profits covering the period of repayment Cash flows and fund flows Whether profitability is adequate to meet stipulated repayments with reference to Debt Service Coverage Ratio, Return on Investment Companys structure & systems

Applicants strength on inter-firm comparisons:For the purpose of inter-firm comparison and other information, where necessary, source data from Stock Exchange Directory, financial journals/ publications, professional entities like CRIS-INFAC, CMIE, etc. with emphasis on following aspects: Market share of the units under comparison Unique features Profitability factors Financing pattern of the business Inventory/Receivable levels Capacity utilization Production efficiency and costs Bank borrowings patterns Financial ratios & other relevant ratios Capital Market Perceptions

Credit Appraisal & Rating For SME Loans

Current price 52week high and low of the share price P/E ratio or P/E Multiple Yield (%)- half yearly and yearly

Also examine and comment on the status of approvals from other Term lenders, market view (if anything adverse), and project implementation schedule. A pre-sanction inspection of the project site or the factory should be carried out in the case of existing units. To ensure a higher degree of commitment from the promoters, the portion of the equity / Loans which is proposed to be brought in by the promoters, their family members, friends and relatives will have to be brought up front. However, relaxation in this regard may be considered on a case to case basis for genuine and acceptable reasons. Under such circumstances, the promoter should furnish a definite plan indicating clearly the sources for meeting his contribution. The balance amount proposed to be raised from other sources, viz., debentures, public equity etc., should also be fully tied up.

C. Present relationship with Bank: Compile for existing customers, profile of present exposures: Credit facilities now granted Conduct of the existing account Utilization of limits - FB & NFB Occurrence of irregularities, if any Frequency of irregularity i.e., number of times and total number of days the account was irregular during the last twelve months Repayment of Term commitments Compliance with requirements regarding submission of stock statements, Financial Follow-up Reports, renewal data, etc. Stock turnover, realization of book debts Value of account with break-up of income earned

Credit Appraisal & Rating For SME Loans

Pro-rata share of non-fund and foreign exchange business Concessions extended and value thereof Compliance with other Terms and conditions

D. Credit risk rating: Draw up rating for

Working Capital and Term Finance.

E.

Compile promoters and the proposed guarantors.

Opinion

Reports:

opinion

reports

on

the

company,

partners/

F. Existing charges on assets of the unit: If a company, report on search of charges with ROC.

G. Review of the proposal:

Review of the proposal should be done covering (i) (ii) strengths and weaknesses of the exposure proposed risk factors and steps proposed to mitigate them

H. Proposal for sanction:

Prepare a draft proposal in prescribed format with required backup details and with recommendations for sanction.

J. Assistance to Assessment:
Interact with the assessor, provide additional inputs arising from the assessment, incorporate these and required modifications in the draft proposal and generate an integrated final proposal for sanction.

1. Assessment:Indicative List of Activities Involved in Assessment Function is given below:

Credit Appraisal & Rating For SME Loans

Review the draft proposal together with the back-up details/notes, and the borrowers application, financial statements and other reports/documents examined by the appraiser. Interact with the borrower and the appraiser. Carry out pre-sanction visit to the applicant company and their project/factory site. Peruse the financial analysis (Balance Sheet/ Operating Statement/ Ratio Analysis Fund Flow Statement/ Working Capital assessment/Project cost & sources/ Break Even analysis/Debt Service/Security Cover, etc.) to see if this is prima facie in order. If any deficiencies are seen, arrange with the appraiser for the analysis on the correct lines. Examine critically the following aspects of the proposed exposure.

Recommendation for sanction: Recapitulate briefly the conclusions of the appraisal and state whether the proposal is economically viable. Recount briefly the value of the companys (and the Groups) connections. State whether, all considered, the proposal is a fair banking risk. Finally, give recommendations for grant of the requisite fund-based and non-fund based credit facilities.

2. Sanction:Indicative list of activities involved in the sanction function is given below: Peruse the proposal to see if the report prima facie presents the proposal in a comprehensive manner as required. If any critical information is not provided in the proposal, remit it back to the Assessor for supply of the required data/clarifications. Examine critically the following aspects of the proposed exposure in the light of corresponding instructions in force: Banks lending policy and other relevant guidelines RBI guidelines Borrowers status in the industry Industry prospects

Credit Appraisal & Rating For SME Loans

Experience of the Bank with other units in similar industry Overall strength of the borrower

Loan administration - Post sanction Credit process:Need

Lending decisions are made on sound appraisal and assessment of credit worthiness. Past record of satisfactory performance and integrity are no guarantee for future though they serve as a useful guide to project the trend in performance. Credit assessment is made based on promises and projections. A loan granted on the basis of sound appraisal may go bad because the borrower did not carry out his promises regarding performance. It is for this reason that proper follow up and supervision is essential. A banker cannot take solace in sufficiency of security for his loans. He has to Make a proper selection of borrower Ensure compliance with terms and conditions Monitor performance to check continued viability of operations Ensure end use of funds. Ultimately ensure safety of funds lent.

Stages of post sanction process

The post-sanction credit process can be broadly classified into three stages viz., follow-up, supervision and monitoring, which together facilitate efficient and effective credit management and maintaining high level of standard assets. The objectives of the three stages of post sanction process are detailed below. FOLLOW UP Ensuring Compliance with terms and conditions of sanction on an ongoing basis. Ensuring performance safety & recoverability of assets SUPERVISION Ensuring effective follow up to maintain asset quality Keeping look-out for early warning signals.

Credit Appraisal & Rating For SME Loans

MONITORING Ensuring effective supervision. Monitor customer satisfaction. Ensuring quick response to early warning signals.

Credit Rating System

Credit rating estimates credit worthiness of an industry. It is done by bank for internal evaluation and to analysis the probability of the SME, to pay back the loan. Credit ratings are calculated from financial history, market risk, management risk, current asset and current liabilities. A poor credit rating indicates high risk of defaulting on a loan and thus leads to high interest rates or refusal of a loan by the banks. The Rating is done by the banks representative only by visiting the site and analyzing different aspects related to the rating. The representative give marks on the basis of satisfying condition and requirement in line with bank policy and guideline. Then the total score is calculated and the SME is rated according to the total percentage of the marks scored in overall observation. Depending on the rating the bank decides the rate of interest to be paid for different credit proposals.

Loan Proposal Summary:S.P.Chemi equip is a limited company established on 5th February 2007. The registered office of the company is located at plot no A-20, MIDC, Anand nagar, Ambernath (east). The company is manufacturer of chemical equipments, vessels & heat exchangers in ferrous and non ferrous material. The firm has expertise in designing / fabrication and erecting of various equipments i.e. tanks, vessels, heat, exchangers and structures in various material such as stainless steel, carbon steels nickel , inconnel etc. apart from repairing of old tanks ,vessels and heat exchangers . They had a wide variety of manufacturing products ranging from
1. Reactors ss : 316/ss : 304/nickel/carbon steel 2. Vessel - ss:316/ss : : 304/nickel/carbon steel 3. Tanks - - ss:316/ss : : 304/nickel/carbon steel 4. Heat exchangers - ss:316/ss : : 304/nickel/carbon steel

Credit Appraisal & Rating For SME Loans 5. Chimney carbon steel 6. Structures carbon steel

The borrower has been banking with us since 2007 and has been regular in transactions with us without any defaults. The proposal was received on 21st April 2012 from AIROLI Branch. The customer
demanded for fresh cash credit facility limit of rs 42.00 lacs cum fresh bank guarantee limit of rs 20.00 lacs. But after the analysis of audited balance sheet we found that customer was eligible for Rs 36.92lacs only, on the basis of turnover method. The proposed limit of Rs.lacs is secured by collateral security worth of Rs320 lacs which covers the sanctioned limit by more than 200% and also on the basis of financial analysis it is considered as satisfactory.

The credit rating was carried out by visiting the unit and the unit has scored 44.16 marks with rating at BB grade and applicable rate of interest at BR+2.40(SME) =13.10% (BR @ 10.70%) as applicable for SME units.

Financial Analysis:Audited 31.03.2009

Net sales Gross Profit Net Profit Current Ratio Total Debt/Equity Interest Coverage Ratio Current Asset Turnover Net Working Capital

Estimated 31.03.2010 68.35 8.56 5.28 0.87 5.68 781.00 1.34 (8.22)

Actuals Estimated (provisional) 31.03.2011 132.78 12.06 8.06 1.05 3.97 1115.00 2.98 3.62 31.03.201 2 135.49 10.36 7.17 1.33 1.62 948.00 3.61 12.40

Projected 31.03.2013 196.46 7.55 5.52 1.14 2.35 2.15 3.19 9.23

21.09 1.64 1.64 0.80 6.58 42.00 0.86 (6.42)

Sales Turnover:The turnover has picked up from 21.70lacs as of 31.03.2009 to Rs 68.37lacs as of 31.3.2010 and for the year ending on 31.03.2011,the Sales turnover further increased sharply to Rs 140.76lacs.The Party has estimated a turnover of Rs 144.58lacs and 209.64 lacs for the year

Credit Appraisal & Rating For SME Loans

ended on 31.03.2012 and 31.03.2013 respectively.The firm has informed that they have made sales of Rs 88.64lacs and received labour charges of Rs 28.82lacs during the period from April 2011 to February 2012. The Party has informed that Order at Srl no 1 and 4 is partly completed. The Proprietor is confident to execute the above orders,but due to shortage of working capital they are unable to bid for more orders.They have all the required infrastructure/machineries etc to execute and complete the projects in time. The above orders will be executed during the upcoming years and the promoter has required infrastructure for carrying out the said orders and accordingly projected for the year ending 31.03.2013 is condered as acheiveable and accepted for assessment.

Profits:The net Profit has increased from Rs 1.64 lacs for the year ended 31.03.2009 to Rs 5.28lacs as of 31.03.2010 an increase of almost 300% which is on account of corresponding increase in operating efficiency.Similarily there is further increase in profit to Rs 8.06lacs during the year 2010-2011.However the firm is projecting the Net Profit at rs 7.!7 lacs for the year 2012. The company has projected the profits in line with the above points for the coming years,and seems to be acheiveable.

Capital/Net Worth/Total Debt Equity Ratio:The Capital of the company is in increasing trend due to retention of retained earning.TDER of 2009 was 6.58 which improved to 3.97 due to retention of profit in 2010-11.

Adjusted Current Ratio:The Current ratio of year ending on 31.03.2009 and 31.03.2010 was 0.80 and 0.87 respectively which improved to 1.05 as of 31.03.2011.This is due to high trade credit creditor.But the same is estimated to improve a satisfactory level of 1.33 as of 31.3.2012.By retaining the profit in the business the current ratio will improve to accepted level. Similarily for the year ending 31.3.2013 the current ratio is projected at 1.14 on account retention of profits in the business. The estimated/projected level of current ratio for 31.3.2012 & 31,3,2013 can be considered as satisfactory except for the year ending 31.3.2009 and 31.03.2010 which is on account of high creditor and fixed asset.

Interest Coverage Ratio(ICR):This ratio for the past two years and estimated/projected for the current year ending 31.3.2012 & 31.3.2013 is above the minium requirement of 1.50 as per Credit Policy guidelines and hence considered as satisfactory and acceptable.

Current Asset turnover ratio:This ratio for the year ending 31.3.2012 and estimated for 31.3.2013 as well as last two years is above the bench mark level of 1.75 and is expected to improve further in view of the increase in volume of operations which can be considered satisfactory.

Credit Appraisal & Rating For SME Loans

The overall performance of the firm is expected to improve during the current year ending 31.3.2013 and they have orders on hand/expected orders which are to be executed during 201213.This will improve the profitability and other financial parameters to fall in line with the policy guidelines. RISK ASSESSMENT:Industry/ Activity risks:As the Company is in the Business of manufacturer of equipment, demand depends more on various companies. any recession may affect the business of the company. Risk mitigation factors The firm has received huge orders from various companies for supply of equipments and their performance for 2011 also indicates increased demand for their product, The party does not envisage any problem in getting orders. Borrowers/ Business risk As business of units requires working capital in the form of fund based limit and guarantee limits failing which the execution of orders may get affected. Risk mitigation factors The party has requested fresh fund based limits are also proposed which will take care of working capital limits aand smooth execution of the orders apart from bank guarantee. Security Risk The firm takes orders from private companies, payments from whom may get delayed depending on the cash flow of that company. Risk mitigation factors Contracts are carried out on behalf of reputed multinational companies and other limited companies and there is no default in the past. Further, limits are secured by Collateral Securities to the extent of 100 % which is above the minimum required level of 10 to 20 %

STIUPLATIONS: The sanctioned limits to be released subject to compliance of the following:

Credit Appraisal & Rating For SME Loans

a) Creation of our charge on the collateral securities existing as well as proposed after ensuring that search Report, Title Clearance report and non encurbance certificate is obtained and verified for clear and marketable title b) An Undertaking to be obtained from the borrower that they to comly stipulations made in Pollution Controlling Authority. c) 50%of the Proposed Working Capital Limit i.e.Rs 21.00lacs to be released and the balance 50% to be released only after submission of Audited Balance Sheet as of 31.03.2012. d) The firm to raise an amount of Rs 3lacs during the year 2012-13 to have matching contribution in the business for the limits of Rs 42lacs.An undertaking to be obtained in this regard before release of limit.

NOTE:-DETAILED APPRAISAL PROCESS AND PROCEDURE OF THIS LOAN SABCTION IS ATTACHED AT THE END OF THE PROJECT.

Credit Appraisal & Rating For SME Loans

METHODOLOGY:For this project i.e. corporate credit analysis, the methodology used is stated below: The banks internal document (Business Credit Application), the companys individual balance sheet, equity research reports and certain websites to be referred. Study of the companys background including its key area of operation as well as the industry it is engaged in, gave me a better understanding of the companys position as well as affecting the company. Analyzing the financial performance of the company i.e. its growth/decline in a better way. The risks involved in the company and certain covenants to be tracked on a timely basis. Further assessment required computing the economic revenue that the bank would earn dealing with the client and the loss of that the bank could suffer in case the company defaults.

LIMITATION OF THE STUDY: As the credit appraisal is one of the crucial areas for any bank, some of the technicalities are not revealed. Credit appraisal system includes various types of detail studies for different areas of analysis, but due to time constraint, our analysis was of limited areas only.

Credit Appraisal & Rating For SME Loans

FINDINGS & ANALYSIS: Credit appraisal is done to check the commercial, financial & technical viability of the project proposed its funding pattern & further checks the primary or collateral security cover available for the recovery of such funds. Credit is the core activity of the banks & important source of their earnings which go to pay interest to depositors, salaries to employees & dividend to shareholders. . Credit & risk go hand in hand. In the business world risk arises out of: Deficiencies / lapses on the part of the management Uncertainties in the business environment Uncertainties in the industrial environment Weakness in the financial position

Banks main function is to lend funds/ provide finance but it appears that norms are taken as guidelines not as a decision making. .A bankers task is to indentify/assess the risk factors/parameters & manage/mitigate them on continuous basis. .The Credit Appraisal process adopted by the bank take into account all possible factors which go into appraising the risk associated with a loan. These have been categorized broadly into financial, business, industrial, management risks & are rated separately. The assessment of financial risk involves appraisal of the financial strength of the borrower based on performance & financial indicators. The norms of the bank for providing loans are not stringent, i.e. even if a particular client is not having the favorable estimated and financial performance, based on its past record and future growth perspective, the loan is provided.

Credit Appraisal & Rating For SME Loans

CONCLUSION:Finance management is the backbone of any organizations and hence Yields a number of job options ranging from strategic financial planning to sales. From the study of Credit appraisal of SME, it can be concluded that credit appraisal should therefore be based on the following factors, Financial performance Business performance Industry outlook Quality of management Conduct of account Dena Bank loan policy contains various norms for sanction of different types of loans. These all norms do not apply to each & every case. Dena Bank norms for providing loans are flexible & it may differ from case to case. Usually, it is seen that credit appraisal is basically done on the basis of fundamental soundness. But, after different types of case studies, our conclusion was such that credit appraisal system is not only looking for financial wealth. Other strong parameters also play an important role in analyzing credit worthiness of the firm/company. In all, the viability of the project from every aspect is analyzed, as well as type of business, industry, promoters, past records, experience, projected data and estimates, goals, long term plans also plays crucial role in increasing chances of getting project approved for loan.

BIBLIOGRAPHY:www.rbi.org.in (RBI website)

www.denabank.com (Axis bank website) www.wikipedia.com Books:-

Credit Appraisal & Rating For SME Loans

ANNEXURE:Format for calculating A. Turnover Method B. Modified MPBF method: A. Turnover method:

Projected Accepted Turnover Working Capital (25% of PTA)

xxx xxx -------------- (a)

Margin Higher of: i) ii) 20% of working capital Actual working capital xxx xxx xxx -------------- (b)

MPBF(a-b)

xxx

B.

Modified MPBF method:

Total Current Asset (less) Other Current Liabilities Working Capital Gap

xxx xxx xxx -------------- (a)

Margin Higher of: iii) 25% of working capital xxx

Credit Appraisal & Rating For SME Loans

iv)

Actual working capital

xxx

xxx

-------------- (b)

MPBF (a-b)

xxx

Ratios: Current Ratio:- Current Assets/Current Liabilities Debt-Equity Ratio:-Total Outlay/Total Net Worth Current Assets Turnover Ratio:-Net Sales/Current Assets Interest Coverage Ratio:-EBIT/Interest

Credit Appraisal & Rating For SME Loans